EU: Anti-money laundering (AML) licensing should only apply in other states if the business is ‘established’ there

Abstract

In this article the author has tried to give more detail surrounding the European Banking Authority’s (EBA’s) assertion that cryptocurrency exchanges and wallets will need, not only to register or get a licence in their member state of incorporation as an ‘Obliged Entity’ but that they may need to register or get licensed in every member state where they intend to provide services.

The implication being that a virtual currency (VC) exchange or wallet, for example, in the UK, will now need to get registered or licensed in every member state where it has customers.

The author has analysed relevant aspects of the 3rd and 4th Anti-Money Laundering Directives, the proposed EU Commission Amendment to the 4th Anti-Money Laundering Directive (4AMLD) to regulate VC exchanges or wallets (VC Institutions) as so-called ‘Obliged Entities’ (EU Proposal) and the EBA’s opinion in further depth.

Based on that analysis, the author takes the view that the only reasonable way to interpret the application of 4AMLD to VC Institutions is that it now:

·       requires VC Institutions to be licensed or registered as Obliged Entities in their Home State (see definition below);

·       but only requires Host State (see definition below) licensing or registration when the VC Institution actually ‘establishes’ itself in the Host State (here ‘establishment’ is strictly defined as the establishment of ‘agencies, branches or subsidiaries’ in another EU member state as found in the EU Treaty not the provision of cross-border online services into another member state).

Thereby, the author completely rejects the EBA’s interpretation that VC Institutions may be “required to be registered or licensed in each Member State in which they intend to provide VC-related services”.

The consequences of the EBA’s view being adopted at large, would be to either to discriminate against VC Institutions versus other Obliged Entities, or lead to the absurd conclusion that all Obliged Entities will need to register or obtain licences in each member state of the EU where they provide services.

The purpose of this article is to raise the importance of this pressing issue and invite other interested parties to submit their views.

Definitions:

Home and Host State: a Home State is the EU member state where a company is incorporated. A Host State is the other EU member states where the same company either: i. provides its services; ii. establishes itself in that state or iii. passports itself to that state.

Passporting

Financial institutions in the EU benefit from passporting rights. When they are licensed in a Home State they can elect to service other member states. The notion of providing ‘services’ could entail the establishment of a physical presence, or simply online cross-border services.

The passporting process requests ‘passporting’ when filing for a license in a Home State. The Home State regulator’s role is to communicate the applicant’s intent to expand into other member state markets to the relevant Host regulators. A Host regulator will not, in principle, refuse a passporting request sent from a Home State regulator.

The reason for this default acceptance is the basis of a single market in financial services.

That said, there are areas where some additional, or ‘goldplating’, requirements can be imposed by a Host State regulator.

Gold-plating and Anti-money Laundering

In relation to AML, a Host State can impose further requirements which may affect the financial product being provided into the Host State. By way of example, a financial institution may sell pre-paid cards but only verify identities after a threshold of EUR1,000 is deposited. Whereas in a Host State, such as Germany, for AML purposes the regulator may want to make sure that the identity of a customer is verified after EUR100 is deposited on the card.

This ‘goldplating’ is perfectly acceptable and does not undermine the single market in financial services, although it does fragment the consistency of user experience throughout the EU.

Of crucial importance here, is that no financial institution in the EU which is exercising passporting rights need register or obtain licenses from Host States when it provides cross-border services; otherwise there would be absolutely no need for the ‘passporting’ provision.

4AMLD

The Directive (EU) 2015/849 (4AMLD) is a new directive to replace the Directive 2005/60/EC (3AMLD) which has been the standard AML regime in the EU.

The EU Commission aims to have 4AMLD come into effect before the end of the year or beginning of 2017. In 4AMLD it ‘designates’ certain institutions as being ‘obliged’, meaning subject to the provisions in 4AMLD.

The Obliged Entities are not hugely different to the previous regulated institutions under 3AMLD. They are: banks, payment or e-money institutions, insurance firms, investment firms, lawyers, accountants, estate agents, company services, cash handlers and casinos (see article 2 of 3AMLD versus article 2 in 4AMLD). There are some slight variations such as extending the reach to ‘providers of gambling services’ rather than just casinos, but very broadly the same institutions as before.

