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The IBA’s response to the situation in Ukraine
While it’s been a favoured destination for affluent Russians and their wealth for some time, Global Insight assesses the sudden and growing pressure to keep this source of dirty money out of the City.
Wealthy Russians are a familiar feature of London life. Buying luxury townhouses. Investing in Premier League football clubs. Playing out disputes in the capital’s courtrooms. But, with heightened diplomatic tensions and United States sanctions, the time appears to have come for United Kingdom legislators to tackle the illicit wealth that’s been swilling around the capital for so long.
Evidence of the extent of these illicit flows abounds. In August 2014, for example, the Organized Crime and Corruption Reporting Project revealed a vast money-laundering scheme, involving 21 companies moving $20bn of illicit Russian funds through banks into Europe, the US and elsewhere. Dubbed ‘The Russian Laundromat’, approximately $738m is estimated to have found its way into the UK via some of its best-known banks between 2010 and 2014.
That scandal caused a furore, but is by no means unique. In January 2017, the UK’s Financial Conduct Authority (FCA) fined Deutsche Bank for its role in failing to prevent $10bn being laundered through so-called ‘mirror trading’ between Moscow, London and New York to offshore bank accounts in Cyprus and the British Virgin Islands. The FCA imposed a record £163m fine on the bank for not maintaining adequate anti-money laundering controls and said the bank had ‘exposed the UK financial system to the risks of financial crime’.
In September 2017, in response to such scandals, the UK government enacted the Criminal Finances Act. It’s designed to give law enforcement agencies greater powers to recover the proceeds of crime, tackle money laundering, tax evasion and corruption, and combat the financing of terrorism. Notably, it makes companies liable for failing to prevent employees from engaging in or facilitating tax evasion.
The UK’s National Crime Agency (NCA) estimates that up to £90bn of illicit funds are laundered through the country each year. ‘It’s clearly the case that a lot of illicitly gained money is parked or used in the UK,’ says Matthew Getz, a partner at Boies Schiller Flexner. ‘But, laundering of money in the UK is not just a Russian issue’
Christopher David, counsel in WilmerHale’s UK White Collar Defence & Investigations Practice, agrees that many other countries are similarly at fault. ‘Russia is obviously a problem, but so is China, most of the Middle East and there have been some recent cases involving India,’ he says. ‘Russians are quite visible in London, but there are plenty of other people who, perhaps sensibly, keep themselves less visible, but are equally challenging from a money-laundering point of view.’
In May, a report by the UK House of Commons’ Foreign Affairs Committee – entitled Moscow’s Gold: Russian Corruption in the UK – heavily criticised the UK government for turning ‘a blind eye to London’s role in hiding the proceeds of Kremlin-connected corruption’. The report said this was in sharp contrast with the government’s outwardly critical response to Russia’s alleged role in the nerve agent attack on former double agent Sergei Skripal and his daughter Yulia in Salisbury two months earlier.
The report also calls on the UK government to ‘sanction more Kremlin-connected individuals’. But, Getz notes it stopped short of saying London should cut off its financial ties with Russia altogether. ‘The report lacks the courage of its convictions, in a way, as it says we shouldn’t stop the trading of Russian bonds but we should put in certain half measures making sure that people can’t trade in Russian bonds,’ he says. ‘I understand the reluctance of governments to take a step like that as that partially cuts Russia out of the world economy. This is what they were trying to do with Iran for some time and it’s a lot harder to do it with Russia than with Iran because it’s a much bigger economy, it’s much more closely connected to the UK and it also sells gas to much of Europe. I don’t think this is greed or cowardice. We live in an interconnected world and we can’t just do what we want.’
Maya Lester QC
Barrister, Brick Court Chambers
Many of London’s top law firms and chambers have Russian clients, whether they’re being instructed on their initial public offerings, mergers and acquisitions or investment disputes. The Foreign Affairs Committee’s report curiously chose to single out magic circle firm Linklaters for its role in ‘facilitating’ the flotation of Russian aluminium and hydropower business En+ Group on the London Stock Exchange in November 2017. En+ is one of many Russian companies listed in London, but the report referenced the company because its owner, Oleg Deripaska, features among more than two-dozen Russian companies and individuals targeted on the most recent US sanctions list. Deripaska has since resigned from the company’s board and is in the process of selling down his stake in a bid to persuade the US government to lift the sanctions.
