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Case studies

Lending money against security of securities

Is your business lending and receiving dirty money? A study on business of lending money against security of securities.

Rahn Consolidated (Pty) Ltd’s (“Rahn Consolidated”) articles and case studies are aimed at socialising, climatising, creating awareness and cautioning economic participants on regarding economic crime schemes. The focus will inter alia be on the investigations around Lending money against security of securities , risks, reporting and most importantly, its regulatory compliance. The term “Economic crime schemes” are often used interchangeably with “Financial Crime”. For the purpose of ensuring all readers are kept in the loop, Rahn Consolidated will make use of both terms. Rahn Consolidated being at the forefront of deterring Financial Crime through compliance will focus primarily on the compliance of regarding Financial Crime and ensuring fines by way of administrative sanctions that fines are mitigated as much as possible.

Issue No.11 focuses on businesses registered as lenders of money against securities and mostly provide clarity on credit providers. This article aims to inform readers of what item 11 of schedule 1 of the Financial Intelligence Centre Act (FIC Act) refers to and how such businesses can implement controls to mitigate risks relating to Money Laundering and Terrorist and Proliferation Financing (ML/TPF) in their business.

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Item 11 of Schedule 1 of the Financial Intelligence Centre (FIC) Act identifies an Accountable Institution (AI) as a person who carries on with the business of lending money against the security of securities.

Firstly, it is very important to note that credit providers are regulated by the National Credit Act (NCA). The business of lending money against securities on the other hand is regulated by the Financial Intelligence Centre Act as an AI and supervised by the Financial Sector Conduct Authority (FSCA) due to the use of securities.

The Financial Action Task Force (FATF) Mutual Evaluation Report, explains explicitly the exclusion of Credit Providers from being an AI:

FATF Mutual Evaluation Report_October 2021

It is therefore possible to exclude credit providers as AIs, but including the money lenders against securities.

The table below depicts South Africa’s situation regarding registration and supervision of credit providers vs money lenders against securities

TypeNo. Total |No. Registered |Subject to ML/TPF obligations |ML/TPF Supervisor
Credit providers6 8956 895NoNCR (N/A)
Among which, money lenders against securities7676YesFIC and FSCA

Furthermore, there has not been an recorded ML/TPF sanctions reported on credit providers apart from those that conduct business as money lenders against securities.

  • The reference in item 11 of schedule 1 of the FIC Act to a person who lends money against the securities relates to the Stock Exchange Control Act.
  • The Stock Exchange Control Act refers to a “carrier against shares”. Note that this Act was repealed by the Financial Markets Act (FMA).
  • This definition refers to a practice where a trader could lend money to a client to fund a purchase of shares against the security of shares bought by the client in the previous trade.
  • Item 11 specifically relates to securities with particular reference to instruments that are traded on an exchange such as shares, debentures and futures contracts. 
  • All securities defined in the FMA are included in this definition contained item 11 of schedule 1.
  • In conclusion, item 11 of schedule 1 excludes credit providers apart from those that lend money against securities.
  • To provide some context, Rahn Consolidated will highlight some features of these securities in line with the FMA.

Securities as defined in the Financial Markets Act (FMA):

  • Shares, depository receipts and other equivalent equities;
  • Debentures and bonds;
  • Derivatives instruments;
  • Notes;
  • Instruments based on an index;
  • Units or any other form of participation in a collective investment scheme;
  • Money market securities;

Financial Market Act, 19 of 2012

“Credit providers, other than money lenders against securities, are not subject to ML/TPF obligations except the general requirements to file a Suspicious Transaction Report (STR) that applies to any business that is not subject to supervision or monitoring.”

Apart from Reporting obligations, business of lending money against securities have to comply to the below FIC Act requirements:

  • Register business as an AI with the FIC in order to ensure regulatory reporting through go-AML;
  • Develop a Risk Management and Compliance Programme (RMCP);
  • Conduct Customer Due Diligence (CDD);
  • Develop a compliance framework and appoint a compliance officer;
  • Conduct training on AML/CTPF risks and controls;
  • Effectively keep records; and
  • Effectively submit regulatory reports to the FIC.

