- Source of Funds, Wealth, Income and Assets
- Source of Funds (SOF)
- Source of Wealth (SOW)
- Source of Income (SOI)
- Source of Assets (SOA)
- 4th AMLD
- 5th AMLD
- German GwG
- BaFin-Interpretation and Application Guidance on the German GwG
Source of Funds, Wealth, Income and Assets
Understanding the concepts of Source of Funds (SOF), Source of Wealth (SOW), Source of Income (SOI), and Source of Assets (SOA) is essential in the context of the Anti-Money Laundering directives (4th AMLD and 5th AMLD) of the European Union and the German Anti-Money Laundering Act (GwG), as well as the interpretative guidance provided by BaFin, the Federal Financial Supervisory Authority of Germany. These concepts form the backbone of effective anti-money laundering (AML) and counter-terrorist financing (CTF) efforts, aimed at ensuring the integrity of the financial system by preventing its misuse for illegal activities.
Source of Funds (SOF)
In the context of AML directives and regulations, SOF refers to the origin of specific funds involved in a transaction. This includes understanding the immediate source of the money or assets that are being used in a particular financial transaction. The focus here is on the specific transaction at hand.
For instance, under the 4th and 5th AML Directives, when a customer initiates a significant transaction or establishes a new business relationship with a financial institution, the entity is obliged to investigate and verify where the money used in that specific transaction comes from. This could include, for example, funds from a sale of property, a recent inheritance, or savings accumulated over time. The objective is to ensure that these funds are not the proceeds of crime.
Source of Wealth (SOW)
SOW is a broader concept compared to SOF. It involves understanding how an individual accumulated their overall wealth. This encompasses the total economic resources owned or controlled by the individual. The aim is to build a comprehensive profile of the individual’s financial history and the means by which they have acquired their wealth over time.
In accordance with the German GwG and the BaFin guidance, obliged entities are required to assess the SOW, especially in the case of Politically Exposed Persons (PEPs) or when dealing with high-risk third countries. This assessment helps in identifying any risks associated with wealth that may have been accumulated through illegal means such as corruption or embezzlement.
Source of Income (SOI)
SOI refers to the origin of an individual’s regular income streams. This concept is crucial in distinguishing the ongoing earnings of a person, which could be from various sources like employment, business operations, investments, or any other consistent revenue-generating activities. SOI is particularly relevant in understanding a customer’s financial capacity and stability over time.
In the realm of AML and KYC, knowing the SOI helps financial institutions and other obligated entities to assess the likelihood of an individual’s income being derived from legitimate sources. For instance, a mismatch between an individual’s known income sources and their lifestyle or spending patterns could raise red flags for potential money laundering or other illicit financial activities.
Source of Assets (SOA)
SOA concerns the origins and acquisition methods of an individual’s assets. It requires an understanding of how specific assets were obtained, whether through purchase, inheritance, gifts, or any other means. This concept is crucial in determining the legitimacy of the ownership of these assets.
Under the German GwG and the 4th and 5th AML Directives, when certain high-value assets are involved in transactions, there is a need for due diligence to understand how these assets were acquired. This is especially important when dealing with individuals from high-risk countries or those who have been flagged as PEPs. The BaFin guidance underscores the importance of verifying SOA to prevent the integration of illicitly obtained assets into the financial system.
Article 20(b)(ii) of the 4th AMLD (Directive (EU) 2015/849) addresses additional measures that Member States must require from obliged entities (like banks, financial institutions, etc.) when dealing with politically exposed persons (PEPs). Specifically, this article mandates that, beyond the standard customer due diligence measures already outlined in Article 13, obliged entities must also take adequate measures to ascertain the source of wealth and the source of funds involved in any business relationships or transactions with PEPs.
The essence of this requirement is to ensure a higher level of scrutiny and transparency in financial dealings involving PEPs. Politically exposed persons are individuals who are or have been entrusted with prominent public functions, and because of their position and influence, they are considered as higher risk for involvement in money laundering and terrorist financing.
By mandating the verification of the source of wealth and funds, the directive aims to prevent the misuse of the financial system for money laundering or terrorist financing. This involves understanding how the PEP acquired their wealth (source of wealth) and the origins of the specific funds involved in the transaction or business relationship (source of funds). This heightened scrutiny helps in identifying any potential risks related to corruption, embezzlement, or other illicit activities.
