Take a sector involving high-value transactions, overseas investment and low transparency levels and the opportunity to launder money becomes evident. The UK’s real estate market fits the bill for criminals looking to “clean up” corrupt money by feeding it into a series of commercial transactions to disguise its origins and make it appear to be from a legitimate source.
Historically, it was perceived that the problem of money laundering was confined to expensive residential properties in the heart of London. Recent evidence, though, indicates that the problem is much more widespread, extending to retail, office and other types of commercial property, as well as other geographical locations beyond the UK’s capital. So much so, in fact, the UK government updated its money laundering risk assessment levels at the end of 2020, with some real estate businesses being marked as “high risk”.
There is no question that the sector has many challenges to overcome; this is a complex issue and perpetrators are often sophisticated criminal networks. But can improvements be made? Lack of process, over-reliance on tech, the effects of a pandemic – and even innate human behaviour – are all obstacles, but fortunately, ones that can be overcome.
The money laundering process
The most common model of money laundering involves three stages:
- Placement: where money generated from criminal activity is introduced to the financial system;
- Layering: where the criminal enters into a series of transactions – like renting or buying a property – to conceal the illicit origins of the funds; and
- Integration: when funds have been sufficiently removed from the criminal source and intermingled with clean money, where it is no longer feasible for the origins to be traced. The funds are treated as “clean” money and can be fully integrated into the open market.
An additional complexity is that criminals often use “clean” third parties to assist – commonly close friends or family members without criminal records, who will purchase property on the criminal’s behalf.
Rental property is a target when illegal funds are used to cover rent payments; as well as in businesses using high volumes of cash. More often though, criminals will attempt to buy property on behalf of a “clean” third party and pay rent to that person using illegal funds. Office and retail space present attractive propositions, with high rental yields for prime office and retail space enabling greater sums of money to be laundered.
Once a “clean” property is secured, this then provides entry into the open market to secure credit and mortgages as collateral for laundering further criminal proceeds. Often, refunds will be used to combine illegal and legitimate funds.
Severe consequences
The penalty for breaching UK money laundering regulations can extend to fines, criminal proceedings, prison sentences and with HMRC publishing the names of those companies it fines for breaching the regulations, the reputational damage caused can be catastrophic.
The other important factor for the industry to remember is that money laundering is not victimless; it’s often linked to appalling crimes such as people and drug trafficking. When breaches occur, there is a very real consequence for those victims.
The challenges – and solutions
One problem area for the sector lies in its processes. The government’s recent risk assessment found that estate agency businesses have “a lot of weaknesses in their anti-money laundering and counter-terrorist financing controls”, including a common failure to introduce bespoke policies, controls and procedures to reflect risk assessments of a firm’s specific client or client base. Likewise, there is evidence that many estate agency businesses do not conduct sufficient ID checks, particularly on customers based overseas.
The risk assessment also noted that some businesses “have an over-reliance on ID-checking software which they do not fully understand”. Proptech certainly has its uses and can be relied on to speed up the compliance process but it is by no means a perfect solution, and lacks the human instinct that identifies when something does not feel right.
The prevalence of international investors creates challenge and risk too. Many offshore jurisdictions have less transparency over beneficial ownership than the UK, which allows criminals to create opaque structures of ownership – creating a headache for those trying to identify the true origins of a beneficial owner.
And there’s the effects of the pandemic too. The distressed state of parts of the high street has seen brands sold without the accompanying real estate assets, leaving those to be sold off at a rapid rate, in order to reap maximum returns. That need for speed inevitably creates added pressure on the ability to be thorough with standard protocols and due diligence.
Then there is the human element to consider; familiarity, for example, can create risk. Many property deals are generated through longstanding and ongoing relationships, but while one transaction may be legitimate, the next may not. If there’s a pre-existing relationship and the customer is known, the temptation to overlook standard procedure is exactly the type of lapse in compliance or scrutiny that criminals seek to exploit.
The innate human trait of “saving face” can also be considered a risk. The customer service focus of real estate means that delivering a satisfactory experience for the client is paramount – but at what cost? Employees – particularly those with less experience – may feel uncomfortable at the prospect of pursuing a suspicion or an inkling that all is not as it seems, or feel pressured to get the job done. This is where having a robust training system in place can be invaluable, as well as creating a culture where colleagues are encouraged to speak out when something doesn’t feel right.
It goes without saying that the level of risk to money laundering depends on a business’s role in the letting or transaction. Handling client money materially increases that risk. At all levels of involvement, however, due diligence checks on all parties involved are crucial, including on beneficial ownership and the source of funds. Failure to do so may mean a business ends up unintentionally facilitating money laundering, even where it hasn’t handled any client money.
Increased scrutiny ahead
Now that the risk assessment levels are increased for the sector, greater scrutiny levels are to be expected. As long as the pandemic continues to prompt rapid buying and selling of real estate assets that are no longer attached to brands, the potential for oversight in the due diligence process exists.
No business will succeed in completely eliminating risk, but, with the right measures, culture and audit of compliance, it can be substantially reduced. Proptech can play a valuable role, but the importance of robust policies and procedures and that all-important human judgment element cannot be understated. That feeling of something being right or wrong will often be the most effective test.
Seven steps to minimise money laundering breaches
- Ensure that your anti-money laundering officer regularly reviews government guidance and legislation and advises the business, using the latest information available.
- Perform a business-wide risk assessment. Identify markets, offices and teams with the greatest exposure to high risk transactions. Consider the types of services you offer, the jurisdictions involved, type of customers attracted to particular property and the complexity involved.
- Customer due diligence measures should identify and verify customers and their beneficial owners. If there’s a corporate entity involved, collate evidence to confirm who the ultimate beneficial owner is. For overseas entities, employ a local lawyer or agent to undertake thorough investigations.
- A higher-risk transaction does not necessarily mean that you cannot act, but put measures in place to interrogate and manage that risk. For example, where a particular transaction presents a higher risk, perform enhanced due diligence and introduce monitoring. This may involve regular open-source research and monitoring of sanction lists. Consider refresher due diligence and anti-money laundering processes on clients.
- Improving risk awareness and compliance doesn’t have to be costly. A compliance budget should be targeted. Introducing procedures that require the oversight of two people, is an example of a low-cost but effective measure.
- How sure can you be that the customer due diligence checks performed by other professional services businesses are sufficiently robust? Even if you are entitled to rely on a third party’s due diligence checks, you may still be liable for facilitating a money laundering offence.
- If you have suspicions, consider submitting a suspicious activity report. In 2019/20, estate agents submitted 861 SARs, a 21% increase from the 2017/18 reporting period. Encouragingly, money laundering reporting has improved, but given the sector’s risk profile, there is still progress to be made.
Lucie Barnes is a senior associate at Brodies LLP, specialising in real estate disputes in England & Wales
