By Stelios Orphanides
While the increasingly stricter anti-money laundering (AML) practices applied in the Cypriot financial system in recent years are already disgruntling businesses, the island’s entanglement in the geopolitical tug of war between the US and Russia, one of Cyprus’s major commercial partners, may have significant implications for the economy.
Interviews with several stakeholders –some of whom only agreed to talk on condition of anonymity– show an increasing concern in the ranks of professionals and entrepreneurs in Cyprus over the impact of stricter AML and terrorist financing practices being applied, amid fears that recent US pressure on the island’s financial and business service providers to take US sanctions more seriously into account, may have a transformative effect on the economy.
While some of the interviewees argue that there are ways for Cyprus –which two weeks ago launched a PR campaign to improve its image abroad in terms of combatting the laundering of illicit funds– to both adhere to AML regulations and US sanctions on fears its banks could lose access to the US dollar without angering the island’s large Russian business community, others acknowledged that the situation is at a critical point.
“There is a financial war and we don’t know its outcome,” said economist Marios Clerides, a former banker who also in the past served as chairman of the Cyprus Securities and Exchange Commission (CySEC).
Clerides was responding in a telephone interview a week ago in reference to the US decision to place sanctions on additional Russian government officials, companies and billionaires with ties to the country’s president Vladimir Putin.
As this Russo-American financial war rages, even when Cypriot banks apply strict AML standards while transacting with customers who apparently have no links to persons or entities targeted with sanctions, this still exposes them to additional risks as the means available to them have limitations, Clerides said.
“A Cypriot bank is not the CIA to know whether a certain customer is linked to a certain party” included in a sanctions-list no matter how deep the due diligence procedures applied and so avoid second-round sanctions, he said.
In order to reduce the risk of exposure to sanctioned Russians, Cypriot banks have resorted in recent weeks to prudentially closing accounts belonging to customers with links to Russia, even if the beneficiaries are not necessarily linked to persons targeted with sanctions or had not raised suspicious in the past, two banking sources said.
“The increased due diligence measures taken by banks are a result of the latest sanctions and announcements of supervisory authorities,” a banking source familiar with the matter said adding that the measures may range from “monitoring to closing of accounts”.
A colleague of his at a different bank, also familiar with the matter said that the case of Latvia’s ABLV, which the US Financial Crime Enforcement Network (FinCEN) in February described as a bank of primary money laundering concern with links to North Korea, “has sparked concern among Cypriot banks amid general pressure to clamp down on laundering”.
Already, the side effects of the increased AML measures taken by banks are being felt in the real estate sector, with developers complaining that it has become increasingly difficult for them to get paid for sales of property.
“Transactions with banks have become more difficult in the past six months and they are getting even more difficult,” said Pantelis Leptos, chairman of the Cyprus Land and Building Developers Association (CLBDA) said in a telephone interview. “In the industry it is very difficult to collect from real estate buyers from abroad”.
Leptos said that lenders applying such due diligence processes, while “not exclusively restricted to Russian customers,” have catapulted Cyprus “from one extreme to the other”. Therefore, Cyprus should look “at the highest level” for room to manoeuvre.
A third banking source who was talking on condition of anonymity said that the due diligence procedures are related to the application of a the “know your customer’s customer” (KYCC) practice. While banks could in the past approve an incoming payment to a developer’s bank account when the latter presented the documents of the transaction, now banks also scrutinise the developer’s customer to ensure that his or her funds are legitimate.
The real estate sector, whose demand and supply the government supports with tax breaks and a citizenship scheme as well as town planning relaxations, is a significant source of revenue for the Cypriot economy which three years ago emerged from a prolonged recession, caused by a twin fiscal and banking crisis. The economy expanded last year 3.9 per cent and the finance ministry expects it to grow a further 3.8 per cent this year.
Furthermore, business with Russia, deemed a high-risk jurisdiction with respect to money laundering, is a major source of revenue for Cyprus’s financial services sector, one of the few countries to sign double taxation agreements with Russia. The island is one of the largest investors in the country with the foreign investment stock amounting to €28.9bn in 2016 compared to €31.1bn invested by Russians in Cyprus, reflected also in the large number of Russian-owned companies operating on the island.
On the other hand, Cyprus which aspires to develop its hydrocarbons reserves in its exclusive economic zone (EEZ), relies on the US as a shield against Turkey. While Ankara is strengthening its ties with Moscow, in February, it sent warships to prevent the Italian energy company Eni from carrying out an exploratory drilling. Two US companies, ExxonMobil and Noble Energy Inc. have acquired oil and gas licences, in addition to six other companies from an equal number of countries allied with the US, such as the UK, France, Italy, Israel, South Korea and Qatar.
However, this forecast may be optimistic if one takes into account the impact of the stricter implementation of AML procedures and sanctions on the economy. On top of that, the UK – Cyprus’s main source of incoming tourism which two years ago plunged into uncertainty after its voters decided to leave the EU– is also going hard on Russian capital following the March 4, Salisbury poisoning attack on a former Russian spy and his daughter. The British economy may also be hurt in the process.
A London-based banker said that the UK’s decision to go hard on Russian capital may also be related to the US efforts to make it more difficult for Russia, a major oil producer, and its oil-producing allies such as Iran, to benefit from a recent increase in energy prices. This, he continued, was not unrelated to US president Donald Trump’s decision to unilaterally withdraw from the Iran nuclear deal.
The impact of the new sanctions and stricter AML procedures could also be felt outside the banking and real estate sector unless political initiatives are taken to ensure that Cyprus “will not have to change its economic model,” by giving up on its business services sector, said a former managing partner of a major accounting firm in a phone interview.
“I don’t believe that Cyprus has taken its final decisions on how it will proceed,” he said, asked to comment on information that some major accounting firms were considering shifting their Russian business to either Hong Kong or Singapore because “developments are unpleasant”.
The chairman of the Institute of Certified Public Accountants (ICPAC) said that he did not feel that concern was justified as the body, tasked with supervising the AML compliance of accounting offices and professionals, carries out regular audits on the basis of “one of the strictest” regulatory regimes for combating financial crime.
“The ICPAC is cooperating with major institutions from abroad,” such as the UK-based Association of Chartered Certified Accountants (ACCA) in implementing an effective supervisory framework under with regular onsite visits and audits,” said ICPAC chairman Marios Skandalis who also heads the compliance department of Bank of Cyprus. “The results of these audits to date certainly do not reflect a dramatic emergency situation”.
However, even if all companies in a sector comply with the stricter AML framework and sanctions, one exception could cause severe damage, economist Clerides warned.
“It only takes one office to engage in business with controversial customers and this may hurt the reputation of everyone else,” he warned.
Cypriot banks came close to being banned from transacting in dollars four years ago when the US authorities threatened to blacklist the fragile Cypriot banking system unless the island took action against FBME Bank, which the US branded, just like ABLV, a financial institution of primary money laundering concern.