On February 7, 2018, the Department of Finance released a consultation paper (Paper) reviewing Canada’s anti-money laundering and anti-terrorist financing regime (AML/ATF).
The Paper is intended to support parliament’s upcoming prescribed five-year review of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) and sets out policy considerations that call for amendments to the current AML/ATF regime. The more significant of these measures call for expanding the scope of the PCMLTFA to include new financial service providers, expanding the scope of current provisions dealing with politically exposed persons (PEPs), the potential of information sharing in respect of money laundering and terrorist financing by government agencies with the private sector and modernizing the AML/ATF regulatory framework. As discussed below, some of the changes proposed to the legislative regime are quite significant and affected persons are encouraged to provide comments on the Paper to the Department of Finance. Comments are due by April 30, 2018.
The most significant proposals set out in the Paper are the following:
1. Legislative and Regulatory Gaps
A. New Entities to be Subject to the Regime
The Paper proposes that the scope of the PCMLTFA framework be expanded to include other high-risk businesses that are not included under the current regime. The proposed new businesses and sectors to be covered by the expanded scope of the PCMLTFA include the following:
a. Privately Owned Automated Teller Machines. The Paper contemplates including white-label ATMs in the anti-money laundering regime, consistent with the requirements already in place in Quebec. The policy reasoning is that white-label ATM operators should be subject to the same regulatory standards as financial institutions that provide ATM service. The Paper is silent as to whether this provision is intended to affect operators of Bitcoin or other digital currency ATMs. It is also noteworthy, that unlike financial institutions that know who their debit and credit cardholders are, white-label ATM owners will not have this type of client information. As such, it will be interesting to see how these operators are regulated.
b. Pari-Mutuel Betting and Horse Racing. The Paper contemplates that similar to casinos, pari-mutuel betting and horse racing can be used to launder funds and thus should be similarly regulated.
c. The Real Estate Sector. While certain participants in the real estate sector are already subject to the PCMLTFA, other participants such as mortgage insurers, land registries and title insurance companies are not. The Paper notes that these types of entities are well positioned to gather information related to money laundering and terrorist financing and thus should be included within its scope. The Paper also contemplates including non-federally regulated mortgage lenders within the scope of the AML regime. In discussing what would be included within the category of a “non-federally regulated mortgage lender”, the Paper refers to mortgage finance companies, real estate investment trusts (REITs), mortgage investment corporations, mutual funds trust, syndicated mortgage lenders and individual private lenders. This is a significant expansion from the current regime and would have significant consequences for many of those involved in the real estate sector. The regulation of this sector also gives rise to many complex issues. By way of example, if the regime is expanded to include REITs, will there be an exemption to the application of certain provisions for large publically traded REITs? All of these issues will need to be addressed in implementing these significant changes to the AML regime.
d. Designated Non-Financial Businesses and Professions. While accountants and other non- financial businesses and professions are currently subject to the PCMLTFA in respect of their financial activities, the Paper considers expanding the scope of activities to be covered by the PCMLTFA to non-financial transactions including creating, operating or managing legal persons or arrangements and managing client funds, securities or other assets.
e. Company Service Providers. The Paper contemplates that the PCMLTFA be expanded to apply to businesses and companies that provide services related to the formation and administration of companies, including acting as a director or nominee of a company, managing financial affairs and preparing annual corporate and tax filings.
f. Finance, Lease and Factoring Companies. In another significant development, the Paper contemplates that Canada’s financing, leasing and factoring sector become covered by the PCMLTFA. Currently, these activities are subject to the AML legislative regime only if they are provided by a regulated entity.
g. Armoured Cars. While armoured cars are not currently subject to the PCMLTFA, from examining Financial Transactions and Reports Analysis Centre of Canada’s (FINTRAC) policy interpretations, it is clear that they inevitably have some involvement with PCMLTFA regulated entities whose cash they transport. The Paper notes that the lack of regulation of this industry in Canada creates an environment that enables and facilitates the anonymous movement of bulk cash and thus recommends that it be included within its scope.
h. High-Value Goods Dealers. Because of the opportunities that luxury goods provide to launder proceeds of crime, the Paper recommends that high-value goods dealers become subject to the AML regime. Examples of high-value goods that are outlined in the Paper include luxury goods, cars, boats, yachts, arts and antiquities.
i. Jewellery Auction Houses. Although dealers in precious metals and stones are subject to the PCMLTFA, jewellery auction houses are not. The Paper notes that bringing the actions of jewellery auction houses into the PCMLTFA will create a level playing field in the precious metals sector.
