UBOs: the devil lies in detail

In the past two years, the FATF bogeyman has the government, regulator and banking community scrambling all over. Ostensibly, the public discourse is dominated by criticism of reactionary behaviour demonstrated by subsequent governments to the grey listing. However, the real thrust has in fact come with the imposition of multi-million-dollar penalties on two of the big five, leading to the embarrassing closure of their New York shops – the worst kept industry secret.

Since then, commercial banking jargon has witnessed a major revision. Obscure terms previously limited to the Compliance department’s dictionary - such as ‘link-analysis’, ‘suspicious transaction reporting (STRs)’, ‘trade-based money laundering (TBML)’, ‘non-customer due diligence’, ‘Regtech’, and ‘eKYC’ – have now become popular buzzwords even among the client-obsessed ‘corporate and commercial’ business-shops.

This means that identification of ML/TF risks is now top-of-mind recall for c-level executives across the industry. The change of heart at the top means that the trickle-down effect is already showing in better compliance. Irrespective of the motive; whether out of fear of sanctions’ axe coming down hard or a genuine appreciation of the repercussions that lax treatment of ML/TF risks can have for the society.

These themes dominated the discussions between industry leaders at the ‘Financial Crime Summit: Pakistan’s FATF Way Forward’, a day-long moot that took place in Karachi over the weekend. Talking heads from Compliance spoke of the need to establish an integrated web-portal of beneficial owners to identify ultimate beneficial ownerships (UBOs) – a national registry of corporate entities, if you will – along the lines of those maintained in regions such as EU, China, and surprise – even the tiny kingdom of Bahrain.

The speakers pointed out that a portal for UBOs could follow in the footsteps of the successful eCIB model, which gives banks access to pooled credit history of prospective obligors. It was suggested that a VPN-protected network with restrictive rights and closely monitored history of access would ensure that customer privacy also remains protected.

The common recognition of the problem by the industry is a very welcome sign. Arguably, based on databases and client history already available with banks and SBP, a pooling of information does not pose an insurmountable challenge, especially in light of the newfound enthusiasm by bosses at the big five. However, certain caveats must be highlighted.

While well-intended, the proposed portal will only go as far as laying the foundations of a UBO registry. Even under the latest regulations that have reduced the threshold of substantial shareholding disclosure to twenty percent of total, the disclosure still largely depends on the principle of self-declaration.

Consider that ownership identification is hardly a challenge in case of most mid- or large corporates with declared affiliation with fifty-odd major business groups/families of the country. The problem in fact stems from the obscure privately owned entities, with cross ownership held in the name of individuals.

Consider also that while the revised Companies Act requires that both the numbers of shares held by directors and their nature of directorship – sponsor executive, sponsor non-executive, independent or nominee – be disclosed in the annual returns, no disclosure is required with respect to the beneficial ownership of the nominating entity where nominee director represents a body corporate shareholder.

Similarly, when ‘ostensibly’ diverse set of individual members each owning less than five percent come together to elect a director (himself owning less than five percent), no direct assessment can be made with respect to the interests represented by him based alone on returns filed with SECP. In both situations, banks can only conduct due diligence and name-screening of directors.

Similarly, it is not unheard of in world of corporate law for obscure single large/substantial shareholders of privately held or offshore firms – the “mother-holding” entities – to assign power of attorney to their frontmen, who then go on to elect others as directors in subsidiary companies and ultimate subsidiaries thereof. A box-standard Russian doll layering ownership-structure.

In the existence of such lacunas, commercial banks can only go so far in enforcing best practices of UBO disclosures. One possible improvement could be to require a legally binding declaration from nominee and elected directors alike, that discloses the particulars of their nominator(s) or the list of shareholders that elected them. This document could be submitted with SECP on full confidentiality basis, limited to cross-checking of CNICs against a centrally maintained negative list, to be shared with banks on need-basis only.

If even this level of privacy were not enough, reports generated to banks could solely consist of red- and green flags alone, allowing the potential customer to contest position by providing additional disclosures regarding its ultimate beneficial owner(s).

Based on the confidence demonstrated by Pakistan’s point-person on FATF, the black-list sword may no longer be looming immediately. But in the medium to long term, addressing transnational apprehensions about ML/TF risks to Pakistan’s commercial banking sector will require fixing the UBO lacunas. The banking community has already begun to muster courage in the right direction, taking the process to its logical conclusion will require advocating an unpleasant yet much needed leap.