In 3AMLD it is the role of Competent Authorities in each member state to license or register the institutions covered by 3AMLD (now called ‘Obliged Entities’ – we will use this terminology moving forwards to describe any entity who has been regulated under 3AMLD or who will be under 4AMLD).

Minimum Registration or Licensing Standard

The 3AMLD did set out a minimum standard for registration and or licensing of Obliged Entities in 3AMLD.

It requires that the relevant competent authority in a member state should ensure that the owner or manager of “currency exchange offices and trust and company service providers” (see Section 2 Article 36 3AMLD), casinos and money remittance service providers should be “fit and proper persons”. Article 47 of the 4AMLD has an equivalent clause with a similar requirement, but with a fit and person description that is more prescriptive by requiring member states to take measures “to prevent criminals convicted in relevant areas or their associates” owning or managing an Obliged Entity.

With regards to VC Institutions, the EU Commission has simply amended Article 47 in order to feature this category of business. See below the revised text of 4AMLD with new text suggested by the EU Commission in red.

Section Two

Supervision

Article 47

1.    Member States shall ensure that providers of exchanging services between virtual currencies and fiat currencies, custodian wallet providers, currency exchange and cheque cashing offices, and trust or company service providers, and that providers of gambling services are regulated.

2.     Member States shall require competent authorities to ensure that the persons who hold a management function in the entities referred to in paragraph 1, or are the beneficial owners of such entities, are fit and proper persons.

3.     With respect to the obliged entities referred to in point (3)(a), (b) and (d) of Article 2(1), Member States shall ensure that competent authorities take the necessary measures to prevent criminals convicted in relevant areas or their associates from holding a management function in or being the beneficial owners of those obliged entities.

Mandatory Registration for VC Institutions

Taking a step back, it is evident that the EU Commission is insisting that VC Institutions should be registered or licensed in some form.

This position can be justified by the simple fact that the EU Commission’s suggested amendment to Article 47 of 4AMLD explicitly states: “Member States shall ensure that providers of exchanging services between virtual currencies and fiat currencies […] are licensed or registered”.

This is not a requirement that is at all unique for VC Institutions. As you can see above Member States should also license or register other particular Obligated Entities.

The implication of requiring a registration or licensing regime for VC Institutions is not controversial in itself.

What is controversial is the EBA’s interpretation of the implications that come with the EU Commission requiring licensing or registration of VC Institutions.

The EBA extrapolates that VC Institutions “may therefore be required to be registered or licensed in each Member State in which they intend to provide VC-related services”.

EBA’S Opinion

It is essential to re-read the relevant section of the EBA Opinion that sets the context for the EBA’s view surrounding state-by-state licensing (emphasis added in following quote):

“The EBA notes that by the proposed amendment to the 4AMLD not designating VCEPs and CWPs as financial institutions, no passporting rights under a sectoral Directive apply. VCEPs and CWPs may therefore be required to be registered or licensed in each Member State in which they intend to provide VC-related services. 

“However, the new entities as well as the innovation itself (VC schemes such as Bitcoin, Litecoin etc.) are characterised by the international nature of the services provided. The transmission of VCs from one subject to another can be made utilizing the Internet and can be offered and accessed by any entity located in any part of the world.

“This results in practical difficulties for a competent authority that imposes national registration or licensing requirements to prevent entities that are not licensed or registered in its jurisdiction from providing VC-related services in its jurisdiction. It is therefore essential that competent authorities from different Member States are able to liaise and exchange information in relation to the operation of VCEPs and CWPs on their territory.”

Notion of Providing VC-services

It is essential to note that in the above quote the EBA does not say that VC Institutions incorporated in one member state, who also ‘establish’ themselves in another member state, need to obtain a licence in the Host State too.

No.

The EBA simply states that a VC Institution will need to obtain a licence in a Host State if it “intends to provide VC-related services” in that state. Obviously, the use of the word ‘intend’ should be taken literally as the EBA cannot seriously expect that a licensing requirement in a Host State flows from an intention to provide a service there.

However, what cannot be ascribed to a typo is the fact that the EBA refers to the provision of services and not ‘establishment’ as being the trigger for Host State licensing or registration.

The EBA further talks of:

·       the “international nature of the services provided”;

·       the use of the “internet” in the services provided; and

·       the difficulties of enforcing a Host State registration or licensing requirement when a VC Institution “[provides] VC-related services in [the Host State’s] jurisdiction”.

