AML Regulations and Compliance Practices

Chapter 6
Anti-Money Laundering and
Counter-Terrorist Financing
The Presentation Slides for Teaching
Financial Regulations and Compliance Practices
Website : https://sites.google.com/site/quanrisk
E-mail : quanrisk@gmail.com
Copyright © 2016 CapitaLogic Limited

Declaration
Copyright © 2016 CapitaLogic Limited.
All rights reserved. No part of this presentation file may be
reproduced, in any form or by any means, without written
permission from CapitaLogic Limited.
Authored by Dr. LAM Yat-fai (林日辉林日辉林日辉林日辉),
Principal, Structured Products Analytics, CapitaLogic Limited,
Adjunct Professor of Finance, City University of Hong Kong,
Doctor of Business Administration,
CFA, CAIA, CAMS, FRM, PRM.
Copyright © 2016 CapitaLogic Limited 2

The statutory framework
The regulatory framework
Customer due diligence
Sanction filtering
Outline

Money laundering

Money laundering in early 1900

Dirty monies
The funds produced
in a country by criminal activities in that country
outside a country by activities deemed to be
criminal had the activities been performed in that
country
Country specific
Clean monies in country A could be dirty monies
in country B

Money laundering (ML)
An activity with an intention to make dirty monies
appear to be produced by regular activities
To hide the history of dirty monies
History of monies is unobservable
Only the connected parties of the monies are observable
To hide the criminals connected to the monies which
could be either dirty or clean

Three major approaches
of money laundering
Through financial system
Dirty monies → Financial institutions → Clean monies
The most common, effective and efficient method
Physical movement of dirty monies
Dirty monies in one country → Cash courier
→ Clean monies in another country
Trade based money laundering
Dirty monies in one country → Goods in one country
→ Physical shipment → Goods in another country
→ Clean monies in another country

Three stages of money laundering
through financial system

Three stages of money laundering
through financial system
Placement
The deposits of dirty monies into the financial system
Layering
Many financial transactions to hide the source of dirty
monies
Integration
Laundered monies back to the regular economy
With the impression that the laundered monies are
produced by regular activities

Terrorist
Use violent and destructive approach
Target regular citizens
To achieve a political mission
Freedom fighter
A successful terrorist
Israel was a terrorist group before 1949

Terrorist financing (TF)
To manage the financial assets of a terrorist
Portfolio management
To provide funds to a terrorist
Loans
To provide financial services to a terrorist
Currency exchange
To solicit businesses of providing financial
services to a terrorist
Marketing
Funds intended to be used for terrorist activities

Relationship between ML and TF
An activity with an intention to make funds related to
terrorist activities appear to be used for regular activities
To hide the future use of funds related to terrorist activities
Future use of funds is unobservable
Only the connected parties of the funds are observable
To hide the terrorists who actually connected to the
funds which could be used for either terrorist activities
or regular activities

Board definition of money laundering and
anti-money laundering
Board definition of money laundering (ML)
Money laundering
Terrorist financing
Anti-money laundering (AML)
The initiatives to comply with the statutory and/or
regulatory requirements against money laundering in
nominal terms
The effectiveness of these initiatives is IRRELEVANT

General ordinances
in relation to ML and TF
CAP 405 Drug Trafficking (Recovery of
Proceeds) Ordinance (DTROP)
CAP 455 Organized and Serious Crimes
Ordinance (OSCO)
CAP 537 United Nations Sanctions Ordinance
(UNSO)
CAP 575 United Nations (Anti-Terrorism
Measures) Ordinance (UNTMMO)

Sanction filtering
Outline

CAP 615 Anti-Money Laundering and Counter-Terrorist
Financing (Financial Institutions) Ordinance
To provide for the imposition of requirements relating
to customer due diligence and record keeping on
specified financial institutions
To provide for the powers of the relevant authorities to
supervise compliance with the requirements and this
ordinance
To establish a review tribunal to review certain
decisions made by the relevant authorities under this
ordinance
To provide for the regulation of the operation of a
money service and the licensing of money service
operators

AMLO
Part Topic
1 Preliminary
2
Requirements relating to customer due diligence
and record keeping
3 Supervision and investigations
4 Disciplinary actions by relevant authorities
5 Regulation of operation of money service

Money laundering (洗錢)
An act intended to have the effect of making any
property
that is the proceeds obtained from the commission of
an indictable offence under the laws of Hong Kong; or
of any conduct which if it had occurred in Hong Kong
would constitute an indictable offence under the laws
of Hong Kong; or
that in whole or in part, directly or indirectly,
represents such proceeds, not to appear to be or so
represent such proceeds

