Unofficial translation

Unofficial translation Policy Rule of De Nederlandsche Bank N.V. on Integrity Policy Regarding Commercial Real Estate Activities (Policy Rule on Integrity Policy Regarding Commercial Real Estate Activities) as published in the Netherlands Official Gazette No 2641 of 16 February 2011 De Nederlandsche Bank N.V. Having regard to Article 143 of the Pension Act (Pensioenwet), Article 138 of the Obligatory Occupational Pension Schemes Act (Wet verplichte beroepspensioenregeling) and Sections 3:10 and 3:17(2)(b) of the Act on Financial Supervision (Wet op het financieel toezicht); Having regard to Section 8 of the Anti-Money Laundering and Combating the Financing of Terrorism Act (Wet ter voorkoming van witwassen en financieren van terrorisme); Has decided as follows: Article 1 For the purposes of this Policy Rule the following terms shall be defined as follows: (a) Besluit FTK: Pension Fund (Financial Assessment Framework) Decree (Besluit financieel toetsingskader pensioenfondsen); (b) Bpr Wft: Decree on Prudential Rules pursuant to the Act on Financial Supervision (Besluit Prudentiële regels Wft); (c) business relationship: business relationship as referred to in Section 1(1)(g) of the Wwft; (d) customer: natural or legal person with whom the institution concludes, has concluded or will conclude an agreement in respect of the performance of business or the implementation of the pension scheme; (e) commercial real estate activities: (1º) Project development in the commercial real estate sector; (2º) Financing of investment objects or development projects in the commercial real estate sector; (3º) Investment in the commercial real estate sector; (f) DNB: De Nederlandsche Bank N.V.; (g) institution: (1º) Financial undertaking as referred to in Article 10(1) of the Bpr Wft; (2º) Pension provider as referred to in Article 1 of the Pw; (3º) Occupational pension scheme as referred to in Article 1(1) of the Obligatory Occupational Pension Schemes Act (Wet verplichte beroepspensioenregeling); (h) integrity analysis: the analysis as referred to in Article 19 of the Besluit FTK, Article 14(1) of the Decree on the Implementation of the Pension Act and the Obligatory Occupational Pension Schemes Act (Besluit uitvoering Pensioenwet en Wet verplichte beroepspensioenregeling), and Articles 10(1) and 14(4) of the Bpr Wft; (i) integrity policy: the policy as referred to in Article 19 of the Besluit FTK, Article 14(2) of the Decree on the Implementation of the Pension Act and the Obligatory Occupational Pension Schemes Act (Besluit uitvoering Pensioenwet en Wet verplichte beroepspensioenregeling), and Section 3:10 of the Wft; (j) integrity risk: risk of reputational damage or risk of present or future impairment of an institution s assets or earnings due to inadequate compliance with what has been prescribed by the institution under or by virtue of any legal provision; (k) Pw: Pension Act (Pensioenwet); (l) secondary integrity risk: an institution s integrity risk arising from a business relationship between a customer of that institution and a customer of that customer, in case the customer s customer carries out commercial real estate activities; (m) transaction: transaction as referred to in Section 1(1)(m) of the Wwft; 1

(n) Wft: Act on Financial Supervision (Wet op het financieel toezicht); (o) Wwft: Anti-Money Laundering and Combating the Financing of Terrorism Act (Wet ter voorkoming van witwassen en financieren van terrorisme); (p) Wwft institution: institution as referred to in Section 1(1)(a) of the Wwft, insofar as DNB has been designated to supervise the institution s compliance with the provisions in Article 1(1) introductory wording and (a) of the Decree on the Designation of Supervisors Wwft (Besluit aanwijzing toezichthouders Wwft). Article 2 1. An institution s integrity policy shall cover the institution s integrity risks and secondary integrity risks that are attached to the institution s or its customers commercial real estate activities. 2. The procedures and measures in which the policy as referred to in paragraph 1 above is reflected shall, at any rate, include the recording of cases in which the relationship with a potential customer is refused, or an existing relationship with a customer is terminated, in those events where such a relationship constitutes a threat to the integrity of the institution s business operations. Article 3 1. Any business relationship which a Wwft institution enters into with a third party whose business or profession it is to carry out commercial real estate activities shall be regarded by DNB as a business relationship which by its nature entails a greater risk of money laundering as referred to in Section 8(1) of the Wwft. 2. Any transaction which a Wwft institution conducts on behalf of or with a customer whose business or profession it is to carry out commercial real estate activities shall be regarded by DNB as a transaction which by its nature entails a greater risk of money laundering as referred to in Section 8(1) of the Wwft. Article 4 1. The integrity analysis and the procedures and measures as referred to in Article 2(2) above shall also apply to the conduct of the institution s customers whose business or profession it is to carry out commercial real estate activities. 2. (a) To control the institution s secondary integrity risks, an institution shall identify whether a customer whose business or profession it is to carry out commercial real estate activities, pursues a policy aimed at controlling integrity risks in respect of these activities. (b) If a customer pursues a policy as referred to in subparagraph (a) above, the institution shall check such policy against the standards applicable to the institution itself, including the institution s selfimposed standards. (c) The institution shall take adequate control measures if a customer does not have such a policy or if the customer s policy does not meet the standards as referred to in subparagraph (b) above. 3. The documents and records on the risk classification of customers as referred to in Article 14(5) of the Bpr Wft shall also include the conduct of the institution s customers whose business it is to carry out commercial real estate activities or that are otherwise engaged in the commercial real estate sector. Article 5 This Policy Rule shall come into force with effect from the day following its publication in the Netherlands Official Gazette. 2

