Banking & Finance Update - July 2006

• AML/CTF – impact on the mortgage industry

• Are all mortgage preparation services the same?

AML/CTF – IMPACT ON THE MORTGAGE INDUSTRY

A revised exposure draft of the AML/CTF bill and draft rules were released for comment on 13 July 2006.

There is still no indication as to when the new law will commence, and the industry is pressing for a significant lead-in time to allow systems and procedures to be developed.

The key changes for the mortgage industry are summarised below with a focus on the impact they will have on the mortgage industry.

Although customer identification was always prudent business practice, it was only compulsory under the Financial Transactions Report Act (FTRA) for Authorised Deposit-taking Institutions (ADIs), such as banks, building societies and credit unions. The obligations under the FTRA were generally discharged by conducting a 100 point check or as 21 reference check.

The new law will require all lenders to conduct customer identifications, maintain 'know your customer' (KYC) practices and develop a written AML/CTF Program.

The ability to appoint external agents to conduct customer identification is of keen interest to the mortgage industry due to the extensive use of mortgage managers and brokers.

The Act restricts the appointment of external agents by a reporting entity to three levels as follows.

• the provider of the designated service, including its internal agents

• the primary agent

• a sub-agent

• a sub-sub-agent.

Agents must be appointed in writing and the agreement must contain certain prescribed provisions. There is no need for written authorisation for internal agents (eg. employees and company office bearers), however they must be specifically authorised to carry out identification procedures.

The agreement must be with the next person up in the reporting chain (eg. the sub-sub-agent agreement will be with a sub-agent).

Due to the significant intermediarisation in the mortgage industry, the delegation to sub-sub-agents may be too restrictive. The MIAA is pressing for its members to be accredited, under the Rules, to conduct customer identification on behalf of lenders. If accreditation is not granted, some distribution channels will need to be rationalised so that the chain between the reporting entity and the broker carrying out the identification is no greater than a sub-sub-agency.

The proposals do not contemplate a standard identification regime (like the 100 points) so,there is a risk of inefficiency and increased cost if lenders prescribe different regimes.

Under the exposure draft, information cannot be freely exchanged between agents and the principal, although a primary agent, sub-agent and sub-sub agent may share information with the reporting entity. We will be arguing that freedom of information exchange is essential.

A summary of the key provisions impacting on the mortgage industry is annexed.

The second consultation period expires on 3 August 2006. Submissions are likely to include the following:

• MIAA members with PI and EDR membership should be accredited identifiersa suggested standard for lenders to avoid a multitude of procedures

• exemption from the regime for businesses (or at least small businesses) paying cash wages

• free exchange of information between agents and origination groups is essential, and the provisions allowing this need to deal with how outsourcing works

• responsible entities should not be liable for their agents as this will create a bias against outsourcing

• lending and guaranteeing should only be designated services when provided by entities in the business of lending or guaranteeing

• record keeping requirements need to be rationalised, especially the obligation to keep all documents in connection with the provision of a designated service.

OUTLINE OF PROPOSED REGIME FOR THE MORTGAGE INDUSTRY

The legislation establishes reporting entities who are financial institutions or other persons that provide designated services.

The definition of designated service is complex and includes descriptions of 76 different types of activities. The relevant designated services for the mortgage industry are:

Item 6 – "making a loan, where the loan is made in the course of carrying on a business"

Item 7 – "in the capacity of lender for a loan, allowing the borrower to conduct a transaction in relation to the loan where the loan was made in the course of carrying on a business".

Other finance activities which are designated services include:

• factoring receivables

• leasing goods under a finance lease or hire purchase

• trading in bills of exchange, promissory notes, or letters of credit

• the issue of a bearer bonds but only at the time of redeeming the bearer bond

• issuing a life policy or sinking fund policy

• guaranteeing a loan, where the guarantee is given in the course of carrying on a business or making a payment under a guarantee, where the guarantee was given in the course of carrying on any business

• delivering physical currency to a person, including pay-rolls, where the service is provided in the course of carrying on a business (this will catch all employers who pay employees in cash).

When must customer identification occur?

A reporting entity must conduct customer identification before providing a designated service except for some special cases, as follows.

existing customers – there is no requirement to re-identify existing customers unless, after the commencement of the new law, the reporting entity becomes aware of a suspicious matter. In this case the reporting entity must not continue to provide any designated services until the customer identification procedure has been conducted or the reporting entity takes other action as specified in the Rules – s27A;

low-risk designated services – the reporting entity does not need to conduct identification before providing certain low-risk services as specified in the Rules but must not continue to provide the service once a suspicious matter reporting obligation arises. In such a case, the reporting entity must carry out the identification procedure or take such other action as specified in the Rules – s28A. At this stage no 'low-risk' designated services have been specified in the Rules.

special circumstances – the Rules may specify special circumstances that justify carrying out identification after the service commences – s30. At this stage no such services have been specified in the Rules. In these circumstances, the identification must occur within the period specified in the Rules or five business days after commencement of supply – s31.

What must be reported?

Reporting entities must report suspicious matters to Austrac. A suspicious matter reporting obligation occurs if: a reporting entity or any of their agents or a person accredited to conduct identity verification suspects that:

• a person is using a false identity

• information received may be used in connection with the breach, or attempted breach, of a taxation law or an offence against any law of a Commonwealth or a state or territory

• information received may be of assistance in the enforcement of the Proceeds of Crime Act

• the designated service may be preparatory to financing of terrorism or money laundering.

The report must be given to Austrac within three business days of forming the relevant suspicion or 24 hours in the case of terrorism or money laundering.

AML/CTF compliance reports

A reporting entity must, within the period specified in the Rules, provide Austrac with a report on the reporting entity’s compliance with the Act during the reporting period, as specified in the Rules. The reporting entity is not excused from providing a report if it is self incriminating, however the report itself cannot generally be produced in evidence.

A reporting entity will not be able to provide designated services unless it has adopted an AML/CTF program. The program must be subject to regular independent review.

The AML/CTF program must be designed to identify, mitigate, and manage the risk that through the provision of a designated service might facilitate money laundering or financing terrorism.

A reporting entity must retain the customer identification procedure for seven years after the end of the relationship with the relevant customer. Agents must do the same.

If a customer gives the reporting entity any document relating to the provision of the designated service, the reporting entity must retain the document for seven years. Under the FTRA, only certain documents need be retained. This is a significantly increased obligation.

A reporting entity must monitor the provision of designated services with a view to identifying mitigating and managing the risk of money laundering or financing terrorism in accordance with the Rules – s33A. Customers have to be re-identified if an event in the Rules occurs – s32.
By Jon Denovan & Vicki Grey, Sydney

This publication is provided to clients and correspondents for their information on a complimentary basis. It represents a brief summary of the law applicable as at the date of publication and should not be relied on as a definitive or complete statement of the relevant laws.