Overview of China’s New AML Law

Overview

Money laundering was first criminalized under the 1997 revised Criminal Law of the People’s Republic of China (PRC)¹. Over the years this provision, along with other piecemeal regulations² issued by the State Council and the People’s Bank of China (PBOC) since 2004, has been the primary basis for the Chinese government’s anti-money laundering efforts. The level of money laundering in the PRC however remains troubling to this day; estimates have placed the amount of money laundered at a staggering US$90bn for 2005 alone, according to a government-sponsored study³.

As part of its ongoing battle against such rampant money laundering, the Standing Committee of the National People’s Congress passed, on 31 October 2006, the PRC Anti-Money Laundering Law (AML Law), to take effect on 1 January 2007. The PBOC followed suit on 14 November 2006 with the Financial Institutions’ Anti-Money Laundering Regulations and the Measures on Administration of Financial Institutions’ Reporting Large and Suspicious Transactions (collectively ‘Regulations’), set to replace and repeal the PBOC’s earlier regulatory provisions starting 1 January and 1 March 2007 respectively. Both efforts aim to bolster the government’s stance against money laundering, and to date mark the PRC’s government’s most ambitious undertaking against the crime.

Highlights of the New Law

1. Enhanced legislative and enforcement efforts against money laundering

Though prior regulations allowed authorities to take action against suspicious transactional activities, the new AML Law is significant for having been ratified by the nation’s highest lawmaking body. It denotes the Chinese government’s adherence to curbing money laundering and indicates the administration’s efforts toward gaining membership into the intergovernmental Financial Action Task Force on Money Laundering (FATF).

The Regulations augment current enforcement strategies by appointing the PBOC and its local delegates as the competent supervisory and administrative authority over all anti-money laundering projects and granting the PBOC investigatory powers over suspicious transactional activities. Upon noting an unusual transaction, the PBOC can now review, copy and (if necessary) seal for safekeeping documents pertaining to the relevant account. The PBOC can also temporarily freeze the account for up to 48 hours depending on the gravity of the situation and the level of suspicion involved. If doubts on the legality of the transaction remain after such an investigation, the PBOC can transfer the case to the competent Public Security Bureau, China’s primary judicial authority over investigating crimes.

To further deter money launderers, the AML Law imposes administrative liabilities on financial institutions and responsible personnel who fail to comply with its provisions. On the regulatory side, financial institutions who fail to implement any of the requirements or who refuse or impede anti-money laundering efforts can be fined up to RMB5m (US$625,000) and can have their financial operation permits revoked. Directors, senior management and other personnel with direct responsibility can be levied fines up to RMB500,000, and can be removed or prohibited from practicing in the financial sector.

For cases of direct involvement with money laundering, individuals and entities can be held criminally liable for assisting or facilitating money laundering under the PRC Criminal Law. Individuals found guilty of such activities can face penalties of up to 20% of the money laundered and/or up to 10 years imprisonment. Institutions can be levied fines up to 20% of the amount of money laundered, and chief officers, executives or other personnel with direct responsibility can also be held accountable with penalties reaching up to five years imprisonment.

2. Seven predicate crimes as basis for money laundering violations

The AML Law defines money laundering as the act of concealing or covering up the nature and source of income derived from an illegal activity. The action requires a precedent crime; under the 1997 PRC Criminal Law, one could be convicted of laundering money only if the proceeds hidden were from drug dealing, smuggling and organized crimes. A 2001 amendment included proceeds from terrorism, while a recent amendment in June 2006 further expanded the provision to include proceeds made from corruption and bribery, disrupting control of financial order, and financial fraud. The new Law was passed in concurrence with the PRC Criminal Law, and identifies money laundering with reference to these same seven crimes.

3. Exposure for both domestic and foreign invested financial and non-financial institutions

The AML Law imposes broader and more rigorous anti-money laundering obligations on both local and foreign financial institutions established in China. For the first time in PRC legislation, requirements have also been placed on non-financial enterprises.

