Capital Market & PMLA 2002

 

AML (Anti-Money Laundering) and CFT (Counter Financing of Terrorism) are critical components of financial regulations aimed at preventing illegal activities such as money laundering and the financing of terrorism. In India, the Securities and Exchange Board of India (SEBI) plays a significant role in regulating the securities market and ensuring compliance with these measures.

SEBI's Role in AML/CFT

 A. Regulatory Framework: SEBI has established regulations to ensure that market participants, including stock exchanges, brokers, and other intermediaries, implement robust AML and CFT policies. This is crucial for maintaining the integrity of the financial markets.

 

B. Know Your Customer (KYC): SEBI mandates strict KYC norms for intermediaries, ensuring they verify the identity of their clients. This helps prevent the misuse of the financial system for illicit activities.

 

C. Reporting Requirements: Market participants are required to report suspicious transactions and certain high-value transactions to the Financial Intelligence Unit (FIU-IND). This reporting is essential for detecting and preventing money laundering and terrorist financing.

 

D. Risk-Based Approach: SEBI encourages a risk-based approach to AML/CFT. This means that entities should assess the risk associated with their customers and transactions, allowing them to allocate resources effectively to areas where the risk of money laundering is higher.

 

E. Training and Awareness: SEBI emphasizes the importance of training staff within financial institutions and intermediaries regarding AML/CFT regulations. This helps in building a culture of compliance and vigilance.

 

F. Penalties for Non-Compliance: SEBI has the authority to impose penalties and take action against entities that do not comply with AML/CFT regulations. This serves as a deterrent to potential violators.

 

G. Collaboration with Other Agencies: SEBI works in collaboration with other regulatory bodies and law enforcement agencies to strengthen the overall framework for combating money laundering and terrorist financing.

Importance of AML/CFT in the Securities Market

Investor Confidence: Strong AML/CFT measures enhance investor confidence in the securities market, knowing that there are mechanisms in place to prevent illegal activities.

Market Integrity: Effective AML/CFT practices help maintain the integrity of the financial system, which is vital for its proper functioning.

Compliance with International Standards: By adhering to AML/CFT guidelines, India can align its regulatory practices with international standards set by organizations like the Financial Action Task Force (FATF).

 As a regulator of Market Infrastructure Institutions,  SEBI's efforts in implementing AM/ CFT measures are essential for safeguarding the financial market against misuse and enhancing its overall integrity and trustworthiness.

SEBI Master Circular on AML/CFT – October 2023

SEBI vide circular dated October 13, 2023 has issued Amendment to the Guidelines on Anti-Money Laundering (AML) Standards and Combating the Financing of Terrorism (CFT) /Obligations of Securities Market Intermediaries under the Prevention of Money-laundering Act, 2002 and Rules framed there under.

The key changes brought about by these amendments and their implications:

Enhanced AML/CFT Measures in Host Countries
One of the noteworthy additions to the regulations is the requirement for financial groups to apply additional measures when the host country does not allow proper AML/CFT implementation consistent with home country requirements. These additional measures are aimed at managing Money Laundering (ML) and Terrorist Financing (TF) risks more effectively. It’s crucial for these financial groups to inform the Securities and Exchange Board of India (SEBI) about these measures, ensuring transparency and accountability in cross-border financial activities.

Group-Wide AML/CFT Programs
To reinforce AML/CFT efforts, financial groups are now mandated to establish group-wide programs to deal with ML/TF. These programs must be applicable to all branches and majority-owned subsidiaries. Key components include information sharing for Customer Due Diligence (CDD) and risk management purposes, both at the group level and among branches and subsidiaries. Adequate safeguards to prevent tipping-off are also emphasized, ensuring the confidentiality and integrity of shared information.

Trust Disclosure
In cases involving trusts, reporting entities must now ensure that trustees disclose their status at the commencement of an account-based relationship. This additional transparency and disclosure requirement aims to prevent any misuse of trusts in the context of money laundering or terrorist financing.

Beneficial Ownership Identification
The amendments provide clear guidelines on identifying beneficial owners of various entities. These include companies, partnership firms, unincorporated associations or bodies of individuals, trusts, and entities listed on Indian stock exchanges or in specific jurisdictions. The criteria for identifying beneficial owners include ownership percentages, control, and senior managing officials.

