Russian sanctions highlight the importance of ongoing AML/KYC monitoring

Although private funds are not subject to AML regulations, a CSC webinar outlined best practices for customer due diligence amid heightened investor scrutiny

As the crisis in Ukraine continues and the list of sanctions against Russia-linked entities grows, ongoing risk mitigation in anti-money laundering programmes becomes more important.

Although private funds are not subject to AML regulations, banks and other financial institutions are, and they will pass the burden onto private fund managers, according to a recent webinar. That means they will expect managers to have proper controls, and to know their customers and the source of their funds, as will as fund interests’ beneficial owners.

During the AML and KYC Compliance Considerations for Private Capital Fund Managers webinar hosted by CSC Global and the Financial Executives Alliance, Jared Barnes, senior vice-president and head of AML operations at First Republic Bank said while it has traditionally been uncommon to provide detailed investor information to banks and other financial institutions, entities subject to AML regulations are going to start requiring this information, and requiring private fund manager clients to have a robust AML program.

“Using today’s geopolitical events as an example, if you were to launch a new fund, one thing your institution will want to know is if you have any Russian oligarchs as LPs. Sanctions are coming out weekly, or more frequently, so your financial institution is going to try to evaluate how that is going to impact them,” Barnes added.

Barnes explained that under the AML Act of 2020, all US financial institutions must have programmes in place to comply with Bank Secrecy Act and AML requirements, as well as any in-place sanctions. Financial institutions must know their customers and, where there is a higher risk of money laundering or other suspicious activity, must also conduct due diligence on their customers’ customers.

Although banks and other financial institutions are required by law to identify the true owners behind investments and report any red flags, private equity firms are not. That’s something that has concerned regulators and government agencies for years.

In May 2020, the FBI stated in a leaked intelligence bulletin that it believed nearly $10 trillion in private investment funds, specifically private equity and hedge funds, were being used as vehicles for laundering money. As an example, the FBI pointed to an unnamed New York-based private equity company that took in more than $100 million from a Russian business with alleged ties to organised crime.

Despite these concerns, the AML Act of 2020 largely left private investment funds out of formal regulation.

Chalene Ellis, director of operations and compliance, US Funds services at CSC, said that ongoing risk mitigation is important given current political issues, and the ongoing crisis in Ukraine magnifies the importance of doing risk assessments on an ongoing basis, and not just when onboarding investors.

“One of the most overlooked and least mitigated steps of an AML due diligence programme is constant monitoring,” Ellis said. “You need to be continually screening investors, their underlying beneficial owners, and all associated parties to capture any changes in behaviours and changes in affiliations that may deem the account to be high risk.”

Ellis pointed to the ongoing conflict with Russia and Ukraine, which has prompted numerous sanctions from multiple countries with regard to Russia-affiliated parties, banks and entities, as to why it is important for PE sponsors to screen for such changes.

“If you’re only doing your screening during onboarding, then should someone appear on a sanctions list post-investment, you have no way of qualifying, quantifying and validating that an account should or should be transacted with… If you do not have a way to continuously monitor, then you are leaving yourself open to possibly having high-risk accounts on your books and in your business.”

And having high-risk accounts can leave firms open to reputation risks, fines and the discontinuation of operations. A number of private funds have been disentangling themselves from Russia-linked investors and investments. For example, Pamplona Capital Management began divesting its interests in LetterOne, a private investment company founded by Russian oligarchs.

Private funds have historically relied on the five pillars of an AML/KYC program when onboarding LPs. The five pillars include internal policies, procedures and controls; designation of an AML officer; employee training; independent testing; and customer due diligence. But ongoing due diligence is increasingly being seen as the sixth pillar, according to Ellis.

“Make sure you are continually monitoring accounts, continually screening investors and their underlying beneficial owners, and all associated parties to capture any changes in behaviours or changes in affiliations that may then deem the account to be high risk,” Ellis advised.