B. The Struggles with Beneficial Ownership
Thankfully, the Paper acknowledges the challenges faced by regulated entities in confirming beneficial ownership information. As those that are currently subject to the PCMLTFA can attest to, the beneficial ownership requirements in the PCMLTFA are particularly onerous in that they require regulated entities that are subject to the beneficial ownership requirements to “take reasonable measures to confirm the accuracy of” beneficial ownership information collected from privately owned entities. The problem with this requirement rests in the fact that where a company is a private company, confirmation of beneficial ownership can in the majority of circumstances, realistically only come from the company itself, which FINTRAC has indicted is only acceptable as a last resort (and even then, you may need to rate such clients as high risk). The good news is that the Paper recognizes the difficulty that this requirement imposes on regulated entities given that Canada does not have a central registry of beneficial ownership information. In that regard, the Department of Finance is seeking views on how to improve timely access to beneficial ownership information by authorities including different beneficial ownership registry models. Implementing a registry system for beneficial ownership would ease the regulatory burden currently imposed on regulated entities to make that determination and would be a welcome change.
C. Clarifications/Enhancements to the Existing PCMLTFA
In addition to recommending new categories of participants to be covered by the PCMLTFA, the Paper proposes some fairly significant amendments to clarify and/or enhance existing regulatory provisions of the PCMLTFA. These proposals include the following:
- Politically Exposed Persons/Beneficial Ownership. The Paper notes that currently only financial entities, securities dealers, money services businesses and life insurance companies are required to make PEP determinations and collect and confirm beneficial ownership information, while other regulated reporting entities do not have such obligations. As such, it is contemplated that these requirements be extended to other regulated sectors.
- Definition of Head of an International Organization (HIO). The Paper notes that corruption and bribery scandals affect organizations that are not considered HIOs under the PCMLTFA as they are not established by governments of states. It is noted that these types of organizations (e.g., the International Olympic Committee, the Union of European Football Associations) have considerable political influence in society and on the global economy and that they control significant resources. As such, the Paper contemplates adding such organizations into the definition of HIOs under the PCMLTFA.
- PEP Determination of Beneficial Owners. The Paper contemplates extending the application of the PEP requirement so that regulated entities will be required to make a PEP or HIO determination in respect of the beneficial owners of entity clients. Currently, the requirement to make a PEP/HIO determination only applies to accounts opened for individuals. If this recommendation is implemented, it will significantly expand the scope of due diligence that a regulated entity is subject to and create additional challenges for regulated entities in the context of making beneficial ownership determinations. It is hoped that in drafting any requirements relating to PEP/HIO determinations for beneficial owners, the Department of Finance will take into account that regulated entities do not necessarily have direct relationships with the beneficial owners of corporations or other entities.
- Structuring. “Structuring” in the anti-money laundering context involves the breaking of a large transaction into numerous smaller ones in order to avoid financial transaction reporting. Currently, structuring is not prohibited in Canada although it is in many other jurisdictions. As such, the Paper contemplates amending the PCMLTFA to include a prohibition on the “structuring” of transactions in two different ways. Firstly, the Paper contemplates making it a criminal offence for a person or entity to structure transactions to avoid reporting. Secondly, and more importantly to regulated entities, the Paper contemplates having a prohibition against reporting entities structuring their business models and delivery channels so that transactions can be structured by clients to avoid reporting requirements. This latter prohibition would appear to require regulated entities to configure their systems so that clients are in fact prohibited from being able to structure transactions, which on its face would appear to be a very onerous task.
D. Information Sharing
The Paper notes the importance of the sharing of information between public and private sectors in the context of combatting money laundering and terrorist financing (ML/TF). In addition to discussing the sharing of information among different government agencies, the Paper recognizes that other countries share information both within the government and with the private sector. In that regard, the Paper contemplates the government sharing information with the private sector with respect to ML/TF methods, trends and financial transactions. Such information sharing would be invaluable to regulated entities and this concept has been in the discussion phases for some time. Providing a legal mechanism for the sharing of this information with the private sector will allow regulated entities to use this valuable data in their transaction monitoring to identify suspicious activity that may not be readily apparent.
E. New Changes to the PCMLTFA
In addition to enhancing or refining certain provisions of the PCMLTFA as noted above, the Paper also contemplates some net new measures. The following are the most material:
- Electronic Funds Transfers (EFTs). While certain regulated entities are required to report client initiated cross-border incoming and outgoing EFTs, the Paper proposes that in addition to these EFTs, EFTs that pass through a Canadian financial institution (where Canada is not the sending or receiving destination) should similarly be reported.
