Panama Papers: What are the Implications on Hong Kong’s “Anti-Money Laundering’’ Credentials?

The Panama Papers showed Hong Kong to be a controlling node in the global network of offshore financial centres which allows individuals and companies to manage legitimate trade-flows and tax optimisation strategies, but also to squirrel away ill-gotten gains.

As the International Consortium of Investigative Journalists (“ICIJ”) selectively made public leaked documents relating to more than 200,000 offshore entities held by clients of Panama law firm Mossack Fonseca, it emerged that nearly a third of these clients were found to be in Hong Kong and the PRC.

The revelation should not be a big surprise as at least a third of direct investment into Hong Kong comes from companies principally based in the British Virgin Islands and Bermuda. There are many reasons to use such offshore booking centres – both legitimate and illegitimate – with some entities clearly using them to evade domestic capital controls in China, and others in Hong Kong benefiting from capturing funds within local stock and property markets.

Nevertheless the media spotlight on Hong Kong as a hub for offshore services was not a positive one. What it means in the grand scheme of things is unclear. Anecdotally, fund managers are suggesting the recent stock market slump reflects a general unease in using offshore entities for large investments. The Hong Kong Monetary Authority meanwhile has requested banks to appraise their clients’ exposure to the Mossack Fonseca leaks.

In its bid to convince the rest of the world that Hong Kong’s role in the Panama Papers is nothing more than guilt by association, regulatory pressure will likely fall on some of Hong Kong’s weak spots, with money laundering and its ongoing requirement to meet global standards an obvious target.

Money flows through Hong Kong are increasingly on policy-makers’ radar. As capital poured into China’s booming economy for most of the last 15 years, its monetary authorities could afford to take a lax approach. The situation has now shifted as China faces capital outflow and the senior leadership is acutely focused on anti-corruption efforts. At the same time, China wants to establish the renminbi as an international currency, epitomised by the International Monetary Fund’s recent decision to include the unit in its “special drawing rights” basket. And in this regard, Hong Kong’s status as an alleged money laundering centre does matter.

As a result, the Hong Kong government is acutely sensitive to the issues raised by the Panama Papers.  Chan Ka-keung, Secretary for Financial Services and the Treasury, recently defended Hong Kong’s “anti-money laundering’’ credentials within the Financial Action Task Force (“FATF”). Chan noted that politicians and commentators in many developed economies are quick to label countries with low tax rates and more liberal policies as money laundering havens. “This is very wrong’’ he said.

One problem is that Hong Kong is the only FATF member with no system of currency declaration or disclosure at its border. After a 2008 evaluation by FATF inspectors revealed shortcomings in its reporting mechanisms, officials agreed to provide biannual updates on its anti-money laundering and terrorist financing efforts. A progress report was given in 2012, but subsequently deadlines have been allowed to slip. Inspectors were due to make a follow up visit in April 2016 according to a disclosure by the Hong Kong Monetary Authority, but that has now been bounced to as far back as July 2018 according to the official FATF calendar with a plenary session to discuss findings slated in February 2019.

Such a delay will likely be welcomed by the SAR government as Hong Kong’s report card has some hits, but a fair few misses since the FATF’s last assessment in 2012. In the plus corner, both the number and variety of court convictions have risen and financial institutions can point to solid results from giving staff more awareness training; 42,555 suspicious transaction reports were made in 2015 compared to 37,188 in 2014. The momentum has been mainlined this year with 13,297 reports made in the first quarter (see Joint Financial Intelligence Unit Statistics).

The number of convictions for money laundering, however, is on a mildly declining trend with 27 in the first quarter of 2016 compared to 122 in 2015, 145 in 2014, 138 in 2013 and 160 in 2012. The value of assets “restrained”, or interceded but not ceased, varies greatly depending on the complexity of the prosecution: in the first quarter of 2016 the figure was a fairly insignificant HK$73.5 million compared to HK$341.5 million in 2015, HK$418.9 million in 2014 and HK$873.4 million in 2013 (see Joint Financial Intelligence Unit Statistics).

Moreover, actually seizing assets on behalf of the government has proven difficult. The authorities had a big win in 2013 when HK$645 million was secured, but this masks a generally weak performance. In the first quarter of 2016 just HK$1.3 million was secured versus HK$55 million in 2015 and HK$23.6 million in 2012 (see Joint Financial Intelligence Unit Statistics).

At the same time the regulatory focus has widened in recent years. With enactment of the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (Cap. 615) (the “AMLO”) in 2012, law enforcers are increasingly targeting frontline gate-keepers.

