Proliferation financing

What is it and why does it matter to my firm?

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Proliferation financing (PF) refers to the provision of funds or financial services to aggressive and destabilising ‘proliferation actors’ who may use these to obtain materials, components, data, technologies and expertise to enhance their capability to develop chemical, biological, radiological and nuclear (CBRN) weapons.

The risk of such proliferation actors plausibly obtaining CBRN weapons has recently been assessed to have increased by international fora such as the UN Security Council and the Financial Action Task Force (FATF). Therefore, there exists a strong imperative to disrupt the financial flows, sources of funding and access to financial services that proliferation actors depend upon to acquire CBRN weapons.

HM Treasury has conducted a National Risk Assessment of PF (NRAPF) published in July 2022, the UK’s first such assessment to fulfil the FATF recommendation that countries should identify, assess and understand their PF risks.

The NRAPF’s findings concluded that the UK was an attractive location for proliferation actors to seek funds, financial service products and evade international sanctions regimes. It stated this was due to the openness of the UK’s economy as a major centre of foreign direct investment, the prominence of its financial services sector and the ease of establishing companies in the UK.

However, it noted that these vulnerabilities were mitigated by the UK’s robust legal framework and successful implementation of targeted financial sanctions, export controls and trade embargos.

So, what’s changing?

As a result, important amendments have been made to the UK’s Money Laundering and Terrorist Financing Regulations (MLR 2017), in the form of the ‘The Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022’.

This is the name of the statutory instrument that came into force on 1 September 2022. Its purpose is to ensure that the UK continues to meet international standards on AML and strengthen its capabilities to combat money laundering, terrorist financing and destabilising actors in the international system.

It brings into effect a raft of new requirements and responsibilities that will be incumbent upon firms and regulators alike to comply with to achieve these stated aims. Notable amongst these is the requirement for UK firms to assess their risk exposure to proliferation financing (PF) – however, it also introduces some others such as the requirement to report ‘material discrepancies’ to Companies House on an ongoing basis and extends the definition of a trust and company service provider (TCSP) to include anyone forming a limited liability partnership (LLP) amongst other changes.

Practitioners can review the changes being brought into effect in full by referring to the legislation: The Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022.

What does this mean for you?

The scope of the recommendations set out by FATF extends to include the regulated sector, including accountancy service providers, who must now take appropriate steps to identify and assess their PF risks. As previously referenced, this requirement was transposed into UK law with the recent amendment to MLR 2017.

This assessment can be integrated into the already existing exercise of periodically conducting a firm-wide risk assessment (FWRA) to assess the firm’s exposure to money laundering – something that all firms regardless of their size and organisational complexity should be doing already. This will provide firms with ample provision to consider risk factors relating to the following criteria when assessing their PF risk:

  • clients (eg nuclear materials, chemicals, electronics etc.)
  • geography, ie the location of your clients and the nature of any geographic ties that they may have (eg what countries your firm’s clients transact to, conduct business in, trade to or from, the nationality of your client’s beneficial owner(s) etc) 
  • services
  • transactions
  • delivery channels.

Alternatively, firms may wish to conduct a PF assessment separately, completing it alongside its FWRA or at another point in time. So long as one is conducted, documented and kept up to date then firms are doing enough to be compliant with the regulations.

Where the firm has identified any risk exposure to PF, the firm must update its AML policy and procedures (AML P&Ps) to ensure it has controls and systems in place to effectively manage the PF risks identified within its risk assessment. The firm must also ensure it regularly reviews and updates its AML P&Ps.

Things to keep in mind

This is a brief overview to some of the key risks and red flags that you should be keeping in mind when conducting a PF risk assessment (please note this list is not exhaustive):

  • clients operating in sectors that involve chemicals, restricted materials, arms, import/export businesses etc
  • clients involved in the sale or shipment of ‘dual-use’ goods – items that have both a civil and military application involving sensitive technologies, eg software, electronic components (such as avionics, parts for IT systems, sensors, lasers), mechanical parts and components with a maritime or aviation application, telecommunications equipment etc – medium-sized defence sub-contractors dealing in dual-use goods with overseas clients are thought to be at particular risk
  • clients with contracts in force involving an intermediary that do not make it clear who the real ‘end user’ is – particularly for contracts involving dual-use goods
  • clients that have links to higher-risk geographic jurisdictions, in particular Iran and the Democratic People’s Republic of Korea (DPRK) or to countries thought to be allied to these regimes or located in the same region, eg China, the wider Middle East etc
  • transactions involving politically exposed persons (PEPs) - particularly diplomatic staff of Iran, DPKR or representatives of countries allied to or located in the same region
  • transactions sent or received in which there is a lack of information provided concerning the recipient/counterparty
  • transactions made to pay for goods and services that originate from a different jurisdiction to the one in which the goods and services are bound
  • complex ownership structures – in particular, companies that have or are suspected to have nominee shareholders and/or directors
  • clients that deal primarily in crypto assets, eg clients in which a significant proportion of the assets they hold are crypto assets, a client in which a significant proportion of the transactions it makes and receives are completed using crypto assets etc.

The findings of the NRAPF indicate that the key risk associated with PF that originates from the accountancy sector itself is TCSPs. Firms should take special care and vigilance when providing these services – in particular when forming new companies, appointing new persons to act as a director or partner, and particular vigilance should be applied when appointing nominee shareholders.

The NRAPF highlighted the risk of ‘off-the-shelf-companies’ whereby existing companies (typically dormant for a period) with an established banking history are taken control of by proliferation actors to add a veneer of legitimacy to their activities to be able to obtain credit and financial services. Therefore, practitioners should exercise caution and a degree of professional scepticism when dealing with clients that have recently changed ownership – especially where the business activities of the client do not make sense or fit with the client's profile.

Further resources