Article 6 This Policy Rule shall be cited as: Policy Rule on Integrity Policy Regarding Commercial Real Estate Activities. This Policy Rule and the appurtenant Explanatory Memorandum shall be published in the Netherlands Official Gazette. Amsterdam, 7 February 2011 De Nederlandsche Bank N.V., H.J. Brouwer, Executive Director. De Nederlandsche Bank N.V., A.J. Kellermann, Executive Director. 3

EXPLANATORY MEMORANDUM General Notes In recent years a number of incidents have taking place in the commercial real estate sector that have affected the reputation of the real estate sector as a whole. At the same time, significant financial damage has been done to a number of individual institutions. For some years now, De Nederlandsche Bank (DNB) has considered real estate one of the key objectives of its integrity supervision, and is of the opinion that a commercial real estate activity, by its nature, entails a greater risk of fraud and money laundering. This is attributed to the relatively high value of real estate objects, their often nontransparent pricing and the complexity of transactions, as has been confirmed by publications on this subject. 1 In addition to soundness, integrity is a condition for a stable financial market. Hence, it is important for an institution to identify and control integrity risks. Integrity risks, as reflected in money laundering and fraud, constitute essential risks to the sound operation of the financial system and thus of the economy in a broader sense. Customer Due Diligence (CDD) is one of the pillars of integrity supervision. CDD is a means to mitigate risks by gaining insight into customers. If the institution does not mitigate these risks, the institution might, through the actions of a customer, become involved in violations of the law or socially unacceptable acts that would impair confidence in the institution or in the financial markets in general. Within the real estate sector, a distinction can (inter alia) be made between real estate held for own use and for private purposes, and real estate serving as an investment object. In this Policy Rule we shall confine ourselves to the latter category, hereinafter to be designated as commercial real estate. The Policy Rule relates to an institution s integrity policy regarding commercial real estate activities. The different rules in the Wft, the Pw and the Wwft regarding integrity in business operations are mostly principle-based. This signifies that the measures to control integrity risk must be appropriate to the severity and degree of risk. This Policy Rule does not intend to limit the principle-based character of the legislation. Its objective is that institutions engaged in commercial real estate activities, based on the specific inherent integrity risks attached to these activities, must take adequate control measures that are appropriate to the specific situation. The Policy Rule does not intend to introduce new standards or rules, but it provides tools for compliance with existing rules. The Explanatory Notes to the Policy Rule focus in particular on measures with respect to customer due diligence and acceptance policy. It should be emphasised, however, that these measures do not mitigate all integrity risks attached to real estate activities. Additional measures are needed, for instance, to control the risk of conflicts of interests. Explanatory Notes to Individual Articles Article 1 The definition of integrity risk is consistent with the definition in the Bpr Wft (Article 1) and with the definition in the Explanatory Notes to Article 19 in the Besluit FTK. In the area of commercial real estate, supervised institutions generally carry out three types of activities: real estate development, real estate finance and real estate investment. These activities may be carried out separately but also jointly or successively. A brief description of the characteristics of each activity is given below. 4

