As COVID-19 forces more and more of our daily lives into cyberspace, how well regulated is the digital realm, and how can criminals exploit its grey areas? In this blog, originally from our On Digital Trust publication, Professor Nicholas Lord explains how criminals exploit the murkiness of the digital space to siphon off and launder money, under the guise of legitimate practise.

• Money laundering is estimated to cost the UK £100 billion a year
• The use of corporate vehicles provides a legitimate and anonymous front, behind which criminals are able to steal, move, and launder money
• Greater political awareness and action is needed to fight this, including the creation of a new centralised authority for investigating and vetting all corporate vehicles in the UK

Imagine you are involved in criminal, unlawful or unethical activity that makes serious money for you or your employer. You might, for instance, be a public official awarding procurement contracts, who extorts or accepts substantial bribes and hides them in overseas bank accounts. Or perhaps you work for a multinational corporation that systematically and aggressively avoids tax liabilities in its home country, using schemes that exploit transnational legal mismatches to shift profits to lower tax jurisdictions. From individual and corporate elites, to those implicated in organised crime, the vast global flow of illicit and unscrupulous financial activity is now a priority policy issue for governments and societies worldwide. And, as indicated in the United Nations Sustainable Development Goal 16.4, there is particular concern with the illicit movement of money out of low-income economies and the role those working within wealthier ones are playing in this. So how is it done and what can we do about it?

Keeping secrets

In this murky world of dodgy dealings, those individuals and corporations implicated will seek to keep, if necessary, their illicit finance secret from regulators or enforcement authorities. So how do they hide their identity in order to protect their assets? How is this finance converted into what looks like legitimate money for use in legal markets? And how has the digital space influenced how these objectives are accomplished?

Individual and corporate actors need mechanisms for concealing, converting and/or controlling the illicit finance generated from their activities if they wish to use this wealth for purchasing assets, such as houses and cars, or services such as private school tuition fees, to reinvest into business activities or protect their reputations (eg unauthorised tax avoidance, which is lawful but unethical).

‘Corporate vehicles’ and the global financial system

The University of Manchester’s Corporate Vehicles and Illicit Finance project, run in partnership with Police Scotland and the Centre for Information and Research into Organised Crime (Netherlands) is the first such study in the UK to be looking into this. Our research has demonstrated that one way to accomplish the concealment and control of illicit finance is by using so-called ‘corporate vehicles’ – a term used to refer to an array of legal structures such as companies, trusts, partnerships, and foundations. Such vehicles enable a range of commercial activities including the control and movement of wealth and assets within the financial system. For instance, they permit businesses to incorporate companies in low or no tax regimes, provide flexibility in global markets, and reduce the level of regulation, particularly when set up in jurisdictions that offer great confidentiality. Large flows of monies move through the global financial system via such vehicles and this has become a central feature of business in market-based economies.

However, the Panama Papers leak in 2015, the Paradise Papers leak in 2017, the Mauritius leaks in 2019, and subsequent investigative journalism have illustrated how such legal structures are being misused and abused for illicit purposes, such as the evasion and avoidance of tax by wealthy individuals, the concealment of corrupt funds by public officials, and money laundering, amongst others. These issues have come to the fore globally, but also in the UK specifically. For instance, in 2017 Transparency International found that UK companies have been implicated in facilitating the hiding of illicit wealth and assets and corruption around the world, whilst the National Crime Agency estimates money laundering costs the UK more than £100 billion a year. The movement of illicit finances into the UK property market is also of concern: according to international NGO Global Witness, over £100 billion worth of properties in England and Wales are owned by anonymous companies in overseas tax havens, whilst in 2018 Transparency International identified £4.4 billion worth of UK properties bought with suspicious wealth.

Research evidence

Our research found strong evidence for three key propositions: firstly, that corporate vehicles create an illusion of legitimacy through the abuse of otherwise lawful business arrangements including fabricated financial arrangements and contrived ownership structures; secondly, they provide anonymity for the beneficiaries of illicit assets and insulation from enforcement, making illicit finance virtually untraceable, particularly when organised across jurisdictions that provide great secrecy, or confidentiality; thirdly, these schemes are most often accomplished with the witting collusion or sometimes unknowing (or wilfully blind) assistance of third party legal, financial and other professionals, including company formation agents or trust and company service providers. These professionals help manage other people’s ‘dirty money’, whether generated by commercial enterprises or organised crime groups. In all the cases we have come across, corporate vehicles provide opportunities for managing illicit finances that individuals alone cannot access.

