Promissory Note
Promissory Note – Key Takeaways
- A promissory note is a financial instrument, which is an unconditional, written promise that ensures a person has to pay another a specific amount at a future date.
- Criminals often use promissory notes to obscure the origin of illicit funds, resulting in exposure to money laundering and terrorist financing activities.
- UK regulators require regulated firms to implement customer due diligence, ongoing monitoring, record-keeping, and to submit SAR for suspicious activity relating to promissory notes.
- Failure to identify suspicious activity regarding financial instruments results in regulatory enforcement actions.
What is a Promissory Note in the UK AML Context?
A promissory note is defined as an unconditional promise in written form by a person (the maker) to pay a specified amount of money to someone else (the payee) at a future date. It is a legal document in UK made in return for credit or a loan.
A promissory note is governed by the Bills of Exchange Act 1882, where payment is made on demand or on a specific date in future, and can be endorsed. Unlike cheques and bills of exchange, which are three-party instruments, a promissory note is a two-party instrument. Further, promissory notes are often less complex than loan agreements and can be easily negotiated.
Moreover, promissory notes are legitimate financial instruments, but their flexible nature and lack of regulatory oversight can pose a high risk for Anti-Money Laundering (AML) compliance. Criminals may misuse a promissory note to obscure the source of funds or make it hard for regulators to trace the origin.
Under the Money Laundering Regulations 2017 (MLR 2017) (as amended), it is mandatory for relevant persons (financial institutions, legal professionals, etc.) to implement compliance procedures for the use of promissory notes in business transactions.
How Promissory Notes Create AML Risk in UK Regulated Firms
Criminals often misuse promissory notes to engage in Money Laundering (ML) and Terrorist Financing (TF) risks, some of which are as follows:
- Borrowing money from a third party through a promissory note to purchase property makes it easy to mix dirty money with legitimate real estate transactions.
- Clearing a promissory note through the law firm client account instead of bank transfers, hiding the true origin of money.
- Repeatedly endorsing the promissory note between connected parties within the private lending structures, creating layering.
Along with using promissory notes to hide the origin of funds, criminals also use them to hide beneficial ownership. It becomes easier because these are often private agreements, not always recorded in government, public or bank databases, and are payable to the bearer or the person holding the note.
Further, criminals benefit from promissory notes by using them as a medium to inflate value, create a false trail, or facilitate informal cross-border arrangements (hawala).
To combat ML/TF risks, the Money Laundering Reporting Officer (MLRO) must verify the source of funds, assess unusual payment methods and file a Suspicious Activity Report (SAR) when suspicion is detected.
Promissory Notes Under UK AML Law and Regulatory Expectations
Under the MLR 2017, relevant persons involved in advising, creating, or transferring a promissory note are mandated to perform Customer Due Diligence (CDD) before a transaction occurs. It involves identification of beneficial owners, verification of source of funds and source of wealth, ongoing monitoring and Enhanced Due Diligence (EDD) for high-risk customers.
Further, the Proceeds of Crime Act 2002 (POCA) regulations mandate regulated firms to submit a SAR to the National Crime Agency (NCA) if they suspect ML/TF activity with the use of promissory notes. The red flags that should trigger suspicion include misuse to denote high-value, unverified wealth, or unclear commercial purpose.
Moreover, the Financial Conduct Authority (FCA) supervises regulated firms and expects them to adopt a risk-based approach and document the rationale to handle complex, unusual financial instruments such as promissory notes. The authorities expect regulated firms to provide staff training and use technology-driven controls, and for senior management to be held accountable for preventing ML/TF risks.
Best Practice Controls When Handling Promissory Notes
Regulated firms must conduct Enhanced Due Diligence to verify the source of funds (SoF) and source of wealth (SoW) for transactions involving promissory notes, as required under MLR 2017. Further, relevant persons must validate authenticity (maker’s signature), enforceability (promise to pay a specific amount on demand or at a fixed future date), and issuance for reasonable, valuable consideration (debt settlement, goods, services).
Moreover, regulated firms must validate the chain of title, ensuring that the assignee provides documentation of transfer from the original lender. Also, firms must identify all involved third parties to comply with UK AML laws. In addition, firms must document customer risk assessments and MLRO decisions for filing SARs when promissory notes are involved. Red flags indicating suspicious activity must be escalated to senior management for investigations and SAR filing.
Key Compliance Challenges with Promissory Note Transactions
Common compliance challenges that regulated firms face with promissory note transactions are as follows:
- Compliance teams sometimes find it hard to assess the value and legitimacy of a promissory note because documents can be forged or used to conceal the origin of dirty money.
- Promissory notes act as private, unregulated loans, and staff lacking experience may find it difficult to assess complex financial instruments in non-banking sectors such as accountancy, legal, and real estate.
- Accepting promissory notes without proper AML reviews by senior staff may create severe risks for non compliance, including criminal penalties, financial fines, and reputational damage.
- Compliance teams may find traceability difficult for cross-border notes, which may include high-risk jurisdictions, resulting in sanctions screening complications.
- UK Regulators closely inspect firms involved in complex funding arrangements such as promissory note transactions. Regulated firms failing to identify beneficial owners behind complex structures may face enforcement action.
How AML Consultants UK Can Help with Promissory Note AML Risk
AML Consultants UK helps regulated firms integrate risks from promissory notes into their Firm-Wide Risk Assessments (FWRA) to understand ML/TF risk exposure from these instruments. Further, offers health checks or an independent AML audit checks to determine the effectiveness of controls in preventing criminals from misusing promissory notes.
AML Consultants UK supports regulated firms in drafting AML policies and procedures to implement effective controls and staff training to help understand risks and detect suspicious behaviour. Moreover, helps MLRO with advisory services for investigating suspicious activity and filing SAR decisions.
AML Consultants UK helps firms set rules to identify, evaluate, and manage promissory note transaction risk. In addition, helps implement effective CDD and EDD procedures for high-risk customers and unusual transactions, safeguarding against enforcement actions.
AML Consultants UK provides expert support to select AML software that helps regulated firms stay compliant with UK financial regulations, specifically handling high-risk transactions.
FAQs - on Promissory Notes
Are promissory notes legal in the UK?
Yes, promissory notes are legal in UK, referred to as an unconditional, written promise to pay someone a specific sum of money on demand or at a fixed future date.
Do promissory notes trigger enhanced due diligence?
Yes, promissory notes might trigger EDD if they involve complex, unusual transfers, high-risk countries, PEP, unclear source of funds, or are part of private lending structures.
When should a firm file a SAR involving a promissory note?
A regulated firm should file a SAR for a promissory note in cases such as an unclear source of funds, a lack of commercial purpose, or a forged note.
How should MLROs assess unusual financial instruments?
MLROs should adopt a risk-based approach and use technology to perform ongoing transaction monitoring to assess unusual financial instruments.
Are promissory notes considered high risk under UK AML rules?
Yes, as promissory notes are considered high risk under AML rules when used to hide the origin of funds or the person who benefits from the money (beneficial owner).
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