It follows that the EBA considers the triggering of the requirement for Host State licensing or registration to be simply from the provision of online services from a Home State into a Host State. In essence, the EBA does not draw any distinction between being ‘established’ in a Host State and providing online services into a Host State.

No Passporting Rights

Let’s breakdown the EBA’s first statement.

“The EBA notes that by the proposed amendment to the 4AMLD not designating VCEPs and CWPs as financial institutions, no passporting rights under a sectoral Directive apply.”

As we have seen above, currently financial institutions under Payment Services or Electronic Money or as Investment businesses ‘passport’ their services throughout the EU. They do so because they have, in essence, an EU-wide licence to conduct their business. An institution that provides payment services is regulated under the Payment Services Directive, which sets out an EU wide licensing regime; same is true for most other areas in financial services.

The EBA refers to these thematic directives, dealing with a particular vertical in financial services, as ‘sectoral’.

If you look at the wording of the EBA’s statement they mention that the EU Commission did not decide to designate VC Institutions as financial institutions. ‘Financial institutions’ in this context – we assume – refers to the definition in Article 3 (2) 4AMLD, which refers to regulated institutions under a relevant ‘sectoral’ financial services directive such as the Payment Services Directive of Electronic Money Directive.

Therefore, in the view of the EBA, because VC Institutions are not defined as Financial Institutions, they cannot rely upon an EU-wide licence, or in other words ‘passporting rights’, and, consequently, avoid state-by-state registration or licensing under 4AMLD.

But if you reverse the logic of the EBA’s statement above the implication is that all non-Financial Institutions – or institutions that do not have access to ‘passporting rights’ – have to do state-by-state registration or licensing under 4AMLD.

We expect, of course, that if the EBA’s Opinion is adopted that the EU Commission – as an institution bound by the Charter of Fundamental Rights namely having to heed to express requirements of due process Article 20 equality before the law and article 21 non-discrimination – will ensure that all non-Financial Institutions who are Obliged Entities shall be subject to the same requirements of state-by-state registration or licensing.

Potential Impact

It follows that if the EBA is correct in its interpretation resulting in state-by-state licensing or registration of VC Institutions, that that requirement will be imposed on all non-financial institutions.

Let’s look at the potential impact in more detail:

·       The following professionals are not ‘financial institutions’ but are Obliged Entities in 4AMLD: auditors, external accountants, tax advisors, notaries, lawyers, trust or company service providers – all of these professionals will need to do state-by-state registration or licensing to provide their services in any other member state other than their Home State.

·       Estate agents are Obliged Entities and so will need to be registered or licensed under 4AMLD in every Member State where they sell houses.

·       Cash handlers and providers of gambling services too.

You might say some of the non-financial institutions above are more local than others. Possibly a notary only provides notarial services in its Home State, but it most likely has a website and, without question, doesn’t just have Home nationals using its services. Same is true for estate agents who may be registered as Obliged Entities in Portugal but selling properties in their country to clients based in France.

Sub-category of Obliged Entities

In response, you may retort that VC Institutions have been placed by the EU Commission into a specific sub-category of Obliged Entities in 4AMLD and that they should only be compared with the Obliged Entities within that sub-category.

What could be that sub-category? As referenced to above, the EU Commission have proposed to amend Article 47 of 4AMLD.

In Article 47 the EU Commission have added VC Institutions together with “currency exchange and cheque cashing offices, and trust or company service providers” as all having to be registered or licensed and the same having to be run by “fit and proper persons”.

If the EU Commission or EBA will argue that the state-by-state licensing or registration is required for VC Institutions then the same should be true for “currency exchange and cheque cashing offices, and trust or company service providers” no?

If so then a UK company incorporation agent servicing other member states in the EU will now need to register in each and every member state where its website is accessible and where it sells its services. If a Greek person asks a UK agent to incorporate a company for them, the UK agent will need to also be registered in Greece as an Obligated Entity. Any online currency exchange services will need to be registered or licensed in every member state where it does business.

If, however, company service providers and currency exchange services are NOT required to register in every member state where they provide services then undoubtedly VC Institutions have been singled out and are being discriminated against by the EU Commission, in effect breaching a requirement of the EU Commission to treat all equally before the law – a Charter obligation.