- Bulk Cash. The Paper considers placing limits on the amount of bulk cash that a person could carry in Canada without a legitimate purpose and also considers whether there should be a business registry for those businesses that deal in high volumes of cash. The Paper also considers whether cash control procedures should be legislated more broadly by placing limits/requiring reporting on large cash transactions.
- Geographic Targeting Orders. Geographic targeting orders are currently used in the United States to target high-end residential real estate transactions that are paid for in all cash in six major metropolitan areas. The targeting rules require title insurers to report all cash transactions for luxury homes over a certain dollar threshold in these specified geographic areas. The Paper raises the possibility of revising the PCMLTFA to provide the Canadian government with the ability to issue geographic targeting orders similar to those used in the U.S., another measure in the Paper that appears in part, to be targeted towards the real estate sector.
F. Modernizing the Anti-Money Laundering Framework
The Paper also addresses some important measures to be considered in the modernization of the AML/ATF framework and its supervision. What follows are some of the material matters discussed:
a. Money Services Businesses. In a positive development for those involved in money services business (MSBs), the Paper acknowledges that some money services businesses have had difficulty in maintaining bank accounts with financial institutions as a result of the global de-risking trend and the identified vulnerability of the MSB sector to ML and TF. The Paper notes that reporting entities are expected to manage (but not necessarily eliminate) their exposure to MSBs by taking a risk-based approach with respect to their clients. The Paper does not provide any express recommendations regarding de-risking but the fact that the Department of Finance considers it in the Paper raises the possibility of the Department of Finance taking some type of positive action towards implementing this policy. In that regard, it is notable that the Financial Action Task Force, the Office of the Comptroller of the Currency and other similar regulatory bodies have issued guidance reminding regulated entities that not all MSBs are considered high risk. In that regard, there is a stated regulatory expectation that financial institutions use a risk-based approach to each customer on a case-by-case basis; blanket termination of entire categories of customer accounts is discouraged and is seen as contrary to the principles of a risk-based approach. In keeping with the foregoing, the EU in the revised Payment Services Directive, requires payment service providers to have access to banks’ payment account services. It remains to be seen what further steps, if any, the Department of Finance will take in this regard. This is an area where affected parties should consider providing feedback to the Department of Finance.
The Paper also addresses the MSB registration system. In that regard, the Paper notes that the registration and application procedures could be improved to safeguard the integrity of the system. The Paper proposes that the registration regime be tightened to expand the list of offences that would make an applicant ineligible for registration. Moreover, the Paper speaks to providing FINTRAC with the ability to suspend the registration of an MSB on a discretionary basis, where owners or operators are subject to criminal court proceedings.
b. Border Enforcement. The Paper discusses Part 2 of the PCMLTFA and the requirement to report the importation and exportation of monetary instruments or cash of C$10,000 or more. Of note, the Paper proposes to expand the definition of reportable monetary instruments to include “pre-paid products”. The expansion of the definition of monetary instruments to include pre-paid products was previously proposed in the United States and was met with such significant industry pushback that it was withdrawn (although a new law has since been introduced). It is noteworthy that the concept of including pre-paid products in the definition of monetary instruments was also raised in December 2011 in a consultation paper published by the Department of Finance on strengthening Canada’s AML and ATF regime. It will be interesting to see the Canadian response to this provision.
c. Enhancing and Strengthening Identification Methods. The Paper acknowledges that the PCMLTFA places reliance (some would say undue reliance) on reviewing physical identification documents in person on a face-to-face basis. It also acknowledges that although the permitted identity verification methods have been recently expanded, they need to be more principles-based to allow regulated entities to use a risk-based approach in their adoption of new technologies. As such, the Paper calls for strengthening current identification methods, exploring new identification methods and leveraging new technologies to facilitate and enhance the effectiveness of customer due diligence. This is a very welcome position from the Department of Finance given their past rigid adherence to prescriptive identity verification requirements and is consistent with the Competition Bureau’s findings in its recent publication, Technology-led innovation in the Canadian financial services sector (Fintech Paper), where they indicate that regulations should be principles-based to encourage more innovation in the marketplace and to allow for the flexibility in interpretation as technology changes. For further information, please see our December 2017 Blakes Bulletin: Competition Bureau Releases Final Fintech Market Study.