FIC’s website:http://www.fic.gov.za

ML/TPF risks notes: Money lending institutions against securities

Background: A possible scenario could be where a client applies for a loan to purchase a house. In this example, a unit trust which is part of a collective investment schemes (CIS) as defined in the FMA as one of the securities. The client provided security of around 30% of the loan by putting a lump sum into a unit trust (CIS). He later withdrew the investment early to pay back the loan (capital and interest), making up the shortfall through other funds whose source is unknown.

Money Laundering Risks Identified and trigger events for FIC Act compliance

The use a proportion of the loan to purchase a unit trust combined with the unexpectedly early repayment of the loan led to the accountable institution filing a suspicious transaction report with the FIC. The suspicious transaction report is most likely to assist the authorities to identify gaps where there were schemes in loans granted and utilised to launder money through the unit trust or CIS. Rahn Consolidated assists with effective reporting controls.

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Case studies

Insurance Companies – RAHN CASE STUDY ISSUE NO.10-2022

How Insurance Companies are used to Launder Money : A Study on long-term insurance companies

Rahn Consolidated (Pty) Ltd’s (“Rahn Consolidated”) articles and case studies are aimed at socialising, climatising, creating awareness and cautioning economic participants on regarding economic crime schemes. The focus will inter alia be on the investigations around Insurance Companies, economic crime schemes, risks, reporting and most importantly, its regulatory compliance. The term “Economic crime schemes” are often used interchangeably with “Financial Crime”. For the purpose of ensuring all readers are kept in the loop, Rahn Consolidated will make use of both terms. Rahn Consolidated being at the forefront of deterring Financial Crime through compliance will focus primarily on the compliance of regarding Financial Crime and ensuring fines by way of administrative sanctions that fines are mitigated as much as possible.

Issue No.10 aims to educate readers on the long-term insurance business and how this type of business could be susceptible to money laundering.  Long-term insurance businesses are defined as Accountable Institutions (AIs) which are often not seen as high risk due to misunderstanding of its business activities.

In this issue, Rahn Consolidated aims to draw the reader’s attention to long-term insurance business activities and indicate possible ways in which money can be laundered in this industry. The main focus will be on life insurance products. Apart from Anti-Money Laundering and Counter Terrorist and Proliferation Financing (AML/CTPF), this issue will also pinpoint financial crime risks including fraud in the long-term insurance industry.

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Item 8 of Schedule 1 of the Financial Intelligence Centre (FIC) Act identifies an Accountable Institution as a person who carries on a long-term insurance business as defined in the Long-Term Insurance Act, 1988 (Act 52 of 1998) herein after referred to act “LTIA”.

Long-term insurance business as contemplated in the LTIA (Replaced by Insurance Act 18 of 2017), means “the business of providing or undertaking to provide policy benefits under long-term policies.” Furthermore, a long-term policy means “an assistance policy, a disability policy, fund policy, health policy, life policy or sinking fund policy, or a contract comprising a combination of any of those policies.”

Long-term insurance business is therefore not only limited to life policies, however financial crime perpetrators seem to use long-term policies fraudulently and then use the proceeds for money laundering purposes.

How money laundering and ultimate financial crime (predicate offences) affects long-term insurance business (life insurance business):

  • Risks associated with money laundering and terrorist and proliferation financing (ML/TPF) are relatively lower compared to other financial products (loans, payment services) or other AIs or financial sectors that were discussed in our previous publications (banking, gambling, estate agent etc).
  • Many life insurance products are definitely not sufficiently flexible to be the first vehicle of choice for perpetrators (money launderers)
  • What is prominent in the life insurance business is the source of funds, as a predicate offence might have occurred in order to use the proceeds for purposes of investing in life insurance, not for the benefit of the beneficiaries, but the perpetrator.
  • Effective withdrawal processes and conducting customer due diligence at pay-out are crucial, as is ensuring payment is made to the correct individual and therefore ensuring that you are able to trace funds and people should they utilise withdrawn funds for purposes of  proliferation financing and/or terrorism.

