Are beneficial ownership registries the solution to money laundering?

Prosecuting money laundering requires making a connection between a crime (the ‘predicate offence’) and somebody who owns the proceeds.

Criminals hide the connection between the origin of the proceeds and their availability for use by creating a chain (and often now a network) of movements, each step of which makes it harder to connect the outcome with the origin. Traditionally, this meant moving cash into the financial system, shuffling it around, possibly internationally, and using it to buy expensive objects (cars, houses, jewels, businesses) that seemed increasingly innocent as their distance from the original crime increased.

Financial intelligence units try to follow these chains, but it’s easy to see that the advantage lies with the criminals. Adding another link to the chain is easy, but finding that it exists is much harder.

Criminals are especially interested in mechanisms that completely obscure links in the chain. Changing ownership is one way to do this. A simple way to change ownership is to put the value in someone else’s name, perhaps a spouse or relative. But the mechanism of corporate entities makes this much easier. Networks of businesses can be constructed, and own one another, making it extremely difficult to work out who is the ‘real’ owner — the so-called beneficial owner. (Concealing who really owns value is also a common tax evasion strategy.)

A proposal which is becoming increasing popular as a way to make connections more visible is to create beneficial ownership registries. These are managed by governments, and require any corporate entity to explain who the beneficial owners are; usually with some threshold requirement that this applies to any beneficial owner who owns more than 25% of the entity.

There are some practical problems with this idea. The beneficial owners have to be identifiable in a world of 7 billion people, which means that quite a lot of detail must be provided about each owner. How much of this detail should be public? The idea works better if people in other countries can see and identify beneficial owners, because moving value to another country is a good way to break the chain. But there are countervailing privacy issues, especially as most beneficial owners are not doing anything nefarious.

Each country must build and manage its own beneficial ownership registry; and how can all governments be convinced to participate? Any that do not become magnets for money laundering which may be morally objectionable, but also very profitable for their financial institutions.

The threshold also creates issues. If it is 25%, which is typical today, then only four people have to get together to create an entity whose ownership can be legitimately concealed. If it is 10% then ten participants are required to conceal ownership. This might seem cumbersome for criminals but sadly “money laundering as a service” now exists, and the organisations that provide this service have the resources to aggregate value from many different criminals and mix and match it.

So beneficial ownership registries may help stamp out a good deal of shady practice, but they may not help much with stopping money laundering.

The other way to break chains is the use cryptocurrencies. All transactions within a blockchain are visible, but what is hidden is the identity of those making the transactions. So a criminal can put value into a cryptocurrency using one identity (really a public-private key pair) and take it out again using another identity, and the chain has been completely broken (as long as the key pairs, the identities, are kept separate).

Fortunately, cryptocurrencies are not ideal as places to hold value, even briefly, because the exchange rates between them and the financial system tend to fluctuate wildly and unpredictably. Inserting and removing value is also a relatively slow process.

The bottom line is that it is easy for criminals to disconnect the crimes they commit from the value that they produce, and so the current legal basis for prosecuting money laundering is almost unusable — which the prosecution statistics bear out.

The other approach to limiting money laundering is to regulate the financial system more carefully. This includes things like limiting the ability to move cash in quantity, requiring an increasing array of agents who handle value to report transactions above a certain size or that seem suspicious, and requiring banks and financial institutions to keep track of who they’re dealing with. The problem is that the entities that are required to make reports have considerable discretion about when to do so, and considerable incentives not to because they make money from the transactions involved. The recent spate of breathtaking fines for banks that have violated money laundering rules strongly suggests that they have decided that transactions that are probably illicit but have a fig leaf of deniability are worth doing; and the fines, if they are caught, are simply a cost of doing business.

In the end, the only mechanism that can actually prevent money laundering is unexplained wealth orders, which I’ve written about before. These target the end of the chain, where criminals want to take the value produced by their crimes and use it for their lifestyle. UWOs force the recipients of value to account for where it came from, so the size and complexity of the chain doesn’t matter.