A recent advancement in the EU's scheme of financial regulations manifests itself in the third directive on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing, Directive 2005/60/EC. It is scheduled to be implemented in December 2007. The Directive signifies further moves towards protecting the integrity of the freedom of movement, freedom of establishment and free movement of capital powers, conferred by the EU treaties.

The first EU anti-money laundering directive was originally transposed in a union of only twelve member states and in an environment where the main concern was to prevent the internal market from being usurped to mask the proceeds of crime and to combat drug trafficking. It soon became clear that the scope of the EU anti-money laundering provisions of Directive 91/308/EEC and its amending directive, Directive 2001/97/EC, needed to be widened to prevent using the financial system for 'terrorist financing'. The new Directive 2005/60/EC does exactly this as well as consolidating and bolstering the provisions of its predecessors.

Structurally, the new Directive 2005/60/EC offers no surprises. However, some interesting new terms appear throughout which will require parties to financial transactions to be mindful of who they are dealing with, where funds come from and what the purpose of spending those funds are. Additions to the list of entities which must apply customer due diligence are provided under Article 2. Article 4 also provides for member states to extend the Directive to other professions as they see fit. For the first time, Article 3 defines 'serious crimes' which clears up some ambiguity from previous years. Furthermore, the term 'beneficial owner' has also been defined to prevent the legal owner from acting as a façade for a beneficial entity.

Directive 2005/60/EC would appear to represent the minimum threshold of anti-money laundering and anti-terrorist financing regulations, as Article 5 provides for flexibility, expressly empowering member states to enforce tighter, more stringent regulations on their home state.

Another nuance to watch out for includes what are termed non-domestic 'politically exposed persons', which essentially refers to 'natural persons who are or have been entrusted with prominent public functions and immediate family members, or persons known to be close associates, of such persons'. Potentially, this new category is very large, and designated bodies will be required to conduct enhanced due diligence on this category of individuals.

Generally, Article 9 requires that standard 'know your client' requirements be met prior to the establishment of a business relationship or the carrying out of the transaction. The derogations of Article 9 adopt a risk-based approach and verification of identity can occur during the establishment of the business relationship where there is little risk of terrorist financing and money laundering occurring.

The risk based approach is apparent in Article 11, which provides for a simplified customer due diligence process, under which some customer due diligence requirements do not have to be applied in certain circumstances. In contrast, Section 3, Article 13 provides for enhanced customer due diligence requirements, which triggers further KYC requirements in cases of high risk customers. This 'high risk' category includes customers not physically present for identification purposes and non-domestic politically exposed persons, as mentioned above.

EU member states are required to establish a Financial Intelligence Unit (FIU), as per the provisions of Article 21, if they have not already done so under the 1991/308/EEC Directive. The FIU is required to have access to financial, administrative and law enforcement information in order to fulfil its duties. Institutions and persons covered by the Directive are required to report suspicious or unusual activity to the FIU. The extent of what exactly the terms 'suspicious or unusual' encompass would appear to be discretionary. Bearing in mind that the state of mind required to prove guilt in money laundering and / or terrorist financing is 'knowledge, intent or purpose', it is unclear how much suspicion is enough to warrant an investigation into such state of mind.

There are no standardised formats of FIUs throughout the European Union, although, there are four model recommendations. Such variation in models across the EU may pose technical difficulties in respect of the spirit of cooperation or communicating. The Forty Recommendations issued by the Financial Action Task Force on Money Laundering maintain that all FIUs share three main functions; 'they receive, analyse and disseminate information to combat money laundering and terrorist financing'. These functions stretch from domestic to international territory, with a strong emphasis on sharing information and cross border cooperation.

On a domestic level, it appears that public awareness of the role of our own FIU and FIUs internationally must be heightened in order to reap the benefits of the protective system in place and in order to prevent our financial services sector being undermined by schemes of money laundering or terrorist financing. The Irish FIU will be provided in conjunction with An Garda Siochána, serving as an example of the 'law enforcement model' FIU.

The Directive 2005/60/EC will introduce an enhanced due diligence framework which will necessitate system enhancements and updates and staff training for those covered by the Directive.

It is important to the Irish and European financial service industry alike to strike an achievable and satisfactory balance between over-regulation and deterrence. Information and awareness are the keys to overcoming these financial crimes. The material in this article is for general information only. Professional legal advice should always be sought in relation to any specific matter.

July 2007.

For further information please contact Sarah Lyons.