Importance of the non-financial sector 

The perpetrators of these crimes know that they can bypass the banking sector and still effectively launder money. Cash-intensive businesses such as restaurants and betting shops, the purchase and export of luxury goods and the use of informal money mules are all common vehicles.

Money laundering at scale through financial institutions has been the primary focus of German legislators, with a view to preventing criminals from legalizing their illegitimate income, and assuming influential positions in the social and political life of Germany.

However, the importance of the non-financial sector for money laundering activities raises questions about the responsibilities of public authorities in this area and of the administrative structures in place outside the financial sector to combat money laundering. 

Allocation of responsibilities under section 50 of the Money Laundering Act

Section 50 of the Money Laundering Act sets out which firms are covered by the regulation based on whether they belong to a financial or non-financial sector of the German economy. 

However, these two categories are not defined in more detail in the Money Laundering Act. Instead, it is the responsibility of the Financial Intelligence Unit (FIU) set up at the border customs office to evaluate suspicious activity reports (SARs) and divide companies based on whether they belong to the financial or the non-financial sector.

Which firms are in the financial sector?

Accordingly, the entire banking industry, including financial services institutions and e-money companies, are classified as part of the financial sector. On the basis of the provisions set out in Section 50, money laundering supervision for the entire financial sector is in the hands of the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). 

Which firms are in the non-financial sector? 

According to the classifications set by the FIU, the following companies subject to money laundering regulations (Section 2 AMLA) are to be assigned to the non-financial sector: 

• Insurance intermediaries
• Lawyers, tax consultants, auditors and notaries public
• Trustees
• Real estate agents
• Gaming operators
• Freight traders

The fact that these companies belong to the non-financial sector initially means that money laundering supervision by BaFin is out of the question. As there are no other assigned federal authorities, money laundering supervision of these companies falls within the administrative competence of the states (Länder).

The supervision of the non-financial sector

Non-financial sector organizations typically belong to a chamber of commerce or other form of professional organization who will supervise their activities alongside local authorities. 

As a general rule, this means the same authority that is responsible for ensuring compliance with hygiene regulations in the restaurant business or with food preservation regulations in  supermarkets is also responsible for monitoring jewellers and car dealers. 

The task of monitoring money laundering in the non-financial sector is therefore spread over hundreds of local authorities. Some of these may struggle with access to relevant expertise, staff and the wider industry awareness necessary to supervise firms effectively. 

One measure of the disparity between financial and non-financial businesses can be seen in SAR filings. In 2020 104,325 SARs were filed by the financial sector. Just 2,854 SARs were filed by non-financial companies in the same period. Of these limited SAR filings, only around 400 were filed by goods traders nationwide (source: Bafin Annual Report 2020, page 17). 

Focus on the banking sector

For years, the federal government has given high priority to the fight against money laundering. This has most recently been demonstrated by the tightening of Section 261 of the Criminal Code, which goes far beyond all European legal requirements in its definition of money laundering, including even petty offenses in the circle of predicate offences, as well as the increasingly far-reaching allocation of control tasks to banks. 

A look at the non-financial sector, however, makes it clear that administrative structures have so far not been able to keep pace with political objectives. It has been known for years that the non-financial sector accounts for a significant proportion of criminal money laundering offenses. In this area, administrative tasks aren’t centralized, and the inadequate staffing and technical resources of local authorities mean that effective monitoring of money laundering may not always be guaranteed. 

Further reading

Redefining money laundering in Germany: The Implications of Section 261

Raids Across Germany Target Network Suspected of 140m EUR Money Laundering

Anti-Money Laundering In Germany

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Luko is the number one neo-insurance company in France, insuring more than 40,000 homes, and the fastest growing insurtech company in Europe. The company was founded in 2016 and has raised $22.2 million in its Series A funding round. Their mission is to reinvent home insurance through social responsibility and technology.

