AML supervision reforms – Government response to consultation exercise

By Legal Futures Associate VinciWorks ^[1]

We set out our thoughts on the Government’s consultation on the transfer of Anti-money laundering & counter terrorist-Financing (AML) supervision from the Solicitors Regulation Authority (SRA) (and other legal regulators) to the FCA in December last year (here ^[2]). HM Treasury (HMT) has now published the response to that consultation (here ^[3]).

For those that had hoped the proposals may be watered down, or disappear altogether, I’m sorry to burst your bubble.  Although the resignation of our Prime Minister could have an impact on these reforms, it is possibly more likely to be in the form of delays to the necessary legislative changes rather than an entire change of policy.  At present, the reforms are very much going ahead, albeit they probably won’t be in force until late 2028 at the earliest, and we need to get our heads around that. Whilst the SRA will continue to oversee general conduct, the FCA will control AML and this will inevitably result in a significant structural change to AML compliance for law firms.  Not least, firms will need to be able to easily distinguish between work which falls in and out of scope of the Money Laundering Regulations (MLRs), and therefore FCA supervision.

This consultation, and HMT’s response to it, focuses on the supervisory framework and additional powers the FCA will require in its expanded role. Whilst the document emphasises the government’s approach being to “build on existing powers” and to only “introduce targeted improvements where necessary” and “proportionate”, so as not to “create extra burdens on firms” by creating new obligations, many of the concerns expressed by the legal sector during the consultation process appear to have been minimised, if not ignored.

We have previously raised concerns about the Government’s apparent (and possibly misguided) faith that the FCA would work closely with regulators to thrash out the practicalities of this no-doubt seismic shift for the legal profession, to avoid the very real concerns about duplication of regulation/ costs/ enforcement etc. Whilst HMT emphasises the importance of minimising additional regulatory burdens for firms and of the old and new regulators working apparently seamlessly together, and they do refer to various future legislative changes, both in the form of primary and secondary legislation, the general impression remains that much of the detail may still be left to the good sense and perhaps good will of the regulators. Perhaps that is unfair?  HMT does refer to the MLRs being amended to create “both a duty for supervisors to cooperate with each other, and a clear information-sharing gateway, so files on investigations and enforcement actions can be shared”.  However, HMT also states that “the specifics of how this regime will operate in practice will be for the FCA and existing PBSs [Professional Body Supervisors] to determine in collaboration.”  So, it’s still a case of ‘wait and see’ – let’s hope that the legislative changes will have a bit more structure to them than this quote suggests.

Collaboration and information-sharing will be particularly important given the Government’s decision that legal regulators (such as the SRA) will retain the ‘preventing-economic crime’ regulatory objective brought in by the Economic Crime and Corporate Transparency Act 2023 (ECCTA). There are clearly going to be investigative and enforcement overlaps where AML concerns often run alongside concerns about sanctions (in particular) but also fraud, bribery and tax evasion (which will be outside the FCA’s remit and firmly in the SRA’s).

HMT attempts to address these concerns but with rather vague sentiments about regulators taking a “proportionate, outcomes focused approach, supported by regulatory expectations”.  Even with changes to the MLRs to require cooperation and information-sharing, what will this actually look like in practice, and won’t it inevitably increase costs for both regulators, and therefore the professions they regulate?

Key HMT decisions from the consultation response

FCA public register

• All professional services firms will have to be registered in order to lawfully carry out AML-regulated (in-scope) activities.
• The FCA will have the power to cancel a firm’s registration, but only where they no longer carry out AML-regulated activity (not to be used as an enforcement tool in response to MLR breaches).
• Planned safeguards to prevent firms being unfairly removed from the register (and therefore no longer able to carry out in-scope work), include advance notice, taking reasonable steps to verify inactivity and basing decisions on reliable information. What this will look like in practice is not yet clear.

BOOMs and the ‘Fit and proper’ test

• Currently, the SRA exercises its obligations under Regulation 26 to approve beneficial owners, officers and managers (BOOMs), focusing primarily on criminal records checks.
• The FCA will apply Regulation 58 ‘fit and proper’ requirements to legal sector BOOMs, which allows the FCA to assess integrity, competence and compliance history, in addition to DBS checks.
• HMT “expects the FCA to be able to make use of existing checks where appropriate and to operate processes that avoid unnecessary duplication” during the transition period, but it is not clear what this will mean in practice. Reference is made to the rather vague “structured information-sharing arrangements between FCA and current (supervisors)”. What is clear is that once the changes are embedded, all BOOMs will be subject to the full FCA ‘fit and proper’ test.
• With the more stringent test for BOOMs, could we start to see more firms trying to convince themselves and their regulators that the work they do is actually ‘out of scope’, particularly niche family and employment teams only really brought into scope by the ‘tax adviser’ definition? If so, could this lead to the unintended consequence of less oversight and firms seeking to (but perhaps not succeeding in) flying under the FCA’s radar?