Real estate development The core business of a real estate developer is the realisation of real estate projects at its own expense and risk. The real estate developer is active from the initiation stage up to the moment of occupation. Varying types of organisation are engaged in the development and realisation of real estate projects, with frequently changing parties per project. The method of operation is always project-based, with a sharp distinction being made between a large number of subprocesses that involve a (temporary) delegation of responsibilities. Real estate finance In this Policy Rule, real estate finance shall be understood to mean the financing of real estate for investment purposes. Real estate investment (direct and indirect) In this Policy Rule, investment in real estate shall be understood to mean: the investment of assets in real estate, direct or indirect, with the purpose of generating a future flow of cash revenues from the exploitation and sale of the real estate. This definition makes a distinction between direct and indirect real estate. Simply put, a direct real estate investment is an investment in bricks and mortar, and an indirect real estate investment is an investment in the shares of a collective investment scheme that operates in the real estate market. It should be noted that the definition of customer not only covers the institution s customers where the institution is the service provider or supplier, but also those customers that are the service provider or supplier under an agreement with the institution. Examples are: real estate consultants (brokers, surveyors, real estate lawyers, etc.), but also finance institutions, contractors and real estate fund managers that provide services to the institution. Secondary integrity risk is understood to be the risk and threat that might be posed by a customer of the institution s customer. See also the Explanatory Notes to Article 4. Article 2 Article 3:10(1) of the Bpr Wft requires that the financial undertakings referred to in this Article must conduct an adequate policy that safeguards integrity in business operations. DNB identifies adequate as being appropriate for every type of risk that may arise. As outlined above, commercial real estate activities entail specific risks. Article 143 of the Pw requires that a pension fund sets up its organisation in such a way as to safeguard control and integrity in business operations. Article 19 of the Besluit FTK, which is based on the latter Article, requires that a fund provides for a systematic analysis of integrity risks. Just as required under the Bpr Wft, this involves an analysis and a policy that takes the special risks of commercial real estate activities into account. The analysis of integrity risks in commercial real estate activities may, among other things, be determined by the structural characteristics of the market and its operations (high values, not always unambiguous pricing and complex transaction structures), cultural characteristics (e.g., the quid pro quo culture often cited in the literature, which may lead to conflicts of interests), organisational characteristics (the position of commercial real estate activities within the institution) and possible irregularities (reference can be made here to the red flags mentioned in the reports of the Financial Action Task Force ( Money Laundering and Terrorist Financing Through the Real Estate Sector, 2007) and the Financieel Expertise Centrum (Financial Expertise Centre) ( Rapportage Project 5

Vastgoed (Report Project Real Estate), 2008, Red flags Misbruik Vastgoed actualisering 2010 (Red flags for improper use of real estate update 2010). In addition to the measures addressed in legislation, a number of measures is listed below (not limitative) which specifically focus on integrity risks attached to customers involved in real estate activities. If the customer or the customer s actions generate distinct integrity risks (e.g., in case of an earlier conviction in connection with commercial real estate activities or related criminal matters such as money laundering and fraud or if it concerns customers from countries with limited transparency or a high risk of corruption), the institution shall assess on the basis of its own risk analysis whether the relationship can be continued. In case of suspicion against a customer (in connection with commercial real estate activities or related matters), an assessment based on a risk analysis shall be made whether to engage in or to continue a relationship. If based on such analysis, a relationship is continued, the institution shall ensure that it mitigates the attendant risks in all cases to an acceptable level. The customer shall be classified in the highest risk category and the institution shall closely and fully check new real estate transactions with this customer for possible violations of integrity, thereby obtaining assurance, among other things, about the source of the customer s assets. The institution shall act prudently when expanding its services to such clients. Each new real estate transaction or expansion of existing services shall be looked upon with reticence and shall be approved by persons authorised by the institution. For the sake of completeness we refer to the disclosure requirement under the Wwft, whereby the Financial Intelligence Unit must also be notified of intended (but not yet conducted) unusual transactions, and to the recording of the data leading up to the establishment of the relationship. In the event of doubt as to the integrity of a customer, it is important that an independent department within the institution (e.g. the compliance function) performs further customer due diligence. The department or compliance function may submit an opinion to the persons authorised by the institution to decide on customer acceptance. If, on the basis of a fact-finding exercise, the institution has come to the conclusion that the customer s risk classification is unacceptable, the institution shall consider how to terminate the relationship with the customer. This exit strategy shall be approved by persons authorised by the institution and shall be monitored by the compliance function. In some cases there may exist a network of associated or underlying parties, into which the institution is expected to gain insight. Also, on a transaction-by-transaction basis, an assessment can be made as to the reason for the involvement of the different parties, the type of structure chosen, as well as the rationale and legitimacy of the transaction (does it, for instance, involve an ABC transaction : a successive transaction over a short period of time with the same object). Article 3 In this Article, DNB clarifies that a commercial real estate activity is seen as an activity that entails a greater risk of money laundering as referred to in Section 8 of the Wwft. Therefore, this Article of the Policy Rule only governs the institutions referred to in the Anti-Money Laundering and Combating the Financing of Terrorism Act (Wwft institution). Pursuant to the Wwft, a Wwft institution must perform customer due diligence if, among other things, it enters into a business relationship in or from the Netherlands and conducts certain transactions (Section 3 of the Wwft). A Wwft institution shall perform enhanced customer due diligence if and when a business relationship or transaction entails, by its nature, a greater risk of money laundering (Section 8(1), first sentence, of the Wwft). Pursuant to Section 8(1), second sentence, of the Wwft, categories of business relationships or transactions that by nature entail a greater risk of money laundering may be designated by order in council. This shall be without prejudice to the institution s duty to perform enhanced customer due diligence in the event of a greater risk of money laundering. 6