Industry: Insurance
Product: AML Screening

The Challenge

Luko’s compliance team was having to conduct hundreds, if not thousands, of checks a day, which required a lot of manual effort and slowed onboarding time for customers. Flagging high-risk entities is mandatory according to the The French Prudential Supervisory Authority’s (ACPR) directives, so it was essential to ensure that no suspicious activity was slipping through the net.

Luko’s objectives were to meet the regulatory requirements. They also wanted to automate their systems to be able to receive real-time alerts about risk at contract submission or when a claim was filed.

Therefore, when benchmarking AML providers, one of Luko’s main selection criteria was that the tool had to be API-based to allow automation. It also had to be multi-functional and capable of incorporating various high-quality sources of data. Finally, the tool had to be able to cover Europe and North America. Luko decided to partner with ComplyAdvantage as they fit all the criteria mentioned above and were highly recommended by one of Luko’s business partners.

The Outcome

Working with ComplyAdvantage has allowed Luko to improve their knowledge of financial crime risks. Their team can now easily customize their parameters, change match statuses and escalate alerts to other team members, and the clear audit trail provided by the tool ensures compliance obligations are met.

In addition, customizable matching parameters reduced false positives and incorrect hits, allowing Luko’s team to free up time previously spent on managing false positives to deal with high-risk entities that matter to their business.

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Many uncertainties and misunderstandings surround politically exposed persons, or PEPs. Classifying a client as a PEP is not an aim in itself; rather, it forms part of the process that enables financial institutions and DNFBPs (Designated Non-Financial Businesses and Professions) to assess the higher risks related to PEPs. Of course, being a PEP does not in itself equate to being a criminal or suggest a link to abuse of the financial system. However, PEPs are higher-risk customers, because they have more opportunities than ordinary citizens to acquire assets through unlawful means like embezzlement and bribe-taking. Therefore financial institutions and DNFBPs must be familiar with thePEP red flags and indicators that can be used to detect such abuse. After determining that a customer is a PEP, financial institutions and DNFBPs are responsible for conducting ongoing customer due diligence specifically tailored to the client’s PEP status.

What Are PEP Red Flags?

The FATF has developed a list of PEP red flags / indicators that can assist in the detection of misuse of the financial system by PEPs during a customer relationship. This list of indicators is useful in detecting those PEPs that abuse the financial system and does not intend to stigmatise all PEPs. How to interpret these indicators depends heavily on context. Often, matching one or two of these indicators simply indicates a statistically-raised risk of doing business with a particular customer, and several indicators may need to be met before serious suspicion is warranted. However, in some cases—again, depending on specific circumstances—matching just one or more of these indicators could lead directly to suspicion of illegal activity, such as money laundering.

PEPs Attempting to Shield Their Identity

PEPs are aware that their status as a PEP may facilitate the detection of any illicit behaviour. This means that PEPs may attempt to shield their identity to prevent detection. Examples of ways in which this is done are:

• Use of corporate vehicles (legal entities and legal arrangements) to obscure the beneficial owner
• Use of corporate vehicles without valid business reason
• Use of intermediaries when this does not match with normal business practices or when this seems to be used to shield identity of a PEP
• Use of PEP relatives and close associates as legal owner

Behaviors that are PEP Red Flags:

Some PEP red flags include specific behaviors and characteristics that may raise risk levels or cause suspicion:

• Use of corporate vehicles (legal entities and legal arrangements) to obscure (i) ownership, (ii) involved industries, or (iii) countries
• The PEP makes inquiries about the institution’s AML policy or PEP policy
• The PEP seems generally uncomfortable to provide information about source of wealth or source of funds
• The information that is provided by the PEP is inconsistent with other (publicly available) information, such as asset declarations and published official salaries
• The PEP is unable or reluctant to explain the reason for doing business in the country of the financial institution or DNFBP (Designated Non-Financial Businesses and Professions).
• The PEP provides inaccurate or incomplete information
• The PEP seeks to make use of the services of a financial institution or DNFBP that would normally not cater to foreign or high value clients
• Funds are repeatedly moved to and from countries to which the PEP does not seem to have ties with.
• The PEP is or has been denied entry to the country (visa denial)
• The PEP is from a country that prohibits or restricts its/certain citizens to hold accounts or own certain property in a foreign country

The PEP’s Position or Involvement in Business

The position that a PEP holds and the manner in which the PEP presents his or her position are important factors to be taken into account.