Easing corruption through digital technology

The core matter here is that the digital space has significantly eased how corporate vehicles can be misused by enabling quick, online company formation via transactions that are conducive to anonymity and has opened access to such misuse to a much wider array of individuals. As evidenced by our own research and the World Bank, amongst others, it is now straightforward for anyone to obtain anonymous corporate vehicles at reasonable cost and quickly, online.

An internet search will find numerous providers of company formation and registration services, plus more. Bank accounts for these companies can then be opened in foreign jurisdictions without having to go there physically. For those implicated in serious financial crimes including those who facilitate it, the ease of the process opens up new opportunities for creating and controlling illicit finance and hiding the identity of the beneficial owner. Furthermore, the boom in online-only companies that offer company formation services has created a lucrative market that caters for varied clientele.

Whilst the transition from paper-based to digital-based company formation systems and services should also make it possible for enforcement authorities and regulators to obtain information on who owns, controls and benefits from these companies, there are currently major gaps in terms of the data available and how they are scrutinised. The sheer number of vehicles being created in this way makes it difficult for the identity of beneficial owners to be established. Regulatory non-compliance often goes unchecked due to an under-resourced and poorly mandated Companies House in the UK, as acknowledged in the UK Government’s Corporate Transparency and Register Reform consultation of 2019. We also have a fragmented regulatory system that involves over 20 responsible regulators, such as HMRC, the Financial Conduct Authority and varied professional supervisory authorities.

In policy terms, a plausible route to minimising misuse is to focus on a) professional intermediaries by improving the regulation and supervision of them to reduce opportunities for misuse by their clients, and b) tightening laws and regulations on how and where corporate vehicles can be created.

Currently the digital landscape enables any person anywhere in the world to form UK companies that can be used as vehicles in laundering illicit finance. In the short-term, making it a requirement for only licensed and regulated company formation agents to have the capacity to form corporate vehicles could improve the validity of registration data, ensuring enhanced due diligence of client wealth, and minimising misuse by foreign agents. Such reform initiatives are underway in the UK, eg in relation to the misuse of (mainly Scottish) limited partnerships, but there must be enough resources and mechanisms for enforcing this and they must apply to all forms of corporate vehicle.

In the medium to long-term, I would like to see the creation of a new UK Screening Authority to act as a centralised authority with the budget and scope to regulate company registration data (including foreign ownership) and undertake due diligence on the creation of all vehicles. This would remove the burden on Companies House and reinforce political commitment to addressing ‘dirty money’ flowing into, from and through the UK and its overseas territories. We see a similar authority in the Netherlands with the Judicial Agency for Testing, Integrity and Screening under the Ministry of Justice and Security, which is responsible for assessing the reliability of people and organisations.

A serious challenge

Awareness as to the nature (eg the role of ‘legitimate’ actors) and seriousness and harms of corporate vehicle misuse needs to be raised, particularly within political spheres, as governments seek to protect economic interests whilst also appeasing pressure to respond. For instance, finances stolen from public funds in low-income countries that flow overseas significantly impact on investment opportunities in local infrastructure, diverting money that could be spent on health, education, transport, etc, not to mention in some cases jeopardising financial stability in these places.

Similarly, the flows of illicit finance elsewhere can distort legitimate markets, such as creating booms in house prices and in turn forcing low-income individuals out of their local areas. Yet state responses remain frustratingly piecemeal and lack sufficient vigour, but then as the leaks mentioned have demonstrated, individual and global elites, such as politicians and business leaders, have also benefited from these secretive financial arrangements.

Due to these tensions, there is a lack of urgency to create regulations that reduce the scope for these structures and vehicles to be misused. We must do more to prevent the movement of illicit finances, and this implies the need for substantial financial investment in enforcement, to support the punitive rhetoric, and recognition that both private and civil society organisations have a role to play in this.

Lastly, governments need to be challenged to take a much stronger position on this issue within conversations about creating an attractive economic and fiscal climate for businesses.

This article was originally published in On Digital Trust, a collection of essays providing analysis and ideas on the use of data in healthcare, crime prevention, and democracy in the current political climate. You can read the full publication here.

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