This is one of the more promising developments in the Paper and regulated entities should strongly consider making submissions to address these suggestions so that the PCMLTFA can be modernized to allow regulated entities to leverage the innovative fintech solutions for identity verification that exist in the marketplace.
d. Regulatory Sandbox. In modernizing the AML framework in a manner that aligns with the promotion of innovation in the Canadian financial services sector, the Paper proposes the use of regulatory sandboxes by fintechs in the AML space, a new concept in AML regulation in Canada. In that regard, the Paper proposes allowing fintechs time-limited exemptive relief in order to test products and services in a live environment with more flexible approaches to complying with the requirements of the PCMLTFA. The concept of a regulatory sandbox in respect of AML requirements is in keeping with the recommendations of the Competition Bureau in in the Fintech Paper where it promotes the use of regulatory sandboxes to encourage collaboration throughout the financial services sector. An AML regulatory sandbox would certainly be a positive step in this direction.
G. Administrative Monetary Penalties
The Paper also addresses some aspects of the enforcement regime of the PCMLTFA that are worth noting.
- Public Naming. There has been a lot of controversy surrounding FINTRAC’s practices in respect of publically naming financial institutions that have committed breaches of the PCMLTFA. In that regard, FINTRAC notes that because an entity cannot be publically named until all proceedings have ended, there is an incentive to engage in protracted litigation, thereby diluting the deterrent effect of naming a regulated entity. In keeping with the foregoing, the Paper recommends that in exercising a discretionary power to publically name a person or entity, consideration should be given to criteria or situations where it is not appropriate to name a regulated entity, for example, where doing so may affect the stability of Canada’s financial system, a veiled reference to Canada’s domestic systemically important banks.
- Confidentiality in Court Proceedings. In a significant departure from the current enforcement regime under the PCMLTFA, the Paper seems to recommend that where a regulated entity is challenging a FINTRAC notice of violation in a court proceeding, the ability of that regulated entity to obtain a sealed confidentiality order in respect of those court proceeding should be eliminated. This is troubling from many perspectives, especially given the real reputational risk that an institution faces when these types of allegations are made public without the benefit of due process. This also seems to be in conflict with the Department of Finance’s stance on public naming as noted above. The effect of any changes made to the PCMLTFA along these lines is intended to deter regulated entities from bringing actions against FINTRAC to challenge any of their findings, as those challenges, and thus the allegations could be made public. Regulated entities should consider the ramifications of these proposed changes to the enforcement regime in making their submissions.
- Penalty Calculation. The Paper notes that FINTRAC has in the past been criticized for the lack of transparency in the formula it uses to calculate monetary penalties. In that regard, the Paper recommends including a formula for the calculation of monetary penalties in the regulations to increase transparency and provide more clarity to the process.
H. Other Administrative Changes to the Legislation
The Paper outlines some technical amendments recommended to the PCMLTFA to improve the administration and operation of the PCMLTFA and to improve clarity. The following are some of the more significant recommendations:
- The Travel Rule. The Paper recommends refining the “travel rule” (the requirement to ensure that each EFT includes originator information) to clarify that financial intermediaries must also pass along the originating client’s information. In other words, for the purposes of the travel rule, financial intermediaries are required to obtain information on the actual originating client who requested the ETF and not treat the originating financial institution as the client.
- Correspondent Banking. The Paper notes that while the PCMLTFA addresses correspondent banking, it only does so in the context of onboarding a correspondent bank. As such, the Paper recommends that the correspondent banking provisions of the PCMLTFA be enhanced to come in line with international standards. In that regard, the Paper recommends that the PCMLTFA provide an express requirement for financial entities to evaluate correspondent banking relationships on an ongoing basis similar to the requirement to monitor business relationships on an ongoing basis. In addition, the Paper proposes that correspondent institutions should take reasonable measures to verify the identity of beneficial owners when entering into a business relationship with a respondent institution, yet another beneficial ownership measure set out in the Paper.
- Reporting Schedules. The Paper recognizes that the numerous reporting schedules in the PCMLTFA are all different and result in burdensome processes for regulated entities. As such, the Paper proposes the streamlining of schedules to create one uniform reporting schedule for all prescribed reports. Although there will be technical system changes that will be required as a result of these changes, ultimately, this should be a helpful change to those regulated entities that are subject to numerous reporting requirements.
- Repeal of Exception to Large Cash Reporting. The PCMLTFA currently provides an exception for the requirement to report large cash transactions in specific circumstances (e.g., for clients that are in retail and transportation). The Paper notes that this exception (which comes with other attendant requirements) is not used often and as such, recommends the repeal of the exception.
Given the broad scope of changes contemplated to the AML regime, those that may be affected by the changes proposed in the Paper should consider making submissions to the Department of Finance prior to the April 30, 2018 deadline.