Money laundering and anti-money laundering regulations - Due diligence requirements

Learning Outcomes

After studying this article, you will be able to explain the process of money laundering and the legal framework for anti-money laundering (AML) in England and Wales. You will understand when and how to apply customer due diligence (CDD), including standard, simplified, and enhanced due diligence. You will be able to identify risk factors, define key terms, and apply due diligence requirements to practical scenarios, as required for the SQE1 exam.

SQE1 Syllabus

For SQE1, you are required to understand the due diligence requirements under anti-money laundering regulations. Focus your revision on:

  • the process and stages of money laundering
  • the legal framework for AML in England and Wales (including the Money Laundering Regulations and Proceeds of Crime Act)
  • when and how to apply customer due diligence (CDD) measures
  • the differences between standard, simplified, and enhanced due diligence
  • identifying and verifying beneficial ownership
  • ongoing monitoring of client relationships
  • risk-based approaches and high-risk indicators
  • practical steps for compliance and reporting obligations

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. What are the three stages of money laundering, and why is it important to recognise them in practice?
  2. When must a solicitor apply enhanced due diligence under the Money Laundering Regulations?
  3. What is a beneficial owner, and how should a solicitor verify their identity?
  4. What is the difference between standard and simplified due diligence?

Introduction

Money laundering is the process of disguising the origins of criminal funds to make them appear legitimate. The UK has strict anti-money laundering (AML) regulations to prevent legal professionals and others from being used to facilitate this process. Due diligence requirements are central to AML compliance, ensuring that solicitors and law firms identify their clients, assess risks, and monitor transactions to detect and report suspicious activity.

Key Term: money laundering
Money laundering is the process of concealing the criminal origin of funds or assets to make them appear lawful.

The Stages of Money Laundering

Money laundering typically involves three stages:

  1. Placement: Introducing criminal funds into the financial system.
  2. Layering: Moving funds through complex transactions to obscure their origin.
  3. Legitimization: Returning the laundered funds to the legitimate economy as apparently lawful assets.

Recognising these stages helps solicitors identify suspicious activity and apply appropriate due diligence.

Key Term: anti-money laundering (AML)
AML refers to laws and procedures designed to prevent, detect, and report money laundering and terrorist financing.

Legal Framework for AML and Due Diligence

The main sources of AML law in England and Wales are:

  • The Proceeds of Crime Act 2002 (POCA)
  • The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017)
  • The Terrorism Act 2000

Solicitors must comply with these laws and the guidance issued by the Solicitors Regulation Authority (SRA).

Key Term: customer due diligence (CDD)
CDD is the process of identifying and verifying a client’s identity, understanding the business relationship, and monitoring transactions for AML compliance.

When to Apply Customer Due Diligence

CDD must be carried out in the following situations:

  • When establishing a business relationship with a client
  • When carrying out an occasional transaction of €10,000 or more (or equivalent)
  • When there is suspicion of money laundering or terrorist financing
  • When there are doubts about the accuracy or adequacy of previously obtained client identification

CDD involves identifying the client, verifying their identity using reliable documents, and understanding the purpose of the relationship.

Worked Example 1.1

A solicitor is instructed by a new client to purchase a property for £500,000. The client is not known to the firm. What steps must the solicitor take before proceeding?

Answer: The solicitor must apply CDD by identifying and verifying the client’s identity using reliable documents (e.g., passport and proof of address), understanding the purpose of the transaction, and assessing the risk of money laundering.

Identifying Beneficial Owners

When the client is a company, partnership, or trust, solicitors must identify any beneficial owner—an individual who ultimately owns or controls more than 25% of the entity or exercises significant control.

Key Term: beneficial owner
A beneficial owner is a person who ultimately owns or controls a client entity, such as a company, partnership, or trust.

Key Term: politically exposed person (PEP)
A PEP is an individual with a prominent public function (e.g., senior politician, judge, or military officer), or their family member or close associate, who presents a higher risk for money laundering.

Types of Due Diligence

AML regulations require a risk-based approach. The level of due diligence depends on the risk presented by the client or transaction.

Standard Due Diligence

Standard CDD is applied in most cases and involves:

  • Identifying and verifying the client’s identity
  • Identifying and verifying any beneficial owners
  • Understanding the purpose and intended nature of the business relationship
  • Ongoing monitoring of the relationship

Simplified Due Diligence

Simplified due diligence (SDD) may be applied where the risk of money laundering is low, such as when the client is a UK public authority or a company listed on a regulated market. SDD allows for reduced verification, but only after a documented risk assessment.

