Private investing feel like applying for space travel?

 

David Seligman
Fund Manager

 

 

 

_______________________________________________________________________________________________________

Why your private investments require more paperwork than a space launch (well, almost)

So, you’ve decided to make a new investment. Forget the leisurely stroll through the park; this is more like navigating a bureaucratic jungle, armed with a machete made of paperwork.  You’ll soon find yourself drowning in requests for documents you didn’t even know existed: proof of address, identity documents, source of funds, and if you’re investing through a company or trust, the ever-mysterious ‘ultimate beneficial owners’.

And just when you thought you were done, they ask for updated versions of everything.  Yes, the paperwork never ends.

Why, you might ask, does investing your hard-earned cash require you to provide what feels like your entire life story, financial history, and DNA sequence?  Are they expecting you to fund a secret moon base or perhaps purchase a small island to declare your own micronation?  And why the constant updates?  Do they think you change your identity or address that often?

The answer, while less exciting than a Bond villain’s plot, is crucial in the fight against some very real and very unglamorous activities: money laundering, terrorist financing, and other financial shenanigans.

The Financial Services Task Force (FATF) – The global rule maker you’ve never heard of (but should know)

This intergovernmental organisation, established in 1989, is essentially the global watchdog for dirty money.  Think of them as the financial world’s equivalent of an international superhero league, dedicated to preventing bad guys (and sometimes, let’s face it, seemingly ordinary people doing very unwise things) from using the financial system to their nefarious ends.

The FATF develops standards and promotes policies to combat money laundering and terrorist financing.  It’s their job to make sure that money isn’t being used to fund illegal activities, from drug cartels and human trafficking rings to terrorist activity.  They set the rules, and countries around the world are expected to implement them.

Why the paperwork pile-up?

Here’s where you, the investor, come in.  Financial institutions, investment firms, and anyone handling your money are required to follow these rules.  This means they have to ‘know your customer’ (KYC, in industry jargon).  It’s not that they don’t trust you; it’s that they have to prove they’ve done their due diligence.

Let’s break down the common requests:

• Proof of address: This seems simple enough, but even this can be a headache. A utility bill? A bank statement? What if you’ve just moved, live on a boat, or are a digital nomad with a complicated mailing situation? The goal is to verify that you are who you say you are and that you live where you say you live. It’s a basic step, but a crucial one.

• Identity documents: Your passport, or national ID card is to confirm that you’re not an international super-spy with multiple identities (unless, of course, you are, in which case, good luck with all this paperwork).

• Source of funds:  This is where things get interesting.  Where did this money come from?  Your salary?  Inheritance?  A lucky lottery win?  (If so, congratulations, and please be prepared to prove it!). They want to ensure the money isn’t the proceeds of crime.

• Ultimate Beneficial Owners (UBOs): The paperwork intensifies if you’re investing through a company, trust, or other legal entity.  They don’t just want to know who the company is; they want to know who owns the company, and who ultimately benefits from the investments.  This can lead to a chain of disclosures, especially with complex ownership structures. It’s like peeling an onion, except instead of tears, you get more paperwork.  The reason for this deep dive?  To prevent criminals from hiding their ill-gotten gains behind layers of corporate secrecy.

The absurdity (and necessity) of it all

It can all feel a bit absurd.  You’re just trying to invest some money, not overthrow a government.  Now imagine a world where no one asked these questions.  Money could flow freely from drug cartels to terrorist organisations, and no one would be the wiser.  The financial system would be a Wild West, where the only rule is ‘anything goes’.

The reality is that these regulations, while sometimes cumbersome, are a necessary evil.  They’re designed to protect the integrity of the financial system and prevent it from being used for nefarious purposes.

The FATF’s grand plan

So, what is the FATF trying to establish?  In essence, they’re pushing for a global framework where financial transactions are conducted with integrity, and where criminals and terrorists can’t easily use the system to fund their activities.  It’s a lofty goal, and the paperwork might seem excessive at times, but it’s a crucial part of a global effort to keep the financial system clean/ish.