Financial institutions, the definition of which has been expanded by the AML Law and the Regulations, now include (among other establishments) all policy and commercial banks, urban and rural credit cooperatives, post and savings institutions, finance companies, and all companies engaging in securities, futures, futures brokerages, fund management, insurance, insurance assets management, trust and investment, financial assets management, finance leasing, automobile finance and money brokerage. Businesses involved with currency exchange, payments and settlements, and funds sales are similarly obliged under the Regulations.

Though the AML Law imposes general obligations on non-financial institutions, it does not clearly specify the responsibilities and scope of such establishments. However, this may most likely include all local and foreign non-financial enterprises established in China that can serve as channels or vehicles for money laundering operations, particularly vendors or dealers of real estate, jewellery, precious metals and expensive pieces of art or antiques, auction companies, pawn houses, law firms, and accounting firms.

4. More stringent monitoring and internal control systems required for financial institutions

To fight money laundering on the institutional level, the AML Law requires financial institutions to establish internal control and monitoring systems, as well as supplementary policies necessary for implementing them, which can ensure more robust methods of supervision and enforcement. These include systems for verifying client identities, maintaining client identity information and transaction records, and reporting large and suspicious transactions.

It should be noted that, under the new AML Law, establishment of new financial entities or branches are now subject to authorities’ assessment of proposed anti-money laundering internal control plans, and failure to pass the assessment can result in denial of the establishment application altogether.

5. More red flags for reporting suspicious transactions

Though financial institutions have been required to report large and suspicious transactions to the PBOC’s China Anti-money Laundering Monitoring and Analysis Centre, the new Regulations revise the standards for the large transactions and expand the red flags for suspicious transactional activities to 48. These warning signs, which include transactions or activities that, on the surface, generally seem legal but unusual in certain aspects, have mostly been derived from common practices of money laundering such as laundering money through irregular banking, securities/futures and insurance arrangements, establishment of shell companies and purchase of precious items.

Foreign investors and foreign-invested enterprises (FIEs) should take note that, among the red flags listed under the Regulations, funds transferred to FIEs from foreign sources may be targeted for money laundering scrutiny if:

• An FIE makes an equity investment in China, with newly injected funds from foreign sources (instead of their retained local profits), especially when such investment is not in line with the FIE’s normal operational scale or needs.
• An FIE, shortly after receipt of a capital investment from its foreign investor, transfers such capital fund overseas in such form as payments for services, equipments, goods, royalties, dividends, etc., especially when such quick in-and-out fund transfer is not in line with the FIE’s normal operational scale or needs.
• A foreign investor makes a capital investment in an FIE in an amount greater than the FIE’s approved registered capital.
• A foreign investor makes a capital investment in an FIE (equity) in an amount greater than the FIE’s loan borrowed from a foreign lender (foreign debt)4.
• A foreign investor makes capital contribution to an FIE from an unrelated third country where the foreign investor has no affiliates.

Best Practices

• The AML Law marks the PRC government’s most expansive effort against money laundering to date. As such it is advisable that FIEs abide by the following best practices in order to avoid suspicion of money laundering or unintended facilitation of money laundering while conducting business with relations to China.
• Financial institutions must establish all requisite monitoring and internal control systems against money laundering, and non-financial institutions should follow the same even if not mandated by the AML Law. FIEs should consider including anti-money laundering obligations into the corporate code of conduct and providing relevant anti-laundering training to key personnel, especially to those serving in financial and managerial positions.
• An FIE should avoid making payments to, or receiving payments from, a third party designated by the other party to a contract, especially when the third party is not related to the underlying transaction or contractual parties, and should also avoid acting as an agent to make or receive payments for any party to a contract that is not related to the FIE. In any event, any unusual payment request should be reviewed by the legal department or counsel for legality and compliance assurance.
• Clauses regarding anti-money laundering and anti-commercial bribery should be built into all commercial contracts when significant payments are involved.
• FIEs should avoid swift domestic investment/inbound contribution and outbound payment of capital in the form of payments for services, equipments, goods, royalties, dividends, etc, without compelling business reasons or if not in line with the FIE’s operational scale or needs.
• FIEs should avoid irregular banking practices at obvious odds with normal business operations and financial needs, such as transferring funds much larger than typically needed.