Periodic Updates
Registered intermediaries are now responsible for periodically updating client and beneficial owner information collected through Customer Due Diligence (CDD). This ensures that the information remains relevant, especially for high-risk clients, and strengthens the monitoring of potentially suspicious activities.

Strict CDD Procedure
The amendments introduce a stringent requirement: no transaction or account-based relationship can be undertaken without following the CDD procedure. This ensures that proper due diligence is conducted before any financial activity is initiated, reducing the risk of illicit money flow.

Politically Exposed Persons (PEPs)
The amendments incorporate specific norms applicable to PEPs, consistent with the Prevention of Money-Laundering Rules, 2005. These norms also extend to family members, close relatives, and associates of PEPs, ensuring comprehensive coverage in AML/CFT efforts.

Enhanced Due Diligence (EDD) Measures
Registered intermediaries are now required to apply EDD measures proportionate to the risks associated with business relationships and transactions involving natural and legal persons from countries for which the Financial Action Task Force (FATF) prescribes such measures.

Records Retrieval
In situations where registered entities lack records of their clients’ identity, they must promptly obtain these records. Failure to do so will lead to the closure of the client’s account, emphasizing the importance of record-keeping for AML/CFT compliance.

Appointment of Principal Officer
To streamline the reporting of suspicious transactions and assessments, registered intermediaries are now required to appoint a Principal Officer, who acts as a central reference point for these activities. This officer must be at the management level and serves as a bridge between internal operations and the authorities responsible for AML/CFT oversight.

SEBI Master Circular on AML/CFT – June 2024

Guidelines on Anti-Money Laundering (AML) Standards and Combating the Financing of Terrorism (CFT) /Obligations of Securities Market Intermediaries under the Prevention of Money Laundering Act, 2002

a. The amendments proposed in June 2023 and October 2023, along with the Old Guidelines, are consolidated in the New Guidelines. Further, the directions to stock exchanges and registered intermediaries for implementation of s. 12A of the Weapons of Mass Destruction and their Delivery Systems (Prohibition of Unlawful Activities) Act, 2005 (‘WMDDS Act’), have also been consolidated in the  Guidelines June 2024  issued by the SEBI.

b. Prescribes use of reliable and independent sources of identification and verification of Client Due Diligence

• ·The New Guidelines define Client Due Diligence (‘CDD’) for the first time to mean diligence carried out on a ‘client’ as defined under s. 2(1)(ha) of the PMLA by using reliable and independent sources of identification.
• As per the New Guidelines, the intermediaries must now undertake a three-step verification process, wherein the intermediaries are supposed to (i) identify their clients, (ii) verify their identity using reliable and independent sources of identification, and (iii) obtain information on the purpose and intended nature of their business relationship. Further, the New Guidelines also mandate that the intermediary understand the nature of the business being conducted/undertaken by their client as a part of CDD.

c.  Confidentiality in maintenance of records

The New Guidelines provide that confidentiality has to be maintained because records are being maintained under r. 3 of the PML Rules. The obligation to maintain confidentiality is upon every registered intermediary, its directors, officers, and, inter alia, all other employees. Maintenance of confidentiality as per the New Guidelines will ensure clients are not tipped off knowing the fact of maintenance of such records.

The SEBI master direction June 2024  establishes the key principles for combating money laundering and terrorist financing, providing detailed procedures and responsibilities that has to adhered by registered intermediaries. 

Client Due Diligence

Client Due Diligence (CDD) forms the cornerstone of the circular’s provisions. The circular mandates that intermediaries must conduct thorough due diligence procedures for all clients, with a special underlining on identifying beneficial owners. The process extends beyond merely verifying the immediate client but also understanding the entire ownership and control structure, especially for non-individual clients. For example, the circular requires registered intermediaries to identify the natural persons who ultimately own or control a company client, using thresholds like ownership of more than 25% of shares, capital, or profits. This level of scrutiny aims to prevent the use of complex corporate structures to mask the true beneficiaries of financial transactions.  

