18 April 2016
What you need to know
- Recent days have seen intense media focus on the so-called "Panama Papers", documents leaked from a Panamanian headquartered law firm that detail the use of offshore structures by world leaders, politicians, celebrities and others.
- The International Consortium of Investigative Journalists (ICIJ), which was instrumental in reviewing and reporting on the documents, suggests that Hong Kong was a core market for the Panamanian firm, with the largest number and most active "intermediaries" it used being based here.
- Regulators in a number of other jurisdictions, including both the UK and Switzerland, are actively and publicly scrutinising relationships between financial institutions and the Panamanian law firm. Given Hong Kong's prominence in the dealings of the Panamanian law firm and the ICIJ's statement that it will release a database of offshore entities and associated individuals in early May, similar regulatory scrutiny in Hong Kong is likely.
What you should do
- While the use of offshore structures is commonplace in Hong Kong, coverage of the Panama Papers raises the issue of whether anti-money laundering (AML) obligations have been complied with when assisting clients in creating offshore structures.
- Financial institutions should closely monitor coverage of the issue to see whether they, or their clients, become a focus. Hong Kong self-reporting obligations should be considered and the ability to promptly respond to any regulatory enquiries assessed.
- Where a request for information is received from an overseas regulator, given the general desire of local regulators for equality of information, consideration should be given as to whether Hong Kong regulators ought to be notified of the fact of the request or the substance of the response provided.
- In an age where mass data leaks appear to have become a regular occurrence, financial institutions should also closely review their AML policies and procedures. While it is not possible to change the past, those responsible for AML functions within firms should be confident that today's processes and practices will withstand future scrutiny.
What are the Panama Papers?
The Panama Papers are documents purported to have been leaked from a Panamanian headquartered law firm related to the use of offshore structures. The documents are said to range in time from 1977 to 2015. In total, it is said that approximately 11.5 million documents contained in 2.6 terabytes of data were leaked.
The current focus of media attention relates to the use of offshore structures by world leaders, politicians and celebrities. The ICIJ acknowledges that the use of offshore structures is, of itself, not problematic or illegal. The focus of reporting is therefore to expose the use of offshore holdings by world political leaders, money laundering and tax evasion. The tone is often salacious and could be viewed as highlighting concerns over the morality of transactions, as opposed to their legality. Whether any legal or regulatory standards have been breached by the use of an offshore structure would require careful analysis of the particular facts surrounding the structure and the laws of the jurisdictions involved.
The ICIJ's website states that it will focus its reporting on stories that are "in the public interest" and that it will not release personal data en masse. However, it has also stated that in early May it will release the names of more than 214,000 offshore entities incorporated by the Panamanian law firm, along with people connected to them as shareholders, beneficiaries or directors.
In addition to the media coverage of issues surrounding the use of offshore structures by high- profile individuals, coverage of the Panama Papers has inevitably led to the media and politicians raising broader questions about the general propriety of offshore structures. That focus may result in regulatory reforms that have broader impacts on the offshore industry in the months and years to come.
How do the Panama Papers relate to Hong Kong?
While leaked data encompasses individuals and businesses globally, Hong Kong appears to have been a core market for the Panamanian firm. The ICIJ's analysis of the data suggests that of the 14,000 "intermediaries" (defined by the ICIJ as banks, law firms, company incorporators and other "middlemen") used to set up offshore entities for clients, 2,212 were based in Hong Kong. The UK ranked second with 1,924 intermediaries, and Switzerland third with 1,223. The Hong Kong intermediaries were also the most active, accounting for 37,675 of the 214,000 offshore companies incorporated by the Panamanian law firm.
Those familiar with Hong Kong's financial sector are unlikely to be surprised by these figures. The use of offshore entities has been common in Hong Kong since pre-handover times, when individuals and businesses were concerned about the potential impacts that the resumption of Chinese sovereignty might have. Their use has remained popular for a variety of reasons, and the majority of companies currently listed on the Hong Kong exchange are incorporated in offshore jurisdictions. As Hong Kong's tax regime only imposes tax on profits sourced in Hong Kong, the issue of tax evasion is less relevant in Hong Kong than for other jurisdictions where tax is imposed on an individual or corporate entity's worldwide income and assets.