Enhanced Due Diligence

Enhanced due diligence (EDD) is required in higher-risk situations, including:

  • When the client is not physically present for identification
  • When the client or beneficial owner is a PEP, their family member, or close associate
  • When the client or transaction involves a high-risk third country
  • When the transaction is unusually large or complex, or has no apparent economic purpose

EDD involves obtaining additional information, verifying the source of funds and wealth, obtaining senior management approval, and increasing ongoing monitoring.

Worked Example 1.2

A client wishes to invest £2 million in UK property. The client is a national of a country identified as high-risk for money laundering, and the funds are routed through several offshore companies. What due diligence is required?

Answer: The solicitor must apply EDD by obtaining more information about the client and beneficial owners, verifying the source of funds and wealth, obtaining senior management approval, and conducting enhanced ongoing monitoring.

Ongoing Monitoring and Record Keeping

Solicitors must monitor client relationships on an ongoing basis to ensure transactions are consistent with the client’s profile and risk assessment. Any suspicious activity must be reported to the firm’s nominated officer (Money Laundering Reporting Officer, MLRO), who may file a Suspicious Activity Report (SAR) with the National Crime Agency (NCA).

Key Term: Suspicious Activity Report (SAR)
A SAR is a report made to the NCA when there is knowledge or suspicion of money laundering or terrorist financing.

Key Term: Money Laundering Reporting Officer (MLRO)
The MLRO is the person in a firm responsible for receiving internal reports of suspicious activity and making external reports to the NCA.

Records of CDD, risk assessments, and transactions must be kept for at least five years.

Risk-Based Approach and Red Flags

AML regulations require solicitors to assess the risk of money laundering for each client and matter. Factors increasing risk include:

  • Clients from high-risk jurisdictions
  • Complex ownership structures
  • Unusual payment methods (e.g., large cash payments)
  • Reluctance to provide identification or information
  • Transactions with no apparent economic or legal purpose

Solicitors must document their risk assessments and apply appropriate due diligence measures.

Exam Warning

Failing to apply EDD when required (e.g., for PEPs or high-risk countries) is a common error and may result in regulatory action. Always document your risk assessment and the rationale for the level of due diligence applied.

Practical Steps for Compliance

To comply with AML due diligence requirements, solicitors should:

  1. Conduct a written risk assessment for the firm and for each client/matter.
  2. Apply appropriate CDD measures based on the risk assessment.
  3. Identify and verify beneficial owners where relevant.
  4. Apply EDD for high-risk clients, PEPs, and high-risk countries.
  5. Monitor client relationships and transactions on an ongoing basis.
  6. Report suspicious activity to the MLRO and, if appropriate, to the NCA.
  7. Keep records of CDD, risk assessments, and transactions for five years.

Worked Example 1.3

A solicitor is approached by a new client who wishes to pay a large retainer in cash and is unwilling to provide proof of identity. What should the solicitor do?

Answer: The solicitor should refuse to proceed until satisfactory identification is provided. Large cash payments and reluctance to provide ID are red flags. If suspicion arises, the solicitor should report to the MLRO.

Key Point Checklist

This article has covered the following key knowledge points:

  • Money laundering involves placement, layering, and legitimization of criminal funds.
  • Solicitors must comply with AML laws, including POCA and the Money Laundering Regulations.
  • Customer due diligence (CDD) is required when starting a business relationship, for large transactions, or when suspicion arises.
  • Standard, simplified, and enhanced due diligence apply depending on risk.
  • Beneficial owners must be identified and verified for entities.
  • Enhanced due diligence is required for PEPs, high-risk countries, and complex or unusual transactions.
  • Ongoing monitoring and record keeping are mandatory.
  • Suspicious activity must be reported to the MLRO and NCA.
  • Risk assessments must be documented and due diligence measures tailored accordingly.

Key Terms and Concepts

  • money laundering
  • anti-money laundering (AML)
  • customer due diligence (CDD)
  • beneficial owner
  • politically exposed person (PEP)
  • Suspicious Activity Report (SAR)
  • Money Laundering Reporting Officer (MLRO)
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Pleased to share that I have successfully passed the SQE1 exam on 1st attempt. With SQE2 exempted, I’m now one step closer to getting enrolled as a Solicitor of England and Wales! Would like to thank my seniors, colleagues, mentors and friends for all the support during this grueling journey. This is one of the most difficult bar exams in the world to undertake, especially alongside a full time job! So happy to help out any aspirant who may be reading this message! I had prepared from the University of Law SQE Manuals and the AI powered MCQ bank from PastPaperHero.

Saptarshi Chatterjee

Saptarshi Chatterjee

Senior Associate at Trilegal