Terrorist financing
(恐怖分子籌集資金)
The provision or collection, by any means, directly or indirectly, of
any property in whole or in part, to commit one or more terrorist
acts (whether or not the property is actually so used)
with the intention that the property be used
knowing that the property will be used
The making available of any property or financial (or related)
services, by any means, directly or indirectly, to or for the benefit of
a person knowing that, or being reckless as to whether, the person is
a terrorist or terrorist associate
The collection of property or solicitation of financial (or related)
services, by any means, directly or indirectly, for the benefit of a
person knowing that, or being reckless as to whether, the person is a
terrorist or terrorist associate

and record keeping
Customer due diligence (CDD)
Customer identification
Customer verification
Record keeping
Evidence of CDD
Transaction history
Maximum penalty
A fine of HKD 1 mn; and
Imprisonment of 7 years

AML regulators
FSTB
HKMA SFC IAHK C&ED
Banks and
deposit-taking
companies
Licensed
corporations
Authorized insurers
and
intermediaries
Remittance agents
and
money changers

Money service operations
Money service operators
Remittance agents
Money changers
Regulated by Customs & Excise Department
effective 1 April 2012
Licensed by Narcotics Bureau before 1 April
2012

Coverage in this lecture
This course will mainly cover the regulatory
AML framework for
Banking industry
Securities and futures industry
Insurance industry

A model AML regulatory framework
Ordinance
Specialist
regulator
Policy Supervision Investigation
Advisory
committees
Discipline
Industry
associations

HKMA’s AML Department

SFC’s enforcement Division
General team
Corporate fraud
Corporate misfeasance
Insider dealing and market manipulation
Intermediary misconduct team
Specialist team
Anti-money laundering
Growth enterprise market
Sponsor
Specific products

Investigation
Collect evidences
Interview witnesses
Seek expert opinions
Express in official reports facts found

Discipline
Warning
Order to improve the AML compliance programme
Order to change FI management
Suspension of licence
Maximum fine per investigation case
HKD 10 mn
ML/TF profit × 3
Criminal litigation

Hong Kong fines SBI
for anti-money laundering lapses

AML and CTF (FI) Review Tribunal
To review
Disciplinary decisions made by the AML
regulators under the AMLO against FIs
Licensing decisions made by the C&ED in respect
of money service operators
On civil litigation basis
Balance of probability approach

Components of ML/TF activities
Customer
CounterpartyAmount × Frequency
Copyright © 2016 CapitaLogic Limited
Transaction

Major AML regulatory components
AML
regulations
Know your
customer
Regular
CDD
Enhanced
CDD
Ongoing
monitoring
Know your
transaction
Sanction
filtering
Transaction
monitoring
Specious
transaction
Investigation
Reporting
Risk based
approach
Record
keeping

Sanction filtering
Outline

Identity document
Customer Identity document
Permanent resident HKID card
Child under the age of 12 Birth certificate
Non-permanent resident Passport or travel document
Non-resident Passport or travel document
Never meet the FI
Passport or travel document
National identity card with photograph
National driving licence with photograph

Identity document showing
Full name
Date of birth
Nationality
Identity document number

Major address proofs
A correspondence from a government department or agency within
the last 3 months
A statement issued by a regulated FIs within the last 3 months
A utility bill issued within the last 3 months
A mobile phone or pay TV statement issued within the last 3 months
A letter from a Hong Kong nursing or residential home for the
elderly or disabled
A letter from a Hong Kong university or college
A record of a visit to the residential address by the FI
An acknowledgement of receipt duly signed by the customer in
response to a letter sent by the financial institution to the address
provided by the customer

Representativeness of documents
Original document
True copy certified by
a solicitor practising in Hong Kong
a certified public accountant practising in Hong Kong
a current member of The Hong Kong Institute of
Chartered Secretaries practising in Hong Kong
a regulated FI in Hong Kong
a trust company registered under the Trustee
Ordinance carrying on trust business in Hong Kong
a Justice of the Peace
an equivalent professional in other countries

Revenue estimation information
Type of account
Initial deposits amount
Residential address
Language
Age
Occupation
Investments
Conversation
Dress
Outlook
Mobile phone
People around

Name search
Search a customer name in a watch list database
containing
Sanctioned persons designated by
the United Nations
the home country of the FI
other major countries
Higher risk persons
Politically exposed persons
Critical criminals
Practitioners of industries with higher ML/TF exposures
Other black listed entities
Major connected parties of above