Linklaters says in a statement that it is ‘very surprised and concerned at the passing criticism’ of the firm in the report, but declined to provide further comment. A spokesperson for the Foreign Affairs Committee refused to shed any light on why Linklaters, and not White & Case, which advised En+ on the listing, was referenced in the report. Global Insight put this to White & Case, but the firm also declined to comment.
Jessica Parker is a partner at corporate crime specialists Corker Binning and Senior Vice-Chair of the IBA Business Crime Committee. ‘It was the same with the Panama Papers and tax transparency, which led to a lot of criticism of law firms and accountants that advise on aggressive tax litigation,’ she says. ‘This type of criticism tends to come from Parliamentary committees, but it’s the job of lawyers to advise on the law… It’s for Parliament to draw the lines and for lawyers to advise within those lines. If Parliament doesn’t want these kinds of deals happening in London then they need to legislate to stop them.’
Maya Lester QC, a barrister at Brick Court Chambers, says the report is right to query the lawfulness of such transactions.
‘I think it’s certainly fair to say that the UK could start questioning more than they have done until now the source of Russian money, and precisely the boundaries of what’s lawful and what isn’t when it comes to Russian investment in London,’ she says. ‘It’s fair of course to suggest new ways in which Russian sanctions could be designed or could be strengthened, including by extending sanctions to bonds and sovereign wealth. But beyond that there doesn’t seem to have been adequate recognition of the fact that this is a bit of a change of approach and that it’s a bit unfair to criticise people and firms who, in the past, have been advising Russian clients in a perfectly lawful way, and that the government’s approach has been to welcome Russian investment in the UK.’
The UK government’s ‘golden visa’ regime, for example, has enabled wealthy foreign investors to reside in the UK for 40 months in exchange for investing at least £2m in UK bonds or shares. More than 700 Russian investors are understood to have entered the UK under the Tier 1 visa scheme between 2008 and 2015. In April 2015, the government introduced tougher checks, scrutinising the source of applicants’ wealth for the scheme, but applicants were still eligible to apply for indefinite leave to remain and even full citizenship after five years. The Home Office announced in March that it was reviewing the scheme. One of the most prominent Tier 1 visa recipients, Roman Abramovich, owner of Chelsea Football Club since 2003, is understood to be waiting for the Home Office to renew his visa, which expired in April.
The impact of America’s latest sanctions on Russia has been far-reaching. Companies in the UK and elsewhere are scrambling to work out how they affect them. ‘Law firms, and to some extent barristers, are having to think very carefully about exactly what they can or can’t lawfully do when it comes to Russian clients with any sort of relationship to US sanctioned entities in a way they may not have had to grapple with before,’ says Lester.
Currently, the UK can’t issue sanctions without the consent of the other 27 European Union Member States. ‘The recent US sanctions have got everyone in Europe thinking “should we pull back as well?”’ says Getz. ‘As to whether there would be more sanctions against Russia by the UK in conjunction with the EU or the UK acting alone, it’s really hard to tell. I think it’s doubtful that after March 2019 the UK is going to institute significant new sanctions that the EU are not doing as well.’
Manuel Lafont Rapnouil, Senior Policy Fellow at the European Council on Foreign Relations, says recent events have shown that business interests, specifically the City’s interests, have been a significant factor in the UK’s approach to sanctions. ‘There were some sanctions provisions that would have hit UK financial interests and the City’s interests,’ he says. ‘The UK was not willing to go in that direction for national reasons. In short, there are things that the UK wanted to do and things that it didn’t want to do and the City is a good example of where the UK government draws the line.’
Russian sovereign bonds are currently not subject to UK sanctions and the Skripal attack in March and subsequent expulsion of 23 Russian diplomats did nothing to put off investors. Russia successfully raised $4bn in Eurobond issuances on the London market less than a fortnight after the attack. The bookrunner, VTB Bank, also has a stake in En+, which was subject to US sanctions at that time. But, under UK law, that didn’t prevent it from acting as a bookrunner on the deal. The Foreign Affairs Committee’s report criticises this ‘loophole’ in the EU sanctions regime. And it seems unlikely the UK government would allow the City to take the hit under a post-Brexit sanctions regime.
