In the rapidly evolving landscape of Anti-Money Laundering (AML) regulations, the conventional wisdom of “asking every investor for a source of funds declaration” does not necessarily guarantee compliance. In fact, this approach might inadvertently lead to breaches of the General Data Protection Regulation (GDPR). It is a common pitfall to adhere to compliance superficially—merely “checking the box”—without grasping the underlying purpose and value of these actions.

Understanding Risk-Based AML Compliance

AML legislation is inherently risk-based. This means that it’s designed to be flexible, adapting to the specific risk associated with your business, your products, and your clients. To implement an effective AML strategy, one must start with a thorough understanding of both high-level risk assessments—such as those conducted by the European Union (EU AML Risk Assessment) and your respective country (National Risk Assessment)—and detailed analyses specific to your industry, organization, and clientele.

Tailoring Your KYC Checks

The next step involves tailoring your Know Your Customer (KYC) checks according to the inherent risks identified. This process includes evaluating aspects such as the nature of your product, the markets you operate in, your client base, and the channels through which your services are delivered. For example, an investment fund offering daily liquidity and using intermediaries to reach investors in higher-risk jurisdictions inherently carries more risk compared to a closed-end fund targeting a select group of investors in a low-risk country.

Mitigating Risks According to Your Appetite

The core of risk management is defining your risk appetite. Most fund managers prefer to maintain a low to very low risk level. Common mitigation strategies may include restricting investors to certain jurisdictions, refusing cash transactions, and ensuring that funds originate from accounts in the investor’s name held at reputable banks within the EU.

When is Source of Funds Necessary?

Contrary to common practice, the source of funds declaration should not be a blanket requirement. The FATF guidance and AML regulations specify that customer due diligence measures should include ongoing monitoring of the business relationship and, “where necessary,” the source of funds. The key phrase here is “where necessary.” This means you should establish specific indicators that would trigger a source of funds check. These indicators should be based on risk elements such as funds coming from a high-risk jurisdiction or negative news related to the investor’s wealth sources.

Hence assessing the source of funds (SoF) is not mandatory, except in cases where legal mandates—such as when the client is a Politically Exposed Person (PEP) or there are other higher risk indicators.

Also the nature and depth of the SoF asssessment should be porportionate to identified risk and in most cases a desk research by means of external sources (google search) might provide sufficient information.

Document Your Reasoning

In all aspects of AML compliance, documenting your decision-making process is crucial. This ensures that your strategies are not only compliant with the regulations but are also defendable in audits.

Conclusion

The shift from a tick-box approach to a nuanced, risk-based strategy in AML compliance is not just about adherence to regulations—it’s about protecting your business effectively and efficiently. By understanding and implementing a risk-based AML framework, fund managers can not only ensure compliance but also optimize their operational processes.

In the dynamic field of fund management, staying ahead means being proactive about compliance and risk management. Embrace the complexity of AML with a strategic, informed approach that goes beyond the conventional to safeguard and grow your business.