EU Court’s Landmark Ruling: Restricting Financial Ties to Combat Money Laundering and Terrorism Financing

On March 2, 2023, the European Union’s Court of Justice (CJEU) affirmed the legitimacy of penalties and administrative actions levied by the Financial and Capital Market Commission (FKTK) against PrivatBank to mitigate potential involvement in money laundering and terrorist financing.PrivatBank, based in Latvia, has shareholders A and B, both Cypriot nationals, and Unimain Holdings, a Cypriot company. These shareholders are also PrivatBank’s customers. The FKTK, which is the Central Bank of Latvia, inspected PrivatBank to see if it was complying with anti-money laundering (AML) and anti-terrorism financing (ATF) laws, especially regarding customers linked to its shareholders. The Central Bank found PrivatBank to be non-compliant with AML and ATF requirements particularly because it was giving preferential treatment to certain customers, especially those whose beneficial owners were its shareholders. The credit institution was failing in monitoring the transactions carried out by existing customers as well as the registration of new clients.As a result, on 13 September 2019, the FKTK fined PrivatBank and placed specific restrictions on the bank’s future business relationships, particularly concerning non-Latvian individuals and entities. These restrictions included account turnover limits and the prohibition of certain new relationships. Furthermore, PrivatBank had to verify that the monthly transactions of clients, whose primary stakeholders are either the bank’s shareholders or their associates, along with those connected to these clients, didn’t surpass the 2019 average monthly transaction amount for the specific client, based on the bank’s records. PrivatBank challenged this decision at the Latvian Regional Administrative Court (which is the referring court), requesting the annulment the fine and findings of breach. A, B and Unimain Holdings separately challenged the imposed administrative measure.In their challenge, A, B, and Unimain Holdings claimed the administrative measure violated EU rules. They argued that the FKTK’s measure resulted in a restriction on the movement of capital which was not issued in response to any unlawful activities or on the basis of the provisions on the prevention of money laundering in force within the EU. Furthermore, the restrictions in question unfairly labelled non-Latvian individuals and entities as high-risk. In its defence, the FKTK claimed the measure imposed was not a restriction on free capital movement, as it applied only to PrivatBank and not to other banks, and that the affected customers could deposit their money in other Latvian licensed institutions. They argued the intent was to address and prevent PrivatBank’s AML and ATF infringements.In this respect, the Regional Administrative Court stayed the proceedings to seek clarity on four major questions from the Court of Justice:

• Can financial operations like loans, credits, and account activities be considered as capital movements under EU law within the meaning of Article 63(1) of the TFEU?
• Is a state-imposed restriction on a specific bank that limits its business relationships to only its own country’s nationals considered a restriction on the principle of free capital movement between EU member states guaranteed under the same Article 63?
• Can the prevention of money laundering and terrorist financing justify restrictions on free capital movement under EU law?
• Is a Member State’s method of prohibiting a bank from engaging with non-nationals appropriate, given the objectives of the EU’s AML directive to prevent the use of the Union’s financial system for the purposes of money laundering and terrorist financing?

In reply to the first question the Court held that since Article 63(1) doesn’t directly define “movement of capital” in this context, the Court refers to Directive 88/361’s Annex I as a guide, which in turn specifically mentions operations in financial institutions, notably current and deposit accounts, and explicitly refers to financial loans and credits. It also clarifies that “financial institutions” include banks. Therefore, in conclusion, such activities are indeed considered capital movements as per Article 63(1) TFEU.Addressing the second question, the CJEU concluded, that the measure in question does indeed restrict the freedom to provide services and the movement of capital as per Articles 56 and 63(1) TFEU respectively. It clarified that the administrative measure doesn’t only target relationships between the institution and non-Latvian nationals but is based on their connection to Latvia and their account turnover. The Court asserted that when a national measure touches upon both service provision and capital movement, it’s vital to determine which one predominates. The administrative measure in question, which could also be viewed in the context of the freedom to provide services (e.g., granting credit), affects both the financial services of PrivatBank and the capital flows. Article 56 TFEU forbids any rules that make service provision between states more challenging than within a single state and the administrative measure under discussion makes cross-border service provision tougher, especially for non-Latvians or entities with no ties to Latvia. Such a measure can be seen as indirect discrimination based on nationality, even if it doesn’t explicitly state nationality as a criterion.The main question in the third and fourth inquiries is whether the restrictions imposed are justified in preventing money laundering and terrorist financing as stated in Article 1 of Directive 2015/849 and if this falls under Article 65(1)(b) TFEU which states that the free movement of capital may be limited by a State measure only if it is justified by one of the reasons mentioned in Article 65 or by overriding reasons in the public interest as defined in the Court’s case-law, to the extent that there are no harmonising measures at European Union level ensuring the protection of those interests.The Court asserted that the administrative action taken in the main proceedings aimed to address violations related to anti-money laundering and anti-terrorism financing by PrivatBank. The measure was not only meant to stop the bank from future violations but also to prevent the broader national financial sector from facing reputational damage. Concerning this, Article 65(1)(b) TFEU clarifies that the Treaty doesn’t hinder Member States from taking necessary actions to prevent breaches of their national laws, especially regarding the oversight of financial institutions. Moreover, for any action to be considered ‘necessary’ as per Article 65(1)(b) TFEU, its primary goal must be to prevent violations in the prudential management of financial establishments. Furthermore, it has long been established that the combating of money laundering, which is related to the aim of protecting public order, constitutes a legitimate aim capable of justifying a barrier to the fundamental freedoms guaranteed by the Treaty.An administrative action that restricts the free flow of capital can be deemed appropriate for two reasons. Firstly, as per Article 65(1)(b) TFEU, if the action is crucial to prevent breaches of national laws and regulations, especially when it comes to overseeing financial institutions. Secondly, it can be justified if there’s a need to counteract money laundering and terrorist financing. Given the aims of the administrative measure in question, the Court held that such an action aligns with the conditions stated above. It is the responsibility of the referring court to confirm this.Considering the flaws in PrivatBank’s risk management system, which the referring court has noted, and which was not contested by the main proceeding parties, along with the potential inability of the bank to fulfill its due diligence responsibilities for its customers with substantial account activity, the administrative action in question seems fitting and proportionate to consistently and effectively mitigate the risks of money laundering and terrorist financing.This article was published on The Malta Independent on 08/08/2023 and written by Dr James Debono (Associate, Banking & finance, Fintech & blockchain).