This year has seen a significant increase in scrutiny by regulatory authorities of the informal transfer of money across international borders. Certain accepted commercial practices in the retail sector have recently come under the spotlight because they may unwittingly aid money laundering or the avoidance of sanctions.
Of these practices, the one attracting the attention of the authorities is that of third party payments. Generally, this can describe legitimate arrangements for the transfer of money on behalf of another, for example to settle a debt. These arrangements are more commonly associated with particular regions in Eastern Europe and the Middle East but can come to light in trading relationships anywhere; they include what is known as Informal Value Transfer Systems.
The problem with third party payments is they can create an inadvertent exposure to the risk of financial crime, including money laundering and/or circumvention of international sanctions. This is because the payment arrangements can be used to disguise the identity of the true payor and true source of funds.
Whilst historically this may have been perceived to be a problem only for regulated firms, such as banks and payment services providers, the reality may be different. For example, when providing financial services such as credit facilities, most banks will insist that the customer has adequate systems and controls to prevent criminal practices.
Third party payment arrangements strike at the heart of these controls because they undermine the achievement of the necessary levels of customer due diligence (CDD) by the business, on which the bank may be relying.
To reduce the risk of money laundering when processing payment through the UK banking system, a bank will either conduct CDD on the customer to identify and verify the paying party or, where appropriate, rely on the customer to do this, enforcing this through the covenants in the credit facility agreements.
With undisclosed third party payment arrangements, the bank cannot be confident that its legal and regulatory obligations are being met. For this reason, a business customer accepting third party payment arrangements can also increase the possibility that a customer will be designated high risk, resulting in a bank imposing restrictions on the services it provides.
These requirements can be important regardless of whether the bank's customer is regulated. Following a number of high profile regulatory interventions and penalties, the regulated sector has become very risk averse. Any bank's standard terms and conditions will most likely include restrictions on the use of the account for activities that can create the risk of any party:
HM Treasury maintains an up-to-date list of all designated persons and countries subject to sanctions applicable in the UK.
As well as the terms and conditions, most banking facility agreements will contain similar restrictions. These will normally go further and a borrower is often required to give an undertaking that it has adequate systems and controls in place to prevent a breach of sanctions. On signing a facility agreement, borrowers are also often asked to represent that they do not conduct business with any sanctioned person, business or country. The bank’s approach to managing customer risk is through requirements imposed in facility letters or other customer documents.
If a company utilises third party payment arrangements to do business then this will increase the difficulty of ensuring compliance with these terms. For instance, if the trading relationship is with a company in a sanctioned country (the debtor) but payments are received from a third party in another, non-sanctioned country then the payment will not be identified as derived from the sanctioned country. This may result in a breach of any banking agreement as well as international laws.
Sanctions differ from jurisdiction to jurisdiction and sectors and are therefore very fact specific. Equally, whilst some trade with sanctioned countries is permitted, there are still restrictions on the transfer of funds to and from sanctioned countries – this includes payments made by a third party on behalf of the debtor. Consequently, even if the trading relationship doesn't cause a breach, the third party payment may do so.
The banking regulator in the UK has observed that, in the past, customers have often placed reliance on their bank's own controls to capture any payments that might have been made in breach of sanctions or money laundering regulation. However, a bank is unlikely to view this approach as sufficient to discharge a customer's obligations to prevent or mitigate a breach.
The ideal situation is not to use third party payment arrangements – this will immediately mitigate the legal and compliance risks. Failing that, consider the following:
Regardless of whether a company actively uses third party payment arrangements, all of the above are prudent steps to take to mitigate the risk of financial crime.
If you would like to discuss any of the matters raised in this note please contact Jake McQuitty or Jason Cropper.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at July 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.