A new Criminal Finances Bill is making its way through the UK House of Commons which aims to make it harder for criminals and kleptocrats to use the UK financial system to launder ill-gotten gains, while minimising the burden on legitimate businesses and individuals. The bill gives expanded powers to law enforcement agencies and makes banks and other businesses liable for prosecution if they fail to prevent facilitation of tax evasion. It also introduces ‘Unexplained Wealth Orders’ (UWOs). These would allow the authorities to demand explanations about any assets that appear suspicious. These measures should have both domestic and international benefits in tackling illicit financial flows.

At the end of December a new amendment was introduced, supported by a cross-party group of over 80 MPs. It seeks to force the UK’s Overseas Territories publish open registers of the ultimate (‘beneficial’) owners of companies (a step that the UK took last year).

What are the Overseas Territories and Crown Dependencies?

‘Overseas Territories’ are 14 jurisdictions; former parts of the British Empire that have their own domestic legal systems, but which have chosen to remain in close partnership with the UK. They are mainly small island states and include several Caribbean jurisdictions which have developed specialisms in international financial services such as Anguilla, Bermuda, British Virgin Islands, and Cayman Islands. Jersey, Guernsey, and the Isle of Man are known as ‘Crown Dependencies,’ they have a slightly different relationship with the UK but also have their own legislative assemblies and legal systems.

 
It is extremely rare for the UK to impose rules on its Overseas Territories (or its Crown Dependencies). There have been a few precedents but they tend to be motivated by fundamental human rights issues, such as abolishing capital punishment, and decriminalizing homosexuality, or in response to major governance failure; such as when the UK imposed temporary direct rule on the Turks and Caicos Islands. Margaret Hodge, who sponsored the amendment said, “of course political parties have shied away from using these powers. They can seem somewhat colonial, but I think there are overwhelming moral arguments at stake here.” This blog post considers the arguments and the evidence.

Beneficial ownership

Anonymous ‘shell companies’—which allow people to hide their identity behind nests of interconnected companies and nominee directors—have been identified as a key chink in the armour in anti-money laundering rules, making it hard to trace the spoils of crime and corruption. When the World Bank reviewed 213 grand corruption cases with proceeds worth $50 billion it found that 70 percent of them involved the use of at least one anonymous company or trust. However this should not lead to the perception that every shell company is used for illegitimate purposes. For example, Transparency International points out that four out of five of the 144 London properties which have been investigated as proceeds of corruption over the past 10 years involved shell corporations. However these properties make up fewer than 0.25 percent of London properties held by foreign companies. The Director of Operations for the Metropolitan Police’s Proceeds of Corruption Unit notes that “the percentage of properties purchased via illicit money is tiny in comparison to the legitimate trade.”

The international standard for transparency on beneficial ownership, set by the Financial Action Task Force (FATF), states that “countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by competent authorities.” This does not require an open public register, and other countries have taken different approaches to the UK. Options include regulating Corporate Service Providers (CSPs) to ensure that they collect and verify information about the real owners of companies, and establishing closed central registries which are only accessible to law enforcement.

Mystery shopping for secrecy

The World Bank’s Puppet Masters report undertook an in-depth examination of anonymous shell companies (including through a practical ‘mystery shopper’ exercise where they attempted to register anonymous companies in different jurisdictions). They concluded that requiring professional CSPs to collect and verify information about the ultimate owners of companies is a much more effective way of ensuring reliable information than relying on self-reporting to a central register. The Global Shell Games Project undertaken by Jason Sharman, Michael Findley, and Daniel Nielson followed up with a randomized experiment, where they sent 7,400 email solicitations (in various shades of dodgy) to more than 3,700 Corporate Service Providers in 182 countries to test whether they would follow international rules by requiring proof of identity. Nearly half did not ask for proper identification. Perhaps surprisingly, company service providers in OECD countries like the US and UK were more willing set up companies without checking identity documents, while CSPs from small state financial centres were more likely to follow the rules.

Sharman argues that CSPs should be regulated and required to collect documents establishing the true identity of beneficial owners. However, confidence in this system has been rocked by what has become the most well known CSP in the world—Mossack Fonseca. While the vast majority of the 500,000 companies included in the ‘offshore leaks’ have not been linked to any scandal, the ‘Panama Papers’ highlighted a particular weakness in CSP regulation. In some jurisdictions such as the BVI, an ‘eligible introducer’ exemption allowed CSPs to register companies for customers whose identity was vouched for by an on-shore bank or law firm. The idea is that onshore firm are better placed to collect and verify ‘know your customer’ documentation from local customers than offshore service providers, and it is more efficient to do this once. However this system can break down if the CSP does not hold a copy of the information, and the eligible introducer later declines to produce it or says they do not have it. Jurisdictions may also drag out the process of mutual legal assistance, delaying responding to requests for information.

Could ‘many eyes’ provide low cost verification?

