How the art industry can adapt to the challenges of 5MLD

Written by Paul Eccleson on Wednesday September 2, 2020

The use of works of art and cultural artefacts for criminal purposes is nothing new. Indeed, in many ways, art is the perfect medium for generating criminal proceeds. Objects with a high intrinsic value, small enough to be easily transported, but requiring considerable expertise to recognise their value, offer obvious advantages to the money launderer. A seemingly innocuous artwork displayed on a wall can hide in plain sight a highly profitable criminal endeavour.

For the general public, the looting of objects and theft of artworks has long the been the stuff of movies and crime dramas; for dealers, intermediaries, auction houses, art advisers and valuation experts, a more thorough understanding is required. These are expected to be aware of the potential use of art for criminal purposes, and recognise their obligations outlined under the Proceeds of Crime Act 2002 to deal with the associated risks.

5MLD Obligations

The most recent changes to the art market are significant. January 2020 saw the transposition of the EU Fifth Money Laundering Directive (5MLD) into UK law. After extensive consultation, and with HMRC as the regulator, art market participants (AMPs) face considerably more onerous anti money laundering (AML) requirements. Any AMP[1] involved in an art transaction (or series of transactions) of €10,000 or more is now expected to be able to answer some difficult questions. These questions are in addition to the provenance and authenticity challenges they already face, and must be answered before a transaction is concluded:

• what do you know about the buyer, seller, intermediaries, etc. involved in this deal?
• where did the funds for the this come from?
• where is the cash and, indeed, the piece going?
• is there anything suspicious about the deal?

Such customer due diligence (CDD) cannot be avoided for qualifying transactions. Indeed, depending upon the perceived risks in the transaction, a firm may even need to dig a lot deeper than simple ID checking. Enhanced due diligence (EDD) might require investigating the beneficial owners of trusts, the ultimate purchaser of the piece if represented by dealers or other intermediaries or the establishment of the true ‘source of wealth’ that is being used to fund the deal.

The new laws also expect firms to invest heavily in internal AML frameworks and expertise:

• should you consider yourself as an AMP that falls under these regulations, registration with the HMRC is mandatory[2]
• you will need to designate an individual who will be an expert in AML and the regulatory requirements that come with these laws
• that individual will need to be sufficiently resourced and trained in AML regulations

you will need to have conducted, and keep up to date, a money laundering risk assessment for your business

• all staff within the firm will be expected to be trained to understand their individual obligations to report suspicions and, if necessary, prevent transactions
• a firm will be expected to establish strong policies on AML, and implement procedures to ensure those policies are adhered to

• the firm will be expected to report in an effective and timely manner to the National Crime Agency (NCA) and other authorities if required
• once reported as suspicious, a transaction cannot proceed until the NCA has consented to the completion of the deal
• all records of due diligence and other investigations must be retained and given over to authorities if required.

Failure to follow any of these regulations could result in criminal action against the firm, individuals or both.

5MLD: Details and nuances 

The new regulations apply broadly across all sizes of firms, even sole traders. However, there are nuances and variations within the new laws that firms need to understand. The following are among some of the key points that must be digested. 

- Not all items are classed as ‘works of art’. The regulations use the same definition as the VAT rules.  These tax rules exclude antiques and ‘collectors items’ such as coins and stamps. They also exclude items such as maps, technical drawings, porcelain, books and theatre scenery. This may seem odd in the context of AML, but is a direct consequence of carrying over the tax definition.

- Overseas dealers simply in the UK for events such as art fairs are also subject to the regulations. This means that on-the-spot transactions are expected to be undertaken with adequate CDD.

 - You can rely on another registered body in the deal to perform appropriate CDD checks, but the responsibility for ensuring all checks have been performed correctly remains with you. The other party must be aware that you are relying on them, and release any information related to due diligence to you.

- If you have a long-term relationship with a customer, the diligence and transactions need to be continuously monitored and refreshed. Doing due diligence once and then forgetting about it is not acceptable.

- You must notify authorities if a transaction appears ‘suspicious’, but ‘suspicion’ has a specific (yet tricky) meaning in law. Suspicion must be founded on more than just speculation, but guilt doesn’t have to be proven outright. Deciding if an unusual transaction merits suspicion requires training and judgement. Getting it wrong may open you up to being sued by a third party – particularly if a transaction is significantly delayed or cancelled without due cause.

Getting to grips with the full extent of the regulations is a challenge. The British Art Market Federation, in conjunction with HMRC, have produce extensive guidance on the regulations.[3] The paper runs to 112 dense pages.

Adjusting to CDD

It is still early days for these regulations in the art and antiquities market. Anecdotally, the trade is struggling to implement these expectations in some circumstances. CDD is said to be causing specific headaches, interrupting the flow of a deal. For example, art fairs are traditionally a terrific way for dealers and galleries to interact with customers, understand the marketplace and transact on the spot. CDD threatens to derail that instantaneous contact and inhibit sales. This may be why many works at such fairs are priced at €9,999 or less. Many galleries have proactively contacted their customers and VIP lists to update due diligence for their records. However, due diligence over first time customers and new distribution partners remains a thorny issue.

More extensive AML regulations in the art world are to be welcomed. However, they come with heavy expectations on an industry that is still adjusting to their demands. ICA has a great deal of experience in dealing with those industries (such as financial services) that have been subject to the same AML regulations for many years, and, though the art industry is new to these, can offer considerable support and professional qualifications to help the industry adapt.

For more on 5MLD and the art and antiquities market, see the following in-detail Knowledge Bite from the ICA CPD Centre on the legislation and its consequences [available to ICA Members only].

[1] The definition of an art market participant is very broad. It includes purchasing intermediaries and freeport storage providers, among others.

[2] HMRC are expecting around 3,000 firm registrations, from all sizes of business.

[3] The guidance can be found at: https://www.gov.uk/government/publications/art-market-participants-guidance-on-anti-money-laundering-supervision – accessed July 2020