Commercial watch list databases
World-Check
Fativa
Lexus-Nexus

Sanction
Sanctioned person
Government designated person to whom funds,
financial services and economic resources cannot be
provided
Statutory sanction list
UN sanction list
Excluding persons in China
Non-statutory sanction list
US OFAC sanction list
EU sanction list
and many more

Politically exposed person (PEP)
Defined in the AML guideline
Deemed to be higher risk
An individual who is entrusted with a prominent
public function outside the People’s Republic of
China
Head of state, head of government, senior politician, senior
government, judicial or military official, senior executive
of a state-owned corporation and an important political
party official
A spouse, child, parent or partner of a domestic PEP
An entity having close relationship with a domestic
PEP

Domestic PEP
Defined in the AML guideline
Deemed to be medium risk
Not defined in the AMLO
An individual who is entrusted with a prominent
public function inside the People’s Republic of China
Head of state, head of government, senior politician, senior
government, judicial or military official, senior executive
of a state-owned corporation and an important political
party official
A spouse, child, parent or partner of a domestic PEP
An entity having close relationship with a domestic
PEP

Know your customer
Regular customer due diligence
Risk assessment
Regular
Open account
Higher risk
Potential revenue analysis
Poor potential
revenue
Reject customer
Good potential
revenue
Enhanced CDD
Detailed
justifications
Open account
Sanctioned
Report to JFIU

Potential revenue analysis
For a higher risk customer, will the potential
revenue out weight the costs and risks?
No, reject the customer
Yes, go to enhanced CDD

Enhanced CDD
More customer information
Beneficial owner
Purposes of the account
Business background
Employment background
Family background
Estimated net worth
Source of wealth
Source of funds
Referees
Most of the information cannot be verified

More customer information
Public domain and media information
Positive comments on a customer
Comparison with other similar customers
Expert opinions
Certification by accountants and/or solicitors
Private information
Very difficult to obtain
Industry practices
What is HSBC is doing?
What is Fubon Bank doing?

Positive arguments
Customer
Social status
Contributions to society
Charities
Qualifications
Professional practices
Honours
Peer group
Relationship
Clean businesses
Clean historical records
Similar customers

Sanction filtering
Outline

Counterparty information
Country
Financial institution
Account name
Account number

Sanction filtering
To assess whether the counterparty matches
any entity in the sanction lists
To be performed before processing a
transaction
Watch list searching of the counterparty as the
primary tool
Use computer systems

Name search of counterparty
with watch list database
Search a customer name in a watch list database
containing sanctioned persons designated by
the United Nations
the home country of the FI
other major countries
Commercial watch list databases
World-Check
Fativa
Lexus-Nexus

Sanction filtering
Counterparty name
Not matched in
the sanction lists
Process
transaction
Matched in the sanction lists
Investigation
False positive
Process
transaction
True positive
Report to
the JFIU

Name alternations
Order Michael LI vs LI Michael
Partial name Michael
Abbreviation M. LI
Synonym Mike LEE
Trade name HKU SPACE
Short name SPACE
Commercial code 0484 3849 3838

Non-stop growth of sanction lists
New entries will continue to be added to the
sanction lists
Existing entries will seldom be removed from
the sanction lists
Many sanction lists
https://mrwatchlist.com/watchlists/

Very common names
An entry with a very common name in the
sanction lists will trigger many matched
counterparty names
More and more very common names will be
added to the sanction lists

Matching algorithm
The rules which define a counterparty name as
“match” or “not match”
First name + Middle name + Last name
First name + Last name
All alternations
Selected alternations
Soundex
Jaccard similarity index
There is no partial match

False positive
The counterparty name identified as “match”
by the matching algorithm, after investigation,
is not the entity designated in the watch list
database
The more sensitive the matching algorithm, the
more false positive

Major practical issues
Priority
All transactions are expected to be processed by
day end
Delayed transactions may be subject to penalties
and civil litigations
Quantity
The more matched counterparties
The more investigations
The more costs against revenues

Go or not to go?
Regulator’s expectation
An investigation must be completed before the
transaction is processed
Financial institution’s expectation
The transaction must be processed by day end
Rule-of-thumb
The transaction must be processed by day end
unless there is a strong reason to hold it up

How to calibrate
the matching algorithm?
Regulator’s expectation
As sensitive as possible
Financial institution’s expectation
As insensitive as possible
Rule-of-thumb
To produce the number of matched counterparties
such that you can complete all investigations on
average by 6 pm every day

Reference
Guideline on Anti-Money Laundering and
Counter-Terrorist Financing (for Authorized
Institutions) (Mar 2015)

AML Regulations and Compliance Practices

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