Going underground

It was reported in the legal press at the end of August that seven people had been convicted and sentenced to terms of imprisonment for laundering over £55m through a Chinese underground banking network. Police officers in Stoke Newington, London, started an investigation into the group following intelligence reports that they were selling British currency to Chinese university students through a popular Chinese language messaging app. The cash used to supply the British currency was collected by the group from unknown couriers in bulk, sometimes up to £250k at a time.

Informal value transfer systems

Chinese underground banking is not a new phenomenon. Hundreds of years before the development of formal banking processes, traders are known to have used trusted intermediaries to facilitate cross-border payment and currency transfer. These processes developed independently across many cultures and continents and are often described by academics as ‘informal value transfer systems’ (IVTS). The Arabic and south Asian equivalent is called ‘hawala’ and was practically unknown in western countries until 2001 when American investigators discovered that some of the money used to fund the 9/11 attacks had been moved through hawala processes, inextricably (and largely unfairly) linking hawala to terrorism in the minds of US policymakers.

Chinese underground banking itself was almost entirely unknown in the UK outside the Chinese community until October 2019, when a National Crime Agency (NCA) report, Chinese Underground Banking and Daigou, highlighted the potential risk of criminal funds being moved through IVTS processes.

It’s a mistake to think of underground banking as a single process. As a professional service, a ‘qianzhuang’ or ‘money shop’ will use a wide variety of techniques to move value across borders, including cash smuggling, trade for the sole purpose of transferring value and breaking large sums down into smaller sums below the official reportable limit for transfer through multiple bank accounts. At a personal level, individuals frequently rely on family and friends to send money abroad through their personal bank accounts to evade China’s tough currency controls.

The reported modus operandi of the Stoke Newington group suggests that currency transfer was being paid for in China, from Chinese bank accounts, but that the currency handed over in the UK was sourced from ‘street cash’ derived from drugs sales or other serious crime. This allowed the organised crime group to dispose of criminal property acquired in one country through ostensibly legitimate activity and ‘transfer the value’ to their preferred jurisdiction.

Regulation and legislation

China is not currently formally listed as a high-risk third country for anti-money laundering (AML) purposes, but the risk from Chinese underground banking was flagged in a Legal Sector Affinity Group (LSAG) guidance note published in March 2023. The note highlights the danger that funds can be used to support, for example, a property transaction that may have been legitimately accrued in the country of origin but supplied in the UK out of cash or other funds derived from illegal activity. Accepting cash derived from such activities could potentially amount to acquiring criminal property and / or entering an arrangement which facilitates someone else’s acquisition, transfer, use or control of criminal property, even in circumstances where the client has not knowingly engaged in any unlawful activity. Both offences attract severe criminal sanctions and long terms of imprisonment under the money laundering provisions of the Proceeds of Crime Act 2002 (POCA).

Recent case law suggests that the courts are likely to take a robust approach to enforcing money laundering legislation. In March 2023, the High Court dismissed a claim for judicial review of a forfeiture order for over £67k transferred through an IVTS process (see Fresh View Swift Properties v Westminster Magistrates Court [2023] EWHC 605). The claimants had transferred funds from Nigeria using an unregistered money service business (MSB) who – in classic underground banking style – had paid the funds into Fresh View’s UK account via an ostensibly unconnected third-party account. The court determined that while there was no evidence that the funds had been unlawfully obtained in Nigeria, the fact that they had passed through an unregistered MSB in the UK effectively criminalised the entire sum under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, rendering them liable to forfeiture under the civil provisions of POCA.

The judgment noted both that the directors of the company knew they should have used a regulated MSB, and that forfeiture of the sum concerned was “a proportionate response to meet the high societal need to tackle money laundering”. Arguably, the case leaves it open to foreign nationals to continue to use informal family and friend networks to transfer money to the UK, but it appears that the use of commercial unregulated money transfers will not be tolerated by the courts.

Risk and red flags

For those engaged in property work, the danger posed by funds transferred via underground banking further escalates the risk profile of conveyancing, an area of work already assessed as comparatively high-risk for money laundering purposes by both the NCA and the Law Society. Property transactions are typically high-value and, in recent years, the UK property market has increasingly attracted foreign investors including politically exposed persons (PEPs) and those

from high-risk jurisdictions like Russia. Complex trusts and overseas corporate structures have historically been used successfully to obscure the real ownership of residential and commercial properties. Add to this the risk of money being transferred through unregulated and unverifiable processes, and it‘s easy to see how lack of awareness and failure to conduct proper due diligence could lead to a serious regulatory breach or even criminal penalty.