A key question is whether law enforcement will be granted the necessary resources to investigate the origins of dirty money. Unexplained wealth orders (UWOs) are one indication that things could be moving in the right direction. This tool was introduced under the Criminal Finances Act and has been employed since the beginning of 2018 to force wealthy individuals to explain how they acquired assets over £50,000. Research by Transparency International indicates that approximately £4.4bn of the UK’s property is linked to suspicious wealth, with an estimated £880m linked to Russian individuals.
Robert Amaee is head of white-collar crime and corporate investigations at Quinn Emanuel Urquhart & Sullivan and former head of anti-corruption at the Serious Fraud Office (SFO). He believes UWOs could have a dramatic impact. ‘It shifts the onus,’ says Amaee. ‘If they fail to explain it, then the asset becomes presumed criminal property and may be seized under existing proceeds of crime legislation.’
The NCA says the aim of UWOs is ‘to reduce the attractiveness of the UK as a route to invest proceeds of corruption and illicit finance’ and is considering UWOs in relation to as many as 140 individuals. ‘That process is ongoing and we’re very much at the stage of testing the legislation,’ an NCA spokesperson told Global Insight. ‘Until we’ve successfully got the first ones through court, we wouldn’t expect to see a large number being applied for. Once we’ve tested the case law and got it in place we’ll be in a better position to progress.’
Partner, Boies Schiller Flexner
A spokesperson for the NCA wouldn’t confirm how many Russian cases were being investigated, but said: ‘We target on the basis of criminality, not nationality. A significant number are related to Russian nationals or nationals linked to Russian politically exposed persons (PEPs), not the majority by any means, but equally there are a wide range of other nationalities where we’re looking at the use of UWOs as well.’
Not all illicit funds entering the UK are invested in property, of course. And David questions how the UWOs would apply to alleged corruption and recipients of bribes overseas before they reach UK shores. ‘I’m not sure which enforcement agency is going to take the lead and go after those people. I know the SFO and NCA would have the authority to do this, but at the moment I just wonder if that will be high on their list of priorities,’ he says.
On 23 May, the UK gave Royal Assent to the Sanctions and Anti-Money Laundering Bill, marking a significant step towards the UK government establishing an autonomous sanctions regime once the UK leaves the EU in March 2019.
As a member of the EU, the UK currently operates the EU sanctions regime and only has a limited sanctions regime of its own, which is confined to targeting terrorism and related activities. The Act ensures that once the UK leaves the EU it will have a framework in place that gives the UK government the authority to impose, amend or lift sanctions independently from the UN or the EU without breaching its international obligations.
After the nerve agent attack on former Russian double agent Sergei Skripal and his daughter in Salisbury in March 2018, a so-called ‘Magnitsky’ amendment was added to the bill. The amendment was designed to allow the UK government to impose asset freezes, visa bans and publicly name individuals involved in gross human rights abuses and corruption. The long-awaited provision follows in the footsteps of the US Magnitsky Act, a law originally adopted by President Barack Obama in 2012, and named after Russian lawyer Sergei Magnitsky, who died in pre-trial detention in a Moscow prison cell in 2009 after exposing a large-scale tax fraud.
Bill Browder, Magnitsky’s client and the Chief Executive Officer of Hermitage Capital Management, was instrumental in convincing US lawmakers to use the Magnitsky Act as a tool for dealing with ‘bad guys from Russia’. ‘Most recently they took the exact same tool and applied it to the Russian oligarchs,’ he says. ‘What I’ve done is I’ve set up the technology for dealing with Russia. And the reason why it works so well is that the people in Russia who do these terrible things – who are involved in human rights abuses, who are involved in invading countries, who are involved in cheating in elections – these people all steal a lot of money in Russia and keep that money in the West.
By going after them in a targeted way it hits their Achilles’ heel. So it’s been a dramatic exercise in creating a new policy tool to deal with Russia.’
Britain, Canada, Gibraltar, Estonia, Latvia and Lithuania and have already introduced similar legislation. Although Browder is disappointed the UK has taken so long to follow suit, he said the Skripal attack gave the government no choice but to act. ‘All of the Magnitsky Act work had been lined up and put into play and had more or less been accepted before the whole Skripal poisoning,’ he says. ‘However, the devil is always in the detail. The government in these situations always tries to water down and make tough laws a little less tough because it makes their lives easier. In this particular case they had no political branch to stand on. There was a state-sponsored terrorist attack using chemical weapons in Salisbury, so there’s no way any member of the government could stand up in Parliament and say they need to loosen this law to make it less restrictive.’