Possible PEP red flags are:

• The PEP has substantial authority over or access to state assets and funds, policies and operations
• The PEP has control over regulatory approvals, including awarding licences and concessions
• The PEP has the formal or informal ability to control mechanisms established to prevent and detect ML/TF
• The PEP (actively) downplays importance of his/her public function, or the public function s/he is associated with
• The PEP does not reveal all positions (including those that are ex officio)
• The PEP has access to or control or influence over government or corporate accounts
• The PEP (partially) owns or controls financial institutions or DNFBPs, either privately or ex officio
• The PEP (partially) owns or controls the financial institution or DNFBP (either privately or ex officio) that is a counterpart or a correspondent in a transaction
• The PEP is a director or beneficial owner of a legal entity that is a client of a financial institution or a DNFBP

Industries & Sectors that are PEP Red Flags:

A connection with a high risk industry may raise the risk of doing business with a PEP. Under the FATF’s Recommendation 1, competent authorities, financial institutions and DNFBPs are required for determining which types of clients may be higher risk. For this, financial institutions and DNFBPs will also be guided by national guidance or risk assessments. Which industries are considered at risk depends on the risk assessments and other industry safeguards that are in place and varies from country to country.

Examples of higher risk industries that are PEP red flags include:

• Arms trade and defence industry
• Banking and finance
• Businesses active in government procurement (i.e., those whose business is selling to government or state agencies)
• Construction and (large) infrastructure
• Development and other types of assistance
• Human health activities
• Mining and extraction
• Privatisation
• Provision of public goods and utilities

Product, Service, Transaction or Delivery Channels

FATF recommendations also contain examples of product, industry, service, and transaction or delivery channel factors that suggest higher risk, irrespective of the type of customer.

These examples are:

• Private banking
• Anonymous transactions (including cash)
• Non-face-to-face business relationships or transactions
• Payments received from unknown or unassociated third parties

If these industries, products, services, or transaction or delivery channels are used by PEPs, then this adds an additional risk factor (depending on the nature of the PEP). In addition to the examples already listed in the FATF recommendations, there are other products, industries, services, and transaction or delivery channels that can become particularly vulnerable when used by PEPs.

Examples of these PEP red flags are:

• Businesses that cater mainly to (high value) foreign clients
• Trust and company service providers
• Wire transfers to and from a PEP account that cannot be economically explained or that lack relevant originator or beneficiary information
• Correspondent and concentration accounts
• Dealers in precious metals, precious stones, and other luxurious goods.
• Dealers in luxurious transport vehicles (such as cars, sports cars, ships, helicopters, and planes).
• High end real estate dealers

Country Specific PEP Red Flags and Indicators

The FATF recommendations contain examples of higher risk countries and other geographic risk factors that are irrespective of the type of customer. Additionally, the following red flags and indicators relating to countries can be taken into account when doing business with a PEP:

• The foreign or domestic PEP is from a higher risk country
• Additional risks occur if a foreign or domestic PEP from a higher risk country would in his/her position have control or influence over decisions that would effectively address identified shortcomings in the AML/CFT system
• Foreign or domestic PEPs from countries identified by credible sources as having a high risk of corruption
• Foreign or domestic PEPs from countries that have not signed or ratified relevant anti-corruption conventions (or otherwise have not or have only insufficiently implemented these conventions), such as the UNCAC and the OECD Anti-Bribery Convention.
• Foreign or domestic PEPs from countries with mono-economies (economic dependency on one or a few export products), especially if export control or licensing measures have been put in place

Source: FATF Guidance on Politically Exposed Persons (2013)

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