Moody’s: New guidelines on shell companies improves anti-money laundering practices

A new Central Bank of Cyprus directive that formally and narrowly defines what constitutes a shell company is credit positive for Cypriot banks, says ratings agency Moody’s.

It believes giving a specific definitions of shell companies will help eliminate suspicious transactions and further strengthen banks’ anti-money-laundering (AML) practices.

“The i mplementation of the circular, which was initially sent to the banks for consultation in June 2018, eliminates room for interpretation from individual banks regarding what constitutes a shell company and establishes uniform practices across the Cypriot banking system,” said Moody’s in its analysis outlook.

The circular defines a shell company as an entity that has no physical presence other than a mailing address, no established economic activity in the country of incorporation or has little to no independent economic value.

Not defined as shell companies are holding companies of entities engaged in legitimate businesses and that have identifiable ultimate beneficial owners.

“The country’s framework and the banking system’s AML practices have been strengthening through the years following greater scrutiny from international and domestic financial authorities,” said Moody’s.

As part of the country’s bailout programme, the Moneyval Committee of the European Commission and Deloitte Italy in 2013 conducted an assessment to establish Cypriot banks’ compliance with the legislative and regulatory framework for customer due diligence.

Although these assessments did not have major findings, the authorities took certain actions to strengthen AML practices.

The Moneyval Committee plans conduct another assessment next year.

Notwithstanding actions taken so deficiencies remain, Moody’s said.

In 2014, the central bank placed in resolution the branch of FBME Bank, a Tanzanian bank with Lebanese owners that operated primarily through its Cypriot branch and appointed an administrator to handle the sale of the branch.

The central bank’s actions came after the Financial Crimes Enforcement Network, a bureau of the US Treasury, accused FBME of facilitating financial transactions for multinational organised crime organizations and Hezbollah.

“Cypriot banks continue to be scrutinized in the international press, mainly because of their international banking business centres, which cater to offshore entities registered in Cyprus for tax reasons.”

Given the low corporate tax rate of 12.5% and Cyprus’ double-tax treaties with more than 60 countries, offshore entities benefit

to

far, from lower taxes when they channel their investments to any of these 60 countries via Cyprus.

Cyprus is one of the largest foreign direct investors in Russia, mainly because of these offshore companies.

“Although reduced, a large chunk of Cypriot banks’ funding continues to come from the transactional deposits of these offshore companies, which elevates funding risks for the banks given these deposits’ short-term nature,” said Moody’s.

“At their peak in April 2012, deposits from residents of countries outside the European Union climbed to EUR 21.9 bln, exceeding the size of the domestic economy,” it added.

Following a sharp decline in 2013 because of the large recapitalisation needs of the island’s two largest banks – Bank of Cyprus, which underwent a conversion of deposits to equity, and now-defunct Laiki Bank, which was liquidated – these balances have been consistently declining.

They fell to EUR 7.1 bln as of September 2018 from around EUR 8 bln at beginning of this year and accounted for around 15% of total deposits as of September 2018, down from around 30% in April 2012.

In addition to being subject to tighter regulation, banks have tightened their customer selection criteria.

Between 2014 and year-end 2017, Bank of Cyprus had reduced the number of intermediaries introducing such offshore clients to 324 from 1,601, terminated 5,359 customers and rejected 2,937 potential new customers. The bank also had reduced its number of Russian clients in its international banking business by 60% and its Ukrainian customers by 41%.

Hellenic Bank as of 31 March 2018, had reduced by 50% the number of introducers it uses and by 30% its active international banking clients compared with 2014.

“The banks’ business with Russian companies has the potential to contract further if the US list of Russian individuals under sanctions grows,” said Moody’s.