What risks for financial institutions have been created by the leak?
While there are numerous legitimate purposes for individuals and corporates to use offshore structures, the leaking of the Panama Papers creates a number of potential risks for financial institutions operating in Hong Kong.
One of the main allegations of the ICIJ's coverage of the issue is that the Panamanian law firm agreed to conduct a "lite" form of due diligence on the clients of a number of banks. While this allegation is not Hong Kong-specific, it nonetheless raises a broad issue of whether client due diligence has properly been carried out and AML requirements complied with.
The current focus of the ICIJ's reporting on political leaders also creates particular risks for financial institutions whose private wealth teams have been dealing with politically exposed persons (PEPs). While interactions with PEPs may have been fully compliant and due diligence requirements on both the individuals and the source of their funds satisfied, there remains a risk that such dealings will still attract media scrutiny. Coverage to date has focused on the moral propriety of the use of offshore structures by certain high-profile individuals, and the reporting often contains no information to suggest that specific legal or regulatory obligations have not been complied with.
Other regulators internationally are taking a proactive and public stance with respect to coverage of the Panama Papers. In the UK, it has been reported that the Financial Conduct Authority (FCA) has written to a number of financial institutions asking them to provide information on the extent of their dealings with the Panamanian law firm. Banking regulators in other jurisdictions, such as Switzerland, are also taking active steps to gather information.
What should financial institutions do?
Given the intense media coverage of the issue and the ICIJ's promise to continue releasing more stories and, in early May, to publish a database of all of the 214,000 offshore entities incorporated by the Panamanian law firm, along with details of their shareholders, beneficiaries and directors, media and regulatory scrutiny of the issue is likely to continue. While the level of interest from regulators in each jurisdiction is likely to differ based on their own legal and political considerations, it is unlikely that Hong Kong will be immune from this scrutiny.
Financial institutions should proactively assess whether they have done business or introduced clients to the Panamanian law firm. Where such a relationship is established, an assessment should be made of whether any particular AML or reputational concerns might result from those dealings. In particular, have AML requirements on verifying the identities of clients and enquiring as to the source of funds been satisfied? Close consideration should also be given to any PEPs that are clients, given the greater likelihood that they will attract media scrutiny and the enhanced due diligence requirements for them.
Self-reporting obligations to the Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) should be specifically considered. Where a request for information has already been made by an overseas regulator, consideration should also be given to whether the fact of such an inquiry or the substance of the response should (and can) be provided to the HKMA and/or SFC. Experience from global investigations, such as LIBOR and FX, suggests that local regulators take a dim view of not being provided with information touching on a financial institution's Hong Kong operations where it has been provided to other regulators globally.
If there is any suggestion that client funds invested into offshore structures may represent the proceeds of criminal activity, consideration should also be given to whether there is any need to lodge a suspicious transaction report under section 25A of the Organized and Serious Crimes Ordinance.
Financial institutions should also monitor media coverage of the issue, not only for their own involvement but also that of their clients. Even where a client has utilised the services of the Panamanian law firm through another intermediary, it is possible that their broader relationships with other financial institutions may become the subject of media and regulatory questions.
The leaking of the Panama Papers has placed squarely into the spotlight the role of financial institutions in the offshore finance industry and their compliance with AML obligations. It is likely that this focus will continue over the coming months. Financial institutions should therefore ensure that they are able to promptly respond to any regulator requests for information and that they have a strategy for addressing any reputational risks that might arise.
The Panama Papers can also be used as a prompt to reconsider whether your AML policies and procedures are significantly robust. While it is not possible to change what may have already occurred in the past, mass data leaks, such as the Panama Papers, are becoming increasingly prevalent in the digital age. The question financial institutions should therefore ask themselves is whether they are confident that their current systems and controls are adequate if today's practices, procedures and clients were to become the subject of future scrutiny.
For further information, please contact:
Gareth Hughes, Partner, Ashurst
gareth.hughes@ashurst.com
