A Higher Form of Realty – Beyond the Sale and 5MLD

Posted by Ince on 23rd July 2020 -

Insights / 20-07-2020 

“It's tangible, it's solid, it's beautiful. It's artistic, from my standpoint, and I just love real estate.” – Donald Trump

“Make a customer, not a sale.” ― Katherine Barchetti

Whereas most operators in the real estate industry, Donald Trump included, may be most interested in the “art of the deal”, the Fifth Money Laundering Directive (“5MLD”) requires that estate agency businesses must make a customer known to them and not just make a sale. 

On 29 March 2018, the Treasury Committee launched an inquiry into Economic Crime including the examination of two areas where a risk of money laundering had been identified — property and company formation.

The report published on 8 March 2019, noted several critical views of the role of estate agents. 

Naomi Hirst, Global Witness, said that:

“The investigations that we have done have shown that properties have been bought by politically exposed people from very corrupt countries, and the estate agents could have identified the fact that there might have been something wrong there, by simple Googling in some cases. She also noted that “the very fact that […] estate agents are only filing 0.1 per cent of SARs [suspicious activity reports] in the last session really shows that they are not really aware of the problem”.

Ben Wallace, the Security Minister at the Home Office, said that:

“[…] It is absolutely the case that estate agents have been one of the weak links in the suspicious activity and money laundering schemes. They have not done nearly enough at all […] I have a stick, which is to say to the estate agents, “Where are your SARs? Out of 621,000 SARs each year, 83 per cent are from banks and 0.17 per cent or 0.017 per cent are from estate agents. Why is that?” [1]

The 5MLD passed into UK law through the Money Laundering Regulations 2019, which affects both the sales and lettings sector of estate agency businesses. These new anti-money laundering (“AML”) regulations have been in force since 10 January 2020. 

Changes for estate agents include requirements for additional ownership checks and enhanced due diligence. Also, estate agents are subject to regulatory supervision, oversight and enforcement by HM Revenue & Customs (“HMRC”).

How Money Laundering Works in Real Estate

Money laundering is a growing, worldwide problem estimated to have reached US$1.6 trillion a year. The exact scale of illegal activity in the UK real estate sector is difficult to estimate although, individuals or companies with a high money laundering risk are thought to own more than £4.2 billion of property in London alone.[2]

In recent times, the following headline articles depict the coverage of money laundering and property –  

Wife of jailed banker loses appeal to keep her £15m Knightsbridge home after refusing to abide by new 'McMafia' laws[3] 

Kazakh family win Unexplained Wealth Order battle over London homes[4]

Pakistani tycoon agrees to hand over £190m to UK authorities[5]

Daughter of African kleptocrat has £13m London mansion: How we discovered it[6]

The process of laundering money involves three stages: placement, layering and integration. Real estate will be used to launder money at the final stage of the process: integration. 

At this stage, dirty money has been cleaned, so criminals can buy items without raising much suspicion. This means property will be purchased using illicit money. Once a purchase is completed, the money is concealed in the value of the property for as long as the criminal owns it. Until it is sold, criminals can enjoy the assets they bought illegally using the laundered money. When they decide to sell, the proceeds are realised as clean money from the buyer, and the launderer’s work is done.

The 5MLD seeks to challenge this process by requiring estate agents investigate and ascertain the identities of the buyer and seller. 

It should be noted that money laundering does not necessarily end with the purchase and sale of a property. Money launderers can purchase property and then renovate it. In this scenario, the dirty money funds the renovations. Through doing this, the launderer seeks to raise the value of the property and “flip” it after for greater proceeds. 

Estate Agency Businesses are Required to Register with HMRC

Companies are not permitted to carry out estate agency work where they are not registered with HMRC for AML purposes. Consequently, a business must register with HMRC before it carries out any such work and pays the requisite fees.

Estate agency work has a broad definition, provided for in section 1 of the Estate Agents Act 1979, and some firms which do not consider themselves to be estate agents may still be carrying out such work.

Estate agency businesses can apply to register with HMRC online. The application process will require the business to provide information on its premises. Furthermore, ‘responsible’ people designated in the application will need to pass a fit and proper persons test. A decision will be communicated by HMRC via email, but the status of an application can be monitored via the online portal. Where an application is rejected, there is a mechanism through which such decision can be appealed.

Where a business considered to be carrying out estate agency work does not register with HMRC, it may receive a penalty. The amount of such penalty will depend on the circumstances of the case. In determining the amount of such penalty, HMRC will take into account factors including:

1. Whether the failure to register was self-reported, or if HMRC discovered the breach.
2. Any reasons for not registering.
3. Whether the business has received any previous warnings or penalties.