As outlined above, such greater risk exists in the case of commercial real estate activities. A Wwft institution shall adjust its customer due diligence in order to address such greater risk. As appears from Section 3(2)(d) of the Wwft, customer due diligence shall also involve the monitoring of the customer and of the transactions conducted. The performance of enhanced customer due diligence may be subject to signals that appear in the press as well as to transactions and substantial changes in the customer s business (such as a sharp rise in the number of real estate transactions conducted). Other possible indicators to monitor a customer more closely include: the involvement in so-termed ABC transactions and other complex structures (such as the use of offshore vehicles), a rapid increase in the customer s assets, the involvement of foreign parties, for instance, from an offshore financial centre, or complex international corporate structures. A Wwft institution shall gain insight into the customer s business operations as well as into its ownership and control structure. Insight and investigation into the source of the customer s assets is also of significance. Such an investigation may be risk-based, whereby it is evident that in case of a suspicion of illegally obtained assets, a greater effort is required from the institution. Pursuant to Sections 4(1) and 3 of the Wwft, the customer s beneficial owner must be known before a business relationship is established. The chosen intensity of customer due diligence may depend on whether the client is a supervised institution. It should be noted that this Article does not apply to non-life insurance companies and pension funds, as these are not governed by the Wwft. This is without prejudice to the possible inclusion by pension funds of the above-mentioned indicators in their integrity analysis of customers and relationships. Article 4 Because of the often complex structure of real estate transactions, a multitude of parties are involved, with no direct relationship between the institution and these parties. In most cases, these concern the relationships customers have with their own customers, i.e. indirect relationships. These indirect relationships may well be of influence on the institution s reputation and may entail a secondary integrity risk. It is important that the integrity risks which these indirect relationships may entail are adequately controlled. To that end, the institution shall assess whether its customers, in their turn, check for integrity risks. It is important that the institution ensures or verifies that the customer (e.g. the real estate manager, fund manager or principal contractor) adequately controls these risks (where appropriate, against documented proof). Examples An institution engaged in project development does business with a principal contractor for the development of office premises. The inherent risk is that the principal hires subcontractors that are negligent or less compliant with the principal s integrity standards (and may thus also harm the project developer s reputation). To mitigate this risk, the institution shall ask questions regarding the principal s policy of hiring subcontractors. It is important for a real estate finance institution that the ultimate tenant(s) and user(s) of the premises are known, in order to prevent any reputational risk. To mitigate reputational risks, the institution shall make clear agreements with its customer (the investor), e.g. about the type of activities that are not allowed to be carried out on the premises. The institution shall assess whether the effectiveness of the client s control measures meets the standards set for its own integrity policy. Of importance is that insight be gained into the whole chain of parties involved in the transaction (including the facilitators of the transaction, such as civil-law notaries, surveyors, accountants, estate agents) and that an assessment be made of any attendant integrity risks (in the case of fixed chains). 7

Example Several facilitators are involved in real estate transactions. Despite the fact that there is not always a direct business relationship with these facilitators, the institution shall verify, also in these cases, that business is done with parties of integrity, e.g. by conducting a background search of the facilitator through public sources or by making inquiries in the institution s existing network. The control measures to be taken also depend on the specific integrity risks attached to the method of investment or finance: is it a case of direct or indirect real estate (e.g. limited partnerships or real estate investment funds). If, for instance, indirect real estate investment is concerned, supplementary measures need to be taken, such as an inquiry into the key persons involved in the investment structures and investment funds, an investigation of the fund s real estate objects (the object s history, the parties involved) and an inquiry into the parties involved (co-investors), through which insight is to be gained, among other things, into the source of the fund s assets. The institution may also