The recent highlighted risk from Chinese underground banking is linked in part to China’s economic success and the growth of ethnic Chinese populations in the UK and other Western countries. However, IVTS processes are similarly associated with other countries such as Vietnam, India, Pakistan and some Middle East and African countries. These transfer processes are also used by diaspora communities in the UK and elsewhere who are likely to be familiar with, and have access to, them.

The LSAG guidance indicates that the following red flags may indicate the use of IVTS and potentially suspicious activity:

• transfers of sums just below the threshold of reportable transactions in the country of origin (currently US$50k in China)
• sums received from multiple third-party company or individual accounts with no direct link to the transaction
• multiple payments to retailers of high-value goods
• multiple sums of similar figures or ‘round figures’
• information from the client that appears to be suspicious, inconsistent, contradictory or false, and
• a client who insists on providing their own translations of foreign supporting paperwork.

The guidance also stresses the importance of conducting proper verification of source of funds and source of wealth (where the money came from and how it was accrued). It is likely to be difficult, if not impossible, to conduct a comprehensive investigation into the origin of money used to fund a transaction, but the law requires that you take reasonable steps to confirm and verify as far as possible the information you have been given. What is reasonable will depend on the client, the matter and the surrounding circumstances, including national risk guidance. In relation to funds sourced from overseas, you should consider:

• refreshing your memory as to current risks and what is on your firm-wide risk assessment
• asking the client pertinent questions
• obtaining bank statements
• obtaining proper translations of any documents that you do not understand
• seeking out reliable information about the country of origin of the funds (such as transparency corruption rating and the Financial Action Task Force Mutual evaluation report)
• carrying out due diligence on companies that have transferred money, and
• using official sources to confirm the standing of overseas professionals.

You should document and retain any evidence you collect, including how you came to your decisions, and keep those records for the period required under the Money Laundering Regulations (at least five years from the conclusion of the transaction, and sometimes longer).

Reporting suspicious activity

It is a criminal offence under section 330 of the Proceeds of Crime Act for a person in the regulated sector (including most solicitors) to fail to properly disclose activity which they know, or suspect, constitutes money laundering, during the course of their business. The disclosure or suspicious activity report (SAR) must be made to the Money Laundering Reporting Officer (MLRO) or to the designated contact point at the NCA, generally through the SARS online system.

Where the transaction is ongoing or has not yet taken place, you must submit a defence against money laundering (DAML) SAR and obtain authority to carry out the transaction. In most cases authority is given within seven working days, although the NCA can refuse consent, in which case you will be unable to proceed with the transaction or transfer any money held without further authority.

If NCA consent is given, you are then approved to continue with the transaction in question and cannot be prosecuted for a related money-laundering offence under sections 327–329 of POCA. You are only protected in relation to the criminal property and transaction that are described on the SAR you have submitted. Therefore, it’s critical that you properly explain:

• what the criminal property is
• who you suspect
• lhy you suspect them
• what offence you believe you would be committing in the absence of NCA consent, and
• what you require consent to do.

It’s important to note that the NCA can only grant consent in relation to the three money laundering offences under sections 327–329 of POCA, and for no other purpose. NCA consent does not convey authority to breach sanctions or to engage in fraud or any other criminal activity.

There is no overriding requirement to report suspicions of underground banking. But the stringent legislative requirements to report any suspicion of money laundering, together with the current focus on money moving from China, means many compliance officers will conclude that it’s best practice to do so.

Bear in mind, too, that obtaining consent from the NCA does not necessarily mean that it’s a good idea to proceed with a high-risk transaction. You are perfectly entitled to decline to act if a transaction falls outside the risk appetite of your firm.

Best practice

Government, law enforcement and regulators will no doubt continue to place significant demands on regulated businesses in general, and property lawyers in particular. The best way to protect your people and your firm is to:

• keep up to date with the latest advice and guidance
• properly maintain your firm-wide risk assessment
• make sure you know your clients and understand your client matters
• carry out effective due diligence on the client and their funds
• report any suspicions to your MLRO or to the NCA, and
• document everything important and keep records.

Understanding underground banking and informal value transfer systems, along with sound risk management and properly documented decision-making, leaves your firm well-placed to engage effectively with what is an increasingly important – and potentially profitable – client base.