Central registers it easy to access beneficial ownership information, but they don’t do anything to assure it is reliable, as they generally rely on self-reporting, and registrars do not have capacity for verification. Relying on crooks to honestly self-register seems fool hardy, but hope has been placed on the idea that open databases might be more accurate because of the role of the public, journalists and NGOs in data verification.

Data from from UK’s first release of beneficial ownership information shows the scope and limitations of this approach. Global Witness brought together 30 volunteers over a weekend to look at the data. Their experience highlights the hopes and practical limits of open registers. They compared the UK register with other datasets such as the US sanctions list and lists of politically exposed people—but recognised that they had no means to check whether their ‘hits’ reflected people sharing the same name and birthdate, or indeed whether there were other people that their database crunching had not detected because they did not submit honest information to the register in the first place. Their searches were able to pick out companies whose beneficial owner was given as a company instead of individuals. However without the power to demand further information all they were able to do was pass the matter back to Companies House for their attention. Hera Hussain at Open Corporates notes that seeking to investigate clues of corruption or money laundering by combing through the database is a needle-in-a-haystack experience.

It is certainly worth these organisations continuing to test and investigate what use can be made of the UK’s public beneficial ownership register. But we still don’t know whether an open, unverified register is necessarily preferable to a regulated system. Verifying beneficial ownership information is a routine process. It is important but boring, and relies on triangulating with other information which may not be in the public domain. There are very few needles in a very big haystack of basically law-abiding companies. For example there are over 3.5 million registered companies in the UK. According to the UK National Risk Assessment on Money Laundering and Terrorist Financing in 2013/14, Companies House handled some 9 million filings and registrations. They received complaints and reports of errors relating to in the region of 0.3 percent of companies, and say that in 80 percent of these cases, companies corrected the information immediately, suggesting that the cause was simple error, rather than fraudulent activity. In the vast majority of cases with no particular scandal to investigative it is not clear that journalists, NGOs or other volunteers would be motivated or able to comb through the haystack. The may also lack the information, power, or resources to do it efficiently.

Does privacy matter?

Open self-declared public registers are relatively cheap to set up, particularly for a country like the UK which already has an open corporate register. For developing countries and overseas territories that do not already have the infrastructure of a central register it is a bigger expense, and for those for whom privacy is part of their attraction to customers, it undermines the competitiveness of their offering.

Much, then, comes down to the question of whether it is legitimate to enable law-abiding people to pursue a preference for privacy over the assets they own and the investments they make, so long as they are not able to evade taxes. Should the privacy of the many be overridden by the goal of making life harder for the few money launderers and tax evaders?

While there are clear areas where it can be argued that beneficial ownership should be made public (such as for Politically Exposed Persons, owners of shipping vessels or when a company is bidding for a public contract or concession) this does not necessarily require that all people who own assets through corporate structures be required to put the details of their holdings in the public domain.

There is an overwhelming case for learning

Different jurisdictions are taking different approaches to securing beneficial ownership information: Most international financial centres use regulated CSPs. The British Virgin Islands has recently taken action to close the ‘eligible introducer’ loophole, and is also developing a central register. The EU has adopted central registries which are not public, but whose records may accessed by people with a  'legitimate interest'. Jersey combines a closed central register with strong CSP regulation. The UK, Germany, France, Italy, and Spain have agreed to develop automatic exchange of information. Ukraine Netherlands, Australia, South Africa, and Nigeria have indicated that they intend to develop public registers. The US has long been the easiest place to register an anonymous company, as it has neither licenced CSPs nor registries, although the IRS has strong powers to demand information. The role of banks in identifying beneficial owners and providing information to tax authorities though the Common Reporting System (CRS) is also crucial for closing down routes for tax evasion.

Targeted approaches to making beneficial ownership public are being made in relation to the extractive industries, public procurement tenders and contracts, shipping vessels, and in asset declarations by Politically Exposed People. Technological solutions offer the opportunity to leapfrog traditional paper-based approaches. Global Legal Identifiers for companies are being developed to enable firms to better understand who they are doing business with. Digital approaches may also help to overcome the barriers to access to financial services, social benefits, and political rights for the 1 in 5 people around the world still unable to prove their identity. As Mark Carney recently highlighted, solving this problem through digital ID systems would make existing due diligence requirements easier to fulfill and harder to evade, and would unlock the potential to for fintech innovation to serve more people.

Progress in any of these areas depends on adaptive processes of trying, failing and learning, and adjusting.

Rather than rating countries on whether they have particular iconic laws on their books, there is an urgent need to assess and learn what is working in practice, and to ensure pressure for improved performance by all jurisdictions to demonstrate that they are sound locations for legitimate business. This could include mystery shopper audits of CSPs to test whether due diligence is working, as well as tests of how quickly and cooperatively jurisdictions respond to requests for mutual legal assistance.

Otherwise we risk prematurely pronouncing a single solution, and encouraging policy makers to pass symbolic laws and policies in order to impress or to avoid punishment.

Updated 2/9/2017: This post has been updated to clarify the accessibility of the EU’s closed central registries.