The never-ending paper trail:  Why updates are required

Now, let’s address the burning question: why the constant requests for updated documents?  The answer lies in the dynamic nature of financial crime.  Money laundering and terrorist financing techniques are constantly evolving, becoming more sophisticated and harder to detect.  To keep pace, money laundering and counter-terrorist regulations must also evolve.  This means that financial institutions need to update their KYC procedures and keep their customer information current.

Here are a few key reasons for the periodic updates:

• Changing circumstances:  People move, change jobs, and their financial situations change. Updated documents ensure that the information on file is still accurate.

• New risks:  As new money laundering and terrorist financing risks emerge, financial institutions need to reassess their customer profiles and identify any potential red flags.

• Regulatory requirements:  Regulators regularly update rules, requiring financial institutions to refresh their KYC data to comply with the latest requirements.

• Enhanced due diligence:  In some cases, enhanced due diligence may be required for certain customers or transactions, necessitating more frequent updates.

In short, the periodic updates are not a reflection of distrust, but a proactive measure to maintain the integrity of the financial system in the face of ever-changing threats.

South Africa’s FATF saga:  A nation in the grey zone

South Africa, a major player on the African economic stage, knows this all too well.  In 2023, the country found itself on the FATF’s ‘grey list’, a list of countries under increased monitoring due to deficiencies in their anti-money laundering and counter-terrorist financing (AML/CFT) measures.  This was a significant blow, with potential repercussions for the nation’s economy and international standing.

The FATF’s decision stemmed from concerns that South Africa’s systems were not robust enough to prevent and prosecute financial crimes effectively. Key areas of concern included:

• Weaknesses in the prosecution of money laundering offenses.

• Insufficient measures to ensure that financial institutions and designated non-financial businesses and professions (DNFBPs) comply with their obligations.

• Challenges in identifying and seizing the proceeds of crime.

The ramifications of grey listing

Being on the grey list is more than just a slap on the wrist.  It can have several negative consequences:

• Increased scrutiny:  South African transactions face increased scrutiny from international financial institutions, leading to delays and higher costs.

• Reduced investment:  Foreign investors may become more cautious, reducing capital inflows and hindering economic growth.

• Cost of finance:  Seen as an increased risk, the South African Government will find interest rates higher, whilst being grey listed.

• Reputational damage:  The country’s reputation as a safe and reliable investment destination takes a hit.

South Africa’s race to get off the grey list

The South African Government, spearheaded by the National Treasury, is working hard to address the identified deficiencies and get the country off the grey list.  This involves a multi-pronged approach including legislative reforms, increased enforcement and improved supervision.

The South African Government has made progress in addressing many of the FATF’s concerns, and is aiming to be removed from the list as soon as possible.  The consequences of remaining on the list for an extended period could be severe, impacting the country’s ability to participate fully in the global financial system.

Why South African banks and financial institutions get fined

You might have heard about banks and other financial institutions in South Africa (and around the world) being hit with hefty fines for non-compliance with AML/CFT regulations. These fines serve as a stark reminder of the importance of these rules and the consequences of failing to adhere to them.

Financial institutions are the first line of defense against money laundering and terrorist financing.  They are required to:

• Implement robust KYC and risk management procedures.
• Monitor transactions for suspicious activity.
• Report suspicious transactions to the relevant authorities.
• Maintain adequate records.

The authorities have adopted a zero-tolerance approach where, for example an institution was fined for having an ID document of a client that hadn’t been certified as true.  The message is clear: lax controls will not be tolerated, and financial institutions must take their AML/CFT responsibilities seriously (and so should their clients!).

So, the next time you’re providing yet another document for your private investment, remember that you’re not just jumping through hoops for the sake of bureaucracy – and not just because GTC is asking.  You’re playing a small but important role in a global effort to combat financial crime and protect the integrity of the financial system.

The periodic updates are a necessary part of this effort, ensuring that the financial system remains resilient in the face of evolving threats.  For countries like South Africa, getting off the FATF grey list is a national priority, crucial for maintaining economic stability and international standing. For financial institutions, compliance is not just a regulatory burden; it’s a fundamental responsibility.