What is a Beneficial Owner and Why It's Important for Compliance

On August 30th 2023, the Federal Council of Switzerland initiated a consultation with the aim of strengthening Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) procedures. To these ends, the council brought forward the need for a more robust and transparent system in regards to beneficial ownership.

This marks a very important global trend centred on the fight against opaque ownership structures caused by regional differences, shell corporations, and gaited registers.

Given that our software automates client onboarding, KYC and AML processes, whereof the question of beneficial ownership is key, in this article we’re going to:

• Broadly define beneficial ownership.
• Discuss the different entity types that can be covered under beneficial ownership regulations and how these entities are typically processed.
• The importance of transparent ownership structures for compliance and the processes most closely related to beneficial ownership.
• General practices used when defining ownership structures and the hurdles these processes can run into.
• General terminology that’s often used within the same context as beneficial ownership that can cause confusion.

Lastly, do note that in this article we will be talking about beneficial ownership from a zoomed out perspective. In other words, while we will mention countries such as Switzerland or the UK when talking about specific details, this article sets out to talk about beneficial ownership on a global level.

Therefore, there will be regional differences in how ownership structures are defined, processed, and/or logged.

Featured image for What is a Beneficial Owner and Why They’re Important for Compliance

Raphael Wullschleger

COO

Beneficial ownership for a natural person

Even if a natural person opens an account, banks must ensure to identify the beneficial owner of the assets.

Beneficial ownership for a legal entity

According to EU regulations, a beneficial owner, as it relates to a legal entity, is defined as “A natural person owning more than 25% of the shares or voting rights in an entity, either directly or indirectly…”. However, member states have the option of lowering this threshold at their own discretion.

A company can have multiple beneficial owners, either through shares in the company or voting rights. Furthermore, parties with significant control can qualify as beneficial owners as well.

In terms of identification and verification, a financial institution must have information about the structure of the organisation, as well as identify its shareholders, directors and senior management. Such information is typically gathered via corporate records, shareholder registers and official filings.

Countries that have implemented transparent regulations regarding ownership structures will also typically make it mandatory for certain legal entities to log their ownership structure. For example, in Switzerland this is done through the K and A forms, for legal entities and domicile companies respectively.

And in the UK, these regulations are related to reporting “People with significant control”, which is another name for beneficial ownership.

Beneficial ownership for a trust or foundation

In the context of a trust, a beneficial owner is defined as “the settlor(s), beneficiaries, trustees and any individual who has control over a trust, which can include trust protectors.”

Therefore, the process of identifying the beneficial owner involves identifying all relevant parties, through the standard means we described when talking about a natural person. However, what makes trusts more difficult in this context is that a financial institution also has to determine the nature and extent of each party’s control over the trust.

Foundations typically follow a similar process, with founders, board members and beneficiaries being filed, as well as any persons with significant control over the foundation. And depending on the jurisdiction in question, the filing for foundations might be separate from that of trusts; for example, in Switzerland, these are the S and T forms respectively.

Beneficial ownership for an insurance

In the context of insurance, a beneficial owner is “ the person for whose benefit the property is held”. However, in a similar manner as with trusts, both the beneficiaries and the policyholder must be identified to stay compliant with beneficial ownership regulations.

Furthermore, in the UK for example, more than one person can be a beneficial owner as well, for example, when a married couple takes out life insurance. And premiums paid in this context will count towards the premium limit for both parties.

Regarding identification, it must also be assessed whether any party has significant control or influence over the policy, through means such as premium payments, policy modifications or beneficiary designations.

Why is beneficial ownership essential for AML regulations

Incidents such as the Bahamas leaks as well as the Panama papers highlight the difficulties that can be present when determining beneficial ownership.

In this case, through complex ownership structures where an asset can be held by a legal entity that is itself owned by a different legal entity, the actual beneficial owner can be very difficult to trace.

Such opaque ownership structures can then in turn pave the way for illegal activities such as money laundering, tax evasion, financing of terrorism and general non-compliance.

This is because being able to correctly identify beneficial owners is essential for certain key compliance processes. These processes include:

Risk assessment

During the KYC process, it’s essential for the regulating body to have insight into beneficial ownership in order to properly assess the risk associated with an individual or company. For example, if a legal entity (in this case a company) has alleged or known ties to sanctioned or otherwise prosecuted individuals, said entity would be considered a high risk.

However, if these proposed individuals completely hide their involvement with said company while still being beneficial owners, the whole transaction can be considered an attempt of money laundering or financing of terrorism.

Furthermore, obstructing the beneficial owner prevents the financial institution from performing proper due diligence. For example, in the UK, if a person is from a FATF high-risk country, compliance regulations state that they must go through Enhanced Due Diligence (EDD).

However, if said individual makes a transaction through a third party and isn’t labelled as a beneficial owner, EDD might initially not seem necessary. Thus, the extra safety precautions and monitoring processes would be skipped over in favour of standard Customer Due Diligence (CDD). And this forms the basis of non-compliance.

