Beneficial Ownership in the Investment Industry: A Strategy to Roll Back Anonymous Capital
77 Pages Posted: 24 Oct 2019
Date Written: October 7, 2019
Current regulation of the investment industry and securities trading primarily focuses on protecting investors and maintaining the soundness of the investment and securities market. While financial institutions and other intermediaries are usually also bound to perform customer due diligence and anti-money laundering procedures to prevent illicit financial flows, the secrecy underpinning the investment industry and securities trading significantly undermines measures to address tax evasion, corruption and money laundering. The main secrecy problem in the investment industry and securities trading is that no single party has access to a full picture of individual chains of ownership, meaning nobody fully knows who owns what. At best, some parties have access to partial information.
Two recent transparency advancements improved the investment industry’s situation, but only marginally. Many countries, especially in the EU, have started to establish beneficial ownership registries, where companies, trusts, partnerships and other legal vehicles have to disclose their “beneficial owners”, the individuals who ultimately own, control or benefit from a legal vehicle. However, investment entities (as well as companies listed on a stock exchange, whose shares may be held by investment entities as underlying financial assets) are in many cases being excluded from the scope of these new beneficial ownership registries, either by law or in practice.
The other transparency breakthrough is the OECD’s Common Reporting Standard (CRS) for automatic exchange of information. However, many loopholes and exemptions prevent the new standard from being truly effective at solving the secrecy problem of the investment industry and securities trading. Notwithstanding the many loopholes and exemptions, when the CRS does apply to the investment industry, it only covers information about the value and income from investment entities. It does not collect information on the underlying securities held by investors through investment entities. This makes it impossible for authorities to detect misreporting or underreporting.
To address these secrecy problems, the most comprehensive solution to the secrecy underpinning the investment industry and securities trading could be to disclose every individual that directly or indirectly holds: (i) any interest in an investment fund, (ii) any interest in an underlying financial asset (eg a share in a company listed on a stock exchange), and (iii) how the individual holds these underlying securities, including all intermediaries involved. Given the current trend of super-fast trading where securities may be held for just a few seconds, ownership could be reported regarding the situation at the end of the business day (identifying only the last end-investors who held each interest in the investment fund and in the underlying security at the end of each business day). In addition, this comprehensive identification of the end-investor and its beneficial owner (the individual end-investor) should involve replacing omnibus accounts (that pool together money from many different investors) and employ segregated accounts at the end-investor beneficial ownership level. To be comprehensive in its scope, beneficial ownership thresholds for legal persons (currently at “more than 25%” of ownership) should be lowered so as to require any individual holding any interest in an investment fund or in a financial asset (eg holding one share in Apple) to be registered as a beneficial owner. By identifying every individual holding at least one share or unit of interest it would be possible to account for every underlying financial asset, and every interest in an investment fund in the world (or at least in a given market). This granular ownership detail about every existing investment fund and every underlying financial asset would ensure that there is no case of underreporting or double reporting of financial assets (to prevent evading income tax, capital gains tax, or trying to obtain illegal tax refunds).
Keywords: beneficial ownership, aml, investment fund, collective investment vehicle, hedge fund, automatic exchange of information
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