Risk Based Approach

The circular introduces a risk-based approach to AML/CFT measures, recognizing that not all clients and transactions pose the same level of risk. Intermediaries are required to categorize their clients into low, medium, and high-risk categories based on various factors such as the client’s background, country of origin, nature of business, and transaction patterns. This approach allows for more efficient allocation of resources, with enhanced due diligence measures applied to higher-risk clients. For the First Time, “Clients of Special Category” (CSC) are specifically defined by the circular and also provided  elaborated list who will be considered as CSCs which include the non-resident clients, high net-worth individuals, trusts, charities, NGOs, politically exposed persons (PEP), and clients from high-risk countries. These CSCs are subject to enhanced scrutiny and continuous monitoring.  

Monitoring and Reporting

Monitoring and reporting form another crucial pillar of the circular. Intermediaries are required to have robust systems in place to detect and report suspicious transactions. The circular provided a detailed definition of suspicious transactions, including those that seem to lack any economic or lawful purpose, unusually complex, or show patterns inconsistent with the client’s normal activity. It mandates that intermediaries should not only monitor individual transactions but also pay attention to the overall financial behaviour of their clients. The circular sets specific timelines for reporting of different types of transactions such as Cash Transaction Reports, Suspicious Transaction Reports, and Non-Profit Organization Transaction Reports to the Director, FIU-IND.  

Record Keeping

The Circular imposes obligation on intermediaries to maintain detailed records of transactions, client identification and account files for a five years after the business relationship has ended or the account has been winded-up. The retention of data is a pivotal step for securing the data for future audit and investigations. The circular specifies the exact nature of the information to be maintained, including the nature of transactions, amount and currency, date of transaction, and parties involved. This meticulous record-keeping not only aids in investigations but also helps intermediaries in their ongoing monitoring efforts.  

Compliance Structure

The circular places significant emphasis on the compliance structure within intermediaries. It mandates the appointment of a Principal Officer who will act as a central point of contact for all AML/CFT related matters. Additionally, a Designated Director must be appointed to ensure overall compliance with AML/CFT obligations. These appointments underscore the importance of top-level commitment to AML/CFT efforts within organizations. The circular provides specific definitions and responsibilities for these roles, ensuring that there is clear accountability and a structured approach to compliance.  

Employee Training and Investor Education

Lastly, the circular recognizes the importance of ongoing education and awareness in the fight against financial crimes. It requires intermediaries to have comprehensive and ongoing training programs for their employees. These programs should cover various aspects of AML/CFT measures, including the latest techniques and trends in money laundering and terrorist financing. Moreover, the circular emphasizes the need for investor education. The requirements of AML/CFT measures and the rationale behind requesting certain personal information shall be explained to clients by intermediaries. This two-pronged approach of employee training and investor education aims to create a more informed and vigilant ecosystem that can effectively combat financial crimes.  

To be in compliance with these obligations, the senior management of a registered intermediary shall be fully committed to establishing appropriate policies and procedures for the prevention of ML and TF and ensuring their effectiveness and compliance with all relevant legal and regulatory requirements. The registered intermediaries shall:

1. Issue a statement of policies and procedures and implement, on a group basis where applicable, for dealing with ML and TF reflecting the current statutory and regulatory requirements;
2. Ensure that the content of these Directives are understood by all staff members;
3. Regularly review the policies and procedures on the prevention of ML and TF to ensure their effectiveness. Further, in order to ensure the effectiveness of policies and procedures, the person doing such a review shall be different from the one who has framed such policies and procedures;
4. Adopt client acceptance policies and procedures which are sensitive to the risk of ML and TF;
5. Undertake CDD measures to an extent that is sensitive to the risk of ML and TF depending on the type of client, business relationship or transaction;
6. Have a system in place for identifying, monitoring and reporting suspected ML or TF transactions to the law enforcement authorities; and
7. Develop staff members’ awareness and vigilance to guard against ML and TF.

        Happy Reading,

       

        Those who read this, also read:

      1. AML/CFT : Definitions, Origin

2. PMLA 2002: Objectives & Applicability

      3.Reports by RE under RBI: PMLA2002 

      4. Financial  Intelligence Unit(FIU-Ind)