There is a requirement for estate agency businesses to renew their registration with HMRC annually, and to pay an associated fee. HMRC will notify a business 30 days before a renewal is due. Failure to do so will mean that the company’s registration will be terminated. Consequently, the firm will be removed from the HMRC register and will no longer be permitted to carry out estate agency work. Where a firm ceases to carry out estate agency work and no longer requires to be registered, it should notify HMRC.

The When and How of Customer Due Diligence

Estate agency businesses must carry out due diligence on both their customer and the counterparty to a transaction. Due diligence is required on a customer at the point the estate agent expects the relationship to have an element of duration. This may be when a contractual relationship is formed, but in some cases may be earlier.

Due diligence on a counterparty is required at the point the buyer’s offer is accepted by the seller, regardless of which party the estate agent acts for. In relation to lettings transactions, a similar principal will apply. Carve outs exist for the rules on timing of due diligence, but they are limited in scope and not discussed further in this article.

The purpose of due diligence is to ensure an estate agent knows that the parties to a transaction are who they claim to be. The exercise of due diligence is where an estate agent is most likely to be alerted to the presence of red flags. Standard due diligence is generally straightforward but should be carried out with appropriate attention. Typically, it involves the collection of identification documents, as well as investigations on official registers and compliance search engines.

Estate agents should always consider whether it is necessary to carry out Enhanced Due Diligence (EDD), particularly where red flags are identified. EDD requires an estate agent to take greater efforts to establish the subject’s identity, as well as carrying out additional measures such as source of wealth checks. The level of due diligence implemented should always be informed by the business’ risk based approach.

Red Flags

Red flags are indicators that help estate agents to treat a transaction with greater suspicion.  These include:

• A purchase of a property without a mortgage
• A purchase of a second property very soon after the first purchase has completed
• A lack of interest towards the transaction from a client, for example where they do not want to view the property first
• Successive purchase/sales of the same property ( where a client seeks to buy a property and sell it multiple times)
• An overseas buyer from a country that is considered a high risk jurisdiction including tax havens
• A buyer using a complex structure for settlement 

The above is not an exhaustive list. Therefore, a business risk assessment must be undertaken as part of complying with the AML regulations. All estate agency businesses must have systems and processes in place to identify and report red flags. Controls and employee training should be implemented to ensure such systems and processes are complied with. These policies must be documented and businesses must be prepared to submit them for review at HMRC’s request.

Transactions should be dealt with on a risk-based approach, with more resources spent on transactions which present a greater number of red flags. Identified red flags should be investigated by the estate agent working on the transaction. Where they are not satisfied that the red flags’ cannot be reasonably and legitimately explained, the transaction should be reported to the business’ nominated officer or appointed Money Laundering Reporting Officer (MLRO).

The nominated officer/MLRO should be experienced in judging the money laundering risk a transaction poses. Where, having considered all the circumstances of a transaction, they still judge it to be suspect, the nominated officer/MLRO should file a Suspicious Activity Report (“SAR”) with the National Crime Agency. Responsibility for the failure to file an SAR rests with the nominated officer/MLRO once the transaction has been reported to them.

COVID-19 and Next Steps 

It is recognised that due diligence requirements have become increasingly onerous for estate agents and consequently, this has had negative cost implications for firms. However, opportunities for streamlining do exist by virtue of the direction that firms take a risk-based approach, meaning maximum resources need not be spent on each individual transaction. In order to create an AML framework which satisfies the regulation but still, represents cost efficiency where possible, firms are recommended to seek expert advice and utilise technology solutions.

Firms should act now to undertake risk assessments and create policies and procedures to satisfy HMRC that they take the threat of money laundering seriously, and that they are committed to both the letter and spirit of AML regulation compliance. 

Furthermore, the Royal Institution of Chartered Surveyors (“RICS”) has revised its Anti-Money Laundering guidance in light of COVID-19.[7] The guidance issued in May 2020 ensures regulated firms comply with RICS’ professional standards but does not provide legal advice on specific obligations for firms carrying out regulated activities. It cautions that advice from a legal professional or AML supervisor may still be required.

We offer an end to end service to help businesses with AML compliance from HMRC/FCA registration to policy drafting, procedure implementation, and business risk assessments. In conjunction with our services, we also offer technology solution to assist with process efficiency and cost effectiveness including an outsourced managed service. Please contact Alex Ktorides or Annette Fong for more information.