As you can see if the EBA is correct in its interpretation of the EU Commission’s proposal the consequences are quite absurd and, most likely, unintended.

A More Rational Interpretation

We should hope that the EU Commission will take the more rational view that an Obliged Entity – after it has registered or been licensed in its Home State – will only need to register or obtain a licence in another member state in the EU if it establishes itself there.

If you were to survey any of the non-Financial Institutions from 3AMLD, it is doubtful that they have registered in every member state in order to provide their services there. The inference is that a law firm in the UK would have to register in Bulgaria as an Obliged Entity because it has a Bulgarian client. It is absurd and an anathema to the core principles enshrined in the Treaty on the Functioning of the European Union (the Treaty).

However, if the UK law firm goes to Bulgaria and establishes an office there, sets up a subsidiary there to service the local market, then it could be reasonable to infer that that ‘branch’ or subsidiary should be registered or licensed with the local supervisory authority for Obliged Entities.

Looking At The Treaty

If we look at the definition of the “freedom of establishment” in the Treaty refers to “setting-up of agencies, branches or subsidiaries of any Member State established in the territory of any Member State”.

The core of the definition of establishment in the context of free movement therefore is setting up “agencies, branches or subsidiaries”. The Treaty does not refer to ‘establishment’ as occurring de facto from simply providing services into another member state.

If we look at the VAT Directive (Directive 2006/112/EC) from a tax point of view, it states that the place where a taxable person’s business is established is the place where the functions of the central administration are carried out. Those functions relate to where essential decisions concerning general management are taken, where the registered office is and where management meets. This definition of establishment in the VAT Directive at its core relates to the quality or location of decisions and where the entity is registered.

But as we can see neither the Treaty definition nor the VAT Directive’s definition of establishment points to ‘establishment’ as occurring in a member state by simply selling products or services into that state. The implication would be that if Amazon sells one book to Romania from Luxembourg then it would now be ‘established’ in Romania too.

Therefore, ‘establishment’ can only sensibly be defined as the setting up of an ‘agency, branch or subsidiary’. This definition mirrors that of the Treaty.

With that in mind let’s look at why, contrary to the EBA’s view, we should hope that the EU Commission and Co-Legislators interpret the requirement for additional registration or licensing in the event of ‘establishment’ only.

Article 48 of 4AMLD makes explicit reference to ‘establishment’ in the article just after the article where it requires that VC Institutions be registered or licensed. See as follows (emphasis added):

“Member States shall ensure that competent authorities of the Member State in which the obliged entity operates establishments supervise that those establishments respect the national provisions of that Member State transposing this Directive.

Member States shall ensure that the competent authorities of the Member State in which the obliged entity operates establishments shall cooperate with the competent authorities of the Member State in which the obliged entity has its head office, to ensure effective supervision of the requirements of this Directive.”

The inference here is that competent authorities are supervising Obliged Entities wherever they are ‘established’. It follows if an Obliged Entity is established in multiple member states then it needs to be registered or licensed by the relevant competent authority in ALL the member states where it is established.

In conclusion, the trigger for Host State licensing or registration has to be based on establishing an agency, branch or subsidiary in a Host State. 

If the Author’s opinion is adopted then a VC Institution incorporated, for example, in France will need to be registered or licensed by a supervisory authority in the France. If the same VC Institution decides to set up an ‘agency, branch or subsidiary’ in any other member state then it will need to ensure that either the subsidiary is registered or licensed in the Host State or, if an agent, that the agent is registered or licensed in the Host State and, if a branch, that the French company is registered in the Host State. 

There cannot be another interpretation of the application of 4AMLD to VC Institutions that does not either lead to deliberate discrimination against VC Institutions compared with other Obliged Entities or, worse, complete absurdity where each single Obliged Entity, whether they are selling houses on the internet, or selling currency or VC now needs to get licensing or registration in every single member state where they provide services or have customers.

References:

http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32015L0849

http://ec.europa.eu/justice/criminal/document/files/aml-directive_en.pdf

http://www.eba.europa.eu/documents/10180/1547217/EBA+Opinion+on+the+Commission%E2%80%99s+proposal+to+bring+virtual+currency+entities+into+the+scope+of+4AMLD