On July 1 this year, responsibility under the AntiMoney Laundering and CounterTerrorism Financing Act (2006) will expand significantly to encompass real estate agents, conveyancers, lawyers, accountants and others. This change, known as Tranche 2, holds many pitfalls for new and inexperienced Reporting Entities (REs) including the multi-dimensional impact of scaling in the number of KYCs per transaction and the ownership complexity introduced by non-individual customers.
The Scaling Problem
The inclusion of real estate in the regulatory net from July this year will capture somewhere in the order of five hundred thousand or more transactions per year and it is not widely appreciated that each transaction will require multiple KYCs. In any one transaction there is at least one agent (possibly two if there is a buyer’s agent
involved) and two conveyancers. Since agents are required to conduct KYC due diligence on both the buyer and the seller, there is already an automatic scaling of
the number of KYCs required for each transaction.
Even in simple transactions where neither party is a company or trust it is normal for each customer to involve two or more parties (e.g., a husband and wife, or a young couple plus grandparents where family finance is involved). Companies and trusts can scale the number of required KYCs very rapidly. For example, if one customer in the transaction is a self-managed superannuation trust, the RE is required to conduct KYC due diligence on the trust itself, the beneficiaries and the trustees. Where a private company is involved, the KYC obligations extend to the company, the directors and the major shareholders. This tendency for KYCs to scale rapidly for each transaction is something that REs should be very cognizant of if their external costs are calculated on a per-KYC basis.
The Complexity Premium
Scaling is not the only relevant consideration when calculating the cost of a transaction. The cost of KYCs is determined by two factors: the external data cost (required for verification); and the human cost required for assessment of the KYC information. Where low-risk individuals are involved, both the data costs and human costs are likely to be relatively modest. The cost basis of a KYC, however, increases sharply with complexity. Even in the case of Australian companies, the data cost of verification is 4 to 5 times that of an individual. The real jump in KYC costs, however, emerges when the risk rating of a customer rises to high and Enhanced Due Diligence is required – for example, data-challenged customers, foreign PEPs, foreign private companies, and so on. Not only are these complex cases considerably more expensive in terms of data costs, the human time required increases materially, as does the need for more specialized AML skills. These
complex KYCs are also where the risk of inadvertent breaches of regulatory requirements will be greatest.
Cheap Solutions, Costly Consequences
As the date for commencement of the new scheme approaches it is important for new REs to understand the nature of their businesses and the extent to which they
will be affected by scaling and complexity. All new designated services will be affected to some extent by both considerations. Scaling is most likely to affect real estate transactions. While accountants and lawyers may be faced with fewer transactions than real estate agents and conveyancers, and therefore face less of a
scaling problem, they are more likely to have to address the problems associated with complexity that comes with having a greater proportion of trust and corporate
clients.
The challenges of scaling and complexity of KYC requirements under Tranche 2 will put a significant strain on skilled AML resources in Australia. The cheapest third-
party compliance solutions are promising that technology-driven tools will make compliance simple, but they usually charge per KYC and push the human cost element to the RE leaving them exposed to both scaling traps discussed here. Technology-only solutions without integrated expert advisors and operators are likely
to prove expensive over the longer term, both in terms of the need for upgrading and the potential for fines.
Unsure how scaling and complexity will affect your business in July? Talk to the team at Aus AML today.