Risk-based supervision and supervisory tools

• The FCA will be equipped with a proactive ‘intervention toolkit’ to identify risks early and seek to prevent harm and consequential enforcement action, including information requests, inspections, thematic engagement and the power to issue directions to firms.
• The biggest impact is likely to come in the form of a Skilled Person Report. This tool allows the FCA to require a ‘Skilled person’ (such as a lawyer or accountant) to inspect a firm on the FCA’s behalf, but at the firm’s (significant) expense.
• Our understanding is that this tool is generally used when things have already gone wrong (rather than being a proactive inspection tool), is currently used relatively sparingly, and is unlikely to be used for smaller firms, given HMT’s promise of proportionality. However, it is unlikely to be welcomed by most firms, particularly as it would be in addition to the continued Regulation 21 independent audit requirement. As ever, prevention is better than cure!

Privilege

• One of the most sensitive areas for law firms is Legal Professional Privilege.
• The good news: HMT has confirmed that the FCA will not be able to use its powers to require the disclosure of privileged documents.
• The less good news: HMT’s view is that documents required for “routine AML supervision” generally do not attract privilege.
• Whilst this may be true, we are likely to see arguments in this space, particularly as the FCA are being tasked with creating guidance to ensure there is clarity on what documents are required and how it will handle issues of privilege when they arise. Plenty of lawyers struggle with the principles around privilege, so how will the FCA fare?  Does it make sense that the FCA will be creating this guidance? Time will tell, and we hope the FCA seeks input from the SRA and Law Society when creating guidance on this difficult subject.

AML Guidance for professional services firms

• Another big concern was the potential loss of the LSAG guidance, so it was a relief to read that “HMT agrees that guidance is most effective where it draws on practitioner expertise, where this is practicable” and expects the Legal Sector Affinity Group to remain involved.
• The FCA will take over responsibility for approving sector-specific guidance, with HMT retaining a limited oversight and veto role.
• Could FCA responsibility result in speedier LSAG guidance updates and amendments approvals? This would be a nice change from the current HMT machine.

Enforcement

• The FCA will use its existing enforcement powers, including civil sanctions and, for the most serious cases, criminal proceedings, in relation to the legal sector, with HMT emphasising the need for coordinated enforcement action with existing supervisors to address fears of ‘double jeopardy’.
• To ensure enforcement is proportionate, fair and transparent, HMT intend to carry out a further consultation on how to create a “streamlined” process for dealing with minor, routine breaches (like failing to register on time).

Fees and funding

• Law firms are rightly concerned about increased (and potentially duplicative) regulatory fees as a result of the imposition of an additional regulator.
• These concerns have not been allayed, with HMT confirming that the FCA will be funded through fees charged to firms on a full cost-recovery basis, but with the detail as to the final fee structure left to a separate future consultation, and no mention of a corresponding reduction in existing regulator’s fees.

Transition and supervisory coordination

• HMT has emphasised the importance of minimising additional regulatory burdens for firms during the transition period, including in relation to re-registration requirements and live investigation/ enforcement proceedings, and that it will not take a ‘one size fits all’ approach to supervision. All of this is to be welcomed, but we are not really any further forward in terms of how this will actually work in practice.
• HMT has confirmed that they, and the FCA, ‘will continue to engage closely with firms, PBSs, HMRC and regulators and civil society to develop transition and implementation plans, and more detail will be provided in due course’. We shall need to watch this closely.

What now?

HMT have acknowledged that implementation will take “several years”, with best guesses suggesting late 2028 at the earliest.  Accordingly, much of our advice from December still holds:

• Keep doing all you can to comply with current SRA AML expectations and be ready for their continuing inspections and desk-based reviews. It’s an urban myth that they’re taking their foot off the AML gas! Now is not the time to drop your AML-guard.
• Ensure that what you say happens in your Firm Wide Risk Assessment and AML Policies is happening on the ground and is documented accordingly. Both the SRA and the FCA want to see this.
• Look at, and refine, your data collection processes – in particular so that you can easily distinguish between in and out of scope work. The FCA is very much a data-driven regulator and, from a law firm perspective, will only be looking at in-scope work.
• Read the consultation response and keep a close eye on the forthcoming consultations regarding fee structures and the transition roadmap and have your say.
• Stay alert – further updates will no doubt follow.