Identifying shell companies

The significance of leaks such as the Panama papers is that they showcase how corporations and individuals can abuse shell companies to avoid legal regulations, audit trails and even persecution. That is to say that by taking advantage of opaque ownership structures, large funds can be transferred to these corporations without being properly processed.

In such cases, the shell corporation is usually founded by a third party and has no physical office or employees, making it very difficult to identify the beneficial owner. Therefore, Politically Exposed Persons (PEPs), known criminals, and individuals under sanctions can all be beneficial owners without arousing suspicion.

As an example, among the Panama papers, funds were ever tracked to the 1983 Brink’s-Mat robbery; the largest gold heist in British history.

Regulating crypto currencies

Beneficial ownership has also become increasingly important in the cryptocurrency space. This is because the decentralised nature of most cryptocurrencies made the medium susceptible for money laundering and similar criminal activities. For example, the dark web Silk Road or the more recent FTX scandal.

However, in the EU for example, regulations have passed that require AML procedures to be performed. Article 19a in the Regulation 2023/1113 on information accompanying the transfers of funds necessitates:“ taking risk-based measures to identify, and verify the identity of, the originator or beneficiary of a transfer made to or from a self-hosted address or the beneficial owner of such originator or beneficiary, including through reliance on third parties; “.

Thus, beneficial ownership is likely to be a key part of the KYC process in crypto markets just as it is in traditional banking for the same reasons we’ve mentioned so far.

How to identify a beneficial owner

As with other forms of KYC, identification for beneficial ownership can be done via large databases that detail information about all relevant parties. In the EU, this can be done by anyone through the Beneficial ownership registers interconnection system (BORIS) and in the US, the relevant data would be handled by the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), just to name a few.

However, it’s important to note that these registers aren’t always available to the public. In fact, after the 2022 EU ruling that disbanded the need for countries to hold public registers of beneficial ownership, many countries have made their registers private. Therefore, accessing this data has become more difficult and often relies on third parties.

Common challenges when establishing a beneficial owner

A number of countries don’t share relevant information with other jurisdictions. It’s due to this lack of transparency that it’s often quite difficult to establish a beneficial owner if they’re located and/or their funds go through one of these countries.

Therefore, organisations such as the Financial Action Task Force (FATF) often monitor and assess such countries and provide a framework for their regulations to be brought up to par.

Furthermore, when talking about shell corporations, we can see that the offending parties will often make multiple transactions between different companies, muddying the waters and making it difficult to track down the beneficial owners at play.

And when these two factors exist in conjunction, which isn’t all that rare, the issue is exacerbated even further.

Other terms that are important for compliance

For individuals who aren’t well versed in compliance regulations, a potential source of confusion is the glossary used. Namely, there are a few key terms that tend to crop up when talking about beneficial ownership.

However, while the context they are used in is similar, the meaning is quite different. Therefore, to prevent further confusion, we will go through a few of these terms and detail how they differ from the term beneficial owner within the context we’ve used it in.

Who is the ultimate beneficial owner?

While there can be multiple beneficial owners within a single company or business, there is only one ultimate beneficial owner. This term is typically used when discussing legal entities, as corporate structures tend to have multiple beneficial owners with differing levels of ownership and/or control.

The ultimate beneficial owner in this context is therefore the beneficial owner who holds the largest percentage of ownership and/or control of a given asset. As such, properly identifying them is essential.

To these ends, many AML regulations regarding beneficial ownership will solely focus on the ultimate beneficial owner (UBO), leading to many such regulations being referred to as UBO regulations.

Beneficial owner vs legal owner

Another important distinction is the difference between a beneficial owner and a legal owner. Namely, a legal owner is the person who holds a legal title under their name.

Often, the same person will be both the beneficial owner and the legal owner. For example, a natural person who’s opening a bank account in their own name.

However, this also doesn’t have to be the case. For example, when buying stocks, a person can decide to have said stock under a “street name”; that is to say in the name of the brokerage, instead of their own.

In this context, while the person is the beneficial owner, they are not the legal owner. A person can opt for this option for legitimate reasons but a transparent ownership structure must be maintained.

Beneficial owner vs beneficiary

While these two terms seem interchangeable at a glance, they are quite different in meaning. In fact, these two terms can show up in the same narrative but will usually refer to completely different entities, which further adds to the confusion.

The main difference between a beneficial owner and a beneficiary is that beneficial ownership relates to owning and controlling an asset, not just benefitting from it. A beneficiary on the other hand, excludes both ownership and control.

For example, within an insurance, the person who owns the insurance is the beneficial owner as they can influence and change the parameters of the insurance. On the other hand, a person who is set to receive funds from said insurance but has no influence over it is considered a beneficiary.

Conclusion

In conclusion, having systems in place to identify, verify and log ownership structures is essential for compliance. And while the level at which beneficial ownership is handled differs between jurisdictions, a general trend can be observed of beneficial ownership becoming more strictly enforced.

Therefore, being aware of how beneficial ownership is handled in your jurisdiction and for your entity type is essential for staying compliant.