Parker points out that enforcement is key. ‘The agencies have lots of powers, but many of the changes are just subtle shifts of what’s happened before,’ she says. ‘The real message is more enforcement is required.’ The formation of the Office of Financial Sanctions Implementation (OFSI) in March 2016 could be one solution in this area, says David. ‘I think where we’ll see more of an effect before unexplained wealth orders is that there is a new sanctions enforcement office in the UK,’ he says. ‘Historically there’s been very little sanctions enforcement, but I think that’s going to change. There are certainly more investigations going on at the moment.’
Rae Lindsay is a partner at Clifford Chance and a member of the IBA Legal Policy & Research Unit economic sanctions working group. ‘Under OFSI now there’s this possibility for a civil penalty regime, which falls short of the necessity for prosecution and actual criminalisation of behaviours, but also allows the imposition of civil penalties, which might be an effective deterrent,’ she says. ‘That’s a shift and is taking some of the aspects of the US enforcement model and bringing those into the UK.’
While there are concerns about how much Russian money is circulating around the UK, recent research by Global Witness indicates nearly five times as much Russian money is invested in the British Overseas Territories (OTs). Anastasia Nesvetailova, a professor of international political economy at City University, London, says the offshore world is the chief conduit for dirty Russian money entering London’s financial markets. ‘Any dirty Russian money is being cleaned on the way to London through a very complex set of arrangements, involving offshore shells, facilities, various corporate names – many of them artificial or very intricate – and it is being cleaned on the way here.’
Global Witness estimates that around £68bn from Russia has been invested in the OTs over the past decade, making them the most popular ‘safe haven’ for Russian money after Cyprus and the Netherlands. This creates a clear challenge for UK law enforcement battling to keep illicit funds out of the country. One solution may come in the form of the new Sanctions and Anti-Money Laundering Act (See box: UK gets Magnitsky Act to take on Russia’s ‘Bad Guys’). This contains a specific provision requiring any OTs to establish public registers that reveal the individuals behind companies based there by the end of 2020. The move has not been welcomed by some OTs and the government of the British Virgin Islands has even launched a legal challenge to the provision, claiming the register would pose a risk to the territory’s economy and raises serious constitutional and human rights concerns.
Partner, Corker Binning; Senior Vice-Chair, IBA’s Business Crime Committee
Nesvetailova believes public registers will help clamp down on anonymous investors and shell companies investing in UK assets. ‘Unless there is a full transparency of beneficial owners there is always a way, at least in the short-term, to hide the real ownership of assets,’ she says. ‘To have any use for fairness, public scrutiny or even democracy, it can only work once overseas territories stop fighting back and this can only work if British Overseas Territories open up.’
The government has also published draft legislation requiring overseas companies buying UK residential or commercial property to disclose the identity of the ultimate owners. The public beneficial ownership register is expected to be launched in 2021. David agrees beneficial ownership will enable advisers to keep greater tabs on where invested money is really coming from. ‘The beneficial ownership register will be helpful for regulated businesses, so primarily for banks and lawyers, in tightening up their Know-Your-Customer money-laundering checks, which at the moment are good, but sometimes you get so far up the chain and it becomes very difficult to find out who is ultimately the beneficial owner.’
Measures like these look good on paper, but some are sceptical as to how willing the City is to relinquish wealth that has helped make it the biggest financial centre in the world. ‘There’s a desire by the government to forge ahead down the path of outing beneficial owners of companies that hold UK assets, and by law enforcement to make increasing use of UWOs, but there’s also a sensitivity as to how that might impact on future investment into the UK and the wider economy, in particular post-Brexit,’ says Amaee.
Even if all OTs do agree to create public registers, Nesvetailova says this will leave some segments of the offshore world untouched. ‘These aren’t British Overseas Territories, but they do provide a service and so the chances are that those illicit financial flows will simply be redirected through them,’ she says. The pertinent question is, she says, ‘To what extent will Western financial institutions close the door to those links?’
Ruth Green is Multimedia Journalist at the IBA and can be contacted at email@example.com