Shortcomings in customer due diligence have resulted in a number of prosecutions over the past 18 months, with the rate gathering pace. The majority appear to have been money service operators rather than high-profile banks, and the tenor of the charges suggest an initial “low hanging fruit” line of attack.

In April 2016, for example, a money service operator was convicted at the Eastern Magistrates’ Court for breaching the licensing requirements of the AMLO, resulting in a fine of HK$4,000. In June 2015, a money service operator was sentenced to 200 hours of community service at Fanling Magistrates’ Court after pleading guilty to 12 charges of failing to comply with the customer due diligence and record-keeping. Other prosecutions have resulted in fines, public reprimands and appeared to result from compliance inspections conducted by Customs & Excise officers.

Despite these gains, high-profile legal setbacks may derail Hong Kong’s FATF report card. At the time of going to press, Carson Yeung’s final appeal has been heard at the top court (May 31 to 2 June 2016).

Yeung was granted leave to appeal (HKSAR (applicant) v Yeung Ka Sing, Carson (Respondent), FAMC 28&29 of 2015) in August last year. The fact that Yeung was granted bail pending the outcome has prompted optimism among critics of Hong Kong’s “draconian” money laundering laws that a robust overhaul would ensue.

Yeung was convicted of five charges of dealing with property known or believed to represent the proceeds of an indictable offence, by using five bank accounts to launder HK$721 million between 2 January 2001 and 31 December 2007, contrary to s. 25(1) of the Organized and Serious Crimes Ordinance (Cap. 455) (“OSCO”).

One of the issues to be dealt with was whether the prosecution must prove that the proceeds (the “property’’) being dealt with in a money laundering charge derives from a criminal act. Heavy criticism has been meted out for the approach taken in Hong Kong. In the UK, the prosecution must prove a predicate offence.

One of the questions posed in Yeung’s appeal is whether Oei Hengky Wiryo v SAR (No. 2) (2007) 10 HKCFAR 98 was wrongly decided on this issue. The mens rea for the offence was also under scrutiny and the operation of the rule against duplicity was also to be considered. If it is felt by the CFA that this is not a safe conviction, it remains to be seen in what kind of shape the ordinance emerges. Should prosecutors have to prove a predicate offence, the bar for a conviction would be set significantly higher.

In theory, one area of progress Hong Kong should be able to report to the FATF is a system for cross-border currency disclosure, after it was labelled as non-compliant back in 2012 due to an inadequate system for disclosing and declaring cross border transactions.

FATF did credit Hong for its April 2012 initiative to adopt a mixed system of declarations for inbound passengers and disclosure for outbound ones, setting the threshold for reporting at HK$120,000. The global watchdog lauded this “fast-track” approach as it expected the legislation to be presented “within 2014.” However, it was not until 2015 that a public consultation was carried out.

Given the challenges posed by Hong Kong’s polarised legislature, the fact that lawmakers baulked at the very idea of a declaration system does not bode well for legislation passing any time soon. Already tourism industry figures have spurned the plans as mainland visitors tend to shop using large sums of cash. Lawmaker Christopher Chung Shu-kun commented last year that HK$120,000 “is not even enough to buy a watch.”

The latest update came in February 2016 when it was stated that the Security Bureau would collate feedback with a view to implementing the system, although no time frame was given. The impression was given of the issue being left in the long grass.

Arguably, it would be easier to focus on Hong Kong’s deep bench of legal and accounting professionals. Designated Non-Financial Businesses and Professionals (“DNFBPs”) featured prominently in the 2012 report and in particular the disparity between sanctions the various professions face.

It was noted that DNFBPs were reticent to submit reports. There has been progress on this front – while in 2007 there were just nine suspicious transaction reports (“STRs”) by lawyers, three from accountants and five from trust and company service providers (“TCSPs”), in 2015 the legal sector provided 894. The increase for accountants and TCSPs was less impressive, with the professions providing six and 22 STRs respectively in 2015 (for the 2007 figures, see FATF Mutual Evaluation of Hong Kong, China, 19 Oct 2012, p. 33; for the 2015 & 2016 figures, see Joint Financial Intelligence Unit Statistics).

Perhaps the most pressing question is what will be the catalyst to shift Hong Kong’s somewhat anomalous approach to cross-border financial reporting. The betting must be that Beijing will increasingly want to regulate such monetary flows both from the perspective of macro-prudential financial stability and anti-corruption initiatives. As the country seeks to become a top-tier financial player it will be pulled toward the adoption of international norms, and so pressure will fall on Hong Kong to become truly FATF compliant.

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Jane Moir is a Director at FTI Consulting’s Global Risk and Investigations practice in Hong Kong.