Article 1(11) of the 5th AMLD (Directive (EU) 2018/843) introduces a new provision, Article 18a, which enhances the customer due diligence requirements for transactions or business relationships involving high-risk third countries, as identified under Article 9(2) of the same directive. This provision focuses on increasing scrutiny and information gathering in situations where there is a higher risk of money laundering or terrorist financing.
Information on the Source of Funds and Source of Wealth: The 5th AMLD requires the obliged entities to understand the source of the wealth and funds involved in the transaction or business relationship. This is particularly important for high-risk countries, as it helps to identify funds that may be derived from illegal activities or are intended for illegal use.
This amendment under the 5th AMLD aims to bolster the fight against money laundering and terrorist financing, particularly in the context of transactions or business relationships with entities from countries that pose a higher risk. By requiring more detailed due diligence, the directive seeks to prevent the financial system within the EU from being exploited for illicit activities.
The German GwG has specific provisions regarding the due diligence requirements focusing on the „source of wealth,“ „source of funds,“ and „source of assets.“
General Due Diligence Requirements
- Continuous Monitoring: Obliged entities must continuously monitor their business relationships and transactions.
- Consistency with Information: This monitoring should ensure that transactions are consistent with available information on the contracting party and beneficial owner, their business activity, and customer profile.
- Source of Wealth: Where necessary, the information about the source of wealth of the contracting party or the beneficial owner should be considered.
- Risk Assessment: Enhanced due diligence is required if a high risk of money laundering or terrorist financing is identified through risk assessment.
- Politically Exposed Persons (PEPs): High risk is associated with business relationships involving PEPs, their family members, or known close associates.
High-risk Third Countries
- High-risk Third Countries: High risk is also associated with business relationships or transactions involving high-risk third countries.
Enhanced Due Diligence (EDD) in High Risk Situations
- Source of Funds: Adequate measures must be taken to establish the source of funds involved.
BaFin-Interpretation and Application Guidance on the German GwG
The BaFin Interpretation and Application Guidance on the German GwG (Geldwäschegesetz) provides detailed explanations regarding the implementation of the law, particularly focusing on customer due diligence obligations and enhanced due diligence measures, especially in relation to the ’source of wealth‘ and ’source of funds‘. Here’s a summary of the relevant chapters:
Customer Due Diligence (CDD)
- Continuous Monitoring: Obliged entities must continuously monitor business relationships and transactions.
- Consistency Check: This monitoring ensures transactions are consistent with available information about the contracting party, beneficial owner, their business activity, and customer profile.
- Source of Wealth: When necessary, the information regarding the source of wealth of the contracting party or the beneficial owner must be verified and consistent with the known information.
Enhanced Due Diligence (EDD)
- Politically Exposed Persons (PEPs) (Sections 15 (3) no. 1, (4)): Adequate measures must be taken to establish the source of wealth in business relationships or transactions involving PEPs. The source of wealth must be traceable and verifiable.
- High-Risk Third Countries (Sections 15 (3) no. 2, 15 (5) and (5) (a)): Enhanced due diligence is required for business relationships or transactions involving high-risk third countries. This includes obtaining management approval and verifying the source of funds. The source of wealth must also be traceable and not solely based on statements from the contracting party.
Suspicious Transaction Report (STR)
- Reporting Obligations: Obliged entities must assess all available information in a business relationship to determine if a transaction is suspicious.
- Relevant Criteria for Suspicion: This includes the purpose and nature of the transaction, the identity of the customer or beneficial owner, their financial and business background, and the source of wealth.
- Vigilance in Complex Transactions: Increased vigilance is required for complex or large transactions, especially if the nature, value, or source of wealth does not match the customer’s known personal circumstances or business activities, or if such information is opaque or difficult to verify.
- Directive (EU) 2015/849 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32015L0849
- Directive (EU) 2018/843 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32018L0843
- German Anti-Money Laundering Act (Geldwäschegesetz – GwG) https://www.bafin.de/SharedDocs/Downloads/EN/Aufsichtsrecht/dl_gwg_en.html
- BaFin-Interpretation and Application Guidance on the German Money Laundering Act (October 2021) https://www.bafin.de/SharedDocs/Downloads/EN/Auslegungsentscheidung/dl_ae_auas_gw2021_en.html