“Perpetrators are mostly not flexible when it comes to life insurance products/business, in that invested money cannot easily be withdrawn due to product rules. However there appears greater risks around source of funds and possibility of withdrawn funds being used  for proliferation financing and terrorism”

Apart from Reporting obligations, banks have to comply with the following FIC Act requirements:

  • Register business as an AI with the FIC in order to ensure regulatory reporting through go-AML;
  • Develop a Risk Management and Compliance Programme (RMCP);
  • Conduct Customer Due Diligence (CDD);
  • Develop a compliance framework and appoint a compliance officer;
  • Conduct training on AML/CTPF risks and controls;
  • Effectively keep records; and
  • Effectively submit regulatory reports to the FIC.

FIC’s website:http://www.fic.gov.za

FIcImage

ML/TPF Risks relative to the Life Insurance Business

ML/TPF risks relating to the know-how in distributing these life products: Distribution channel

Most long-term insurance companies (life insurance) rely on intermediaries to distribute their products. The intermediaries differ in size and experience in that some intermediaries may not have the know-how how to

conduct customer due diligence (CDD) on money invested in life cover, including knowing the source of funds. As part of conducting CDD, Rahn Consolidated assists both insurance companies and their intermediaries to identify, verify,

screen and risk-rate clients. Based on information received, source of funds is also requested and validated with the bank. This mitigates the risk of allowing illicit funds to be deposited with the insurance company.

Insurance companies ought to be alert of customer base growth

An insurance company, as trigger events, should be alert of any new campaigns that are aimed at increasing customer base significantly. Although this might not be a bad thing from a business perspective, from a regulatory perspective, the manner in which the growth takes place should not open any opportunity for money laundering or any other financial crime risks.

Subscription for a high value life policy by a new customer that does not correlate with the customer’s needs analysis should be investigated. Compliance should ensure that business does not open these opportunities by not conducting proper CDD.

When conducting risk assessments insurance companies should also consider tax related aspects

As part of financial crime compliance (FCC) and regulatory requirements, there are certain ones that straddle fraud and possible tax evasion to which insurance companies should be alert to. The client identification and verification requirements of the FIC Act also encompass the Foreign Account Tax Compliance Act (FATCA) which require intermediaries to consider tax related aspects as part of risk assessment. This is due to the fact that certain parts of life insurance may attract individuals to evading and hiding income through such channels.

FATF RBA Life Insurance Industry

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Case studies

Follow the Money – RAHN CASE STUDY ISSUE NO.9-2022

Deep-diving into Anti-Money Laundering/Counter Terrorist and Proliferation Financing (AML/CTPF) in the Banking Industry- “Follow the Money Principle”

Rahn Consolidated (Pty) Ltd’s (“Rahn Consolidated”) articles and case studies are aimed at socialising, climatising, creating awareness and cautioning economic participants on regarding economic crime schemes. The focus will inter alia be on the follow the money principle, investigations around economic crime schemes, risks, reporting and most importantly, its regulatory compliance. The term “Economic crime schemes” are often used interchangeably with “Financial Crime”. For the purpose of ensuring all readers are kept in the loop, Rahn Consolidated will make use of both terms. Rahn Consolidated being at the forefront of deterring Financial Crime through compliance will focus primarily on the compliance of regarding Financial Crime and ensuring fines by way of administrative sanctions that fines are mitigated as much as possible.

Front of a Bank Building

Issue No.9 focuses on one of the most prominent Accountable Institutions (AIs) which is inherently a high risk money laundering “machine” due to its very high volume of transactions.

In this issue, Rahn Consolidated’s approach in this regard is to draw the reader’s attention to specific banking requirements relating to AML/CTPF. This issue will also pinpoint Financial Crime risks as a whole in the banking industry alongside Money Laundering/Terrorist and Proliferation Financing (ML/TPF). The banking industry’s actions relating to ML/TPF should be focused on strategies that mitigate these risks and similarly taking into account the regulatory frameworks at both country, business and client levels. The regulatory framework controlling the banking industry is so vast that  non-compliance could result in serious administrative sanctions.

Enjoy the Read!

Item 6 of Schedule 1 of the Financial Intelligence Centre (FIC) Act identifies an Accountable Institution as a person who carries on the business of a bank as defined in the Banks Act, 1990 as amended by Act 9 of 1993 (“the Bank Act”). A Bank is defined as a public company registered provisionally or finally as a bank for purposes of inter alia deposit taking.

Assessing ML/TPF Risks in the banking industry

Due to the high volume of transactions in the banking industry, there appears to be more risks associated with banks in this regard. 

From a Financial Action Task Force (FATF) perspective, there are evolving risks in which banks should ideally look into that largely affect the operational controls of a bank to enable effective compliance.

Man holding a Phone and a credit card

The following are money laundering risks and their correlation to other financial crimes, indicating how banking officials would curb the risks if they were to “follow the money”:

  • Incidents of corruption and bribery are widespread and do not take place in isolation as the proceeds are always layered and integrated back into the industry through money laundering, resulting in banks being very susceptible.
  • Digital banking fraud, including virtual assets, are also prominent amongst other types of ML fraud.
  • Effective banking systems and networks assist in exposing and potentially identifying the proceeds of Terrorist and Proliferation Financing through the flow of transactions in South Africa.
  • Banks need to place more focus on cross-border transactions and impose restrictions after conducting screening procedures and sanctions.

FATF Mutual Evaluation Report

Stricter measures of ML have always been placed on the banking industry. In the FATF immediate outcomes it was found that:

  • To a certain extent, the ‘big four’ banks show more a more developed understanding of ML risks. This simply implies that there is traction in embedment of ML risks, however this also implies that the regulators/authorities and supervisors will be much stricter in ensuring that ML risks are prevented effectively.
  • To a certain extent, the ‘big four’ banks meet reporting obligations. Taking into account the dual reporting mandate on different AIs, it is imperative for each AI to ensure complete compliance with all obligations contained in the FIC Act.
  • Out of 34 registered Banks in South Africa with combined total assets of around R 5 517.00 Billion Rands reported between 2019-2020, it is a bit concerning that the Mutual Evaluators were to a certain extent only satisfied with what is called the ‘big four’ banks. There is definitely still a lot of intervention required in this regard.

“When assessing the effectiveness of preventative measures and AML/CFT supervision, the assessment team assigned the highest importance to banks “

About 88% of the total reports submitted to the Financial Intelligence Centre emanate from Banks – 4 595 579 to be precise,. Rahn Consolidated assists all types of banks in automation and refinement of these reports.

Apart from Reporting obligations, banks have to comply with the following FIC Act requirements:

  • Register the bank as an AI with the FIC in order to ensure regulatory reporting through go-AML;
  • Develop a Risk Management and Compliance Programme (RMCP);
  • Conduct Customer Due Diligence (CDD);
  • Develop a compliance framework and appoint a compliance officer;
  • Conduct training on AML/CTPF risks and controls;
  • Effectively keep records; and
  • Effectively submit regulatory reports to the FIC.

Below are the total number of sanctions imposed on Accountable Institutions, including Banks:

RahnSanctionsOnAIS

FIC’s website: http://www.fic.gov.za

There appears to be more work needed to be more compliant and reduce penalties!

ML/TPF Risks points to note (including broader Financial Crime risks in view of “follow the money”)

Ponzi Scheme implication to banks

Perpetrators often need to have a vehicle to enable them to transact with their illicit funds. A Ponzi scheme’s modus operandi uses non-existent business to lure investors to deposit money for purposes of defrauding them using an entity that does not have a return. In a Ponzi scheme, a bank account needs to be opened. Banks are urged to implement stricter measures before accepting a business relationship with prospective clients.

As part of Rahn Consolidated’s services, Customer Due Diligence is effectively conducted by ensuring that clients are identified and verified and that beneficial owners are screened and risk rated. Assessing where money comes from (source) also assists immensely in curbing risks. AIs need to implement freezing of assets while conducting investigations.

Multiple Accounts implications to banks

Having effective transaction monitoring capabilities assist banks to have a single view of accounts and as a result detect all suspicious/unusual activities and transactions across the bank. A particular case study that affected the Financial Intelligence Centre involved detection of multiple accounts between the same institutions and individuals.

FIC capabilities to be implemented in this regard include but is not limited to transactional monitoring, assessing business relationships and determining the source of income.

Rahn Consolidated assists banks in verifying clients and monitoring transactions regularly in order to identify ML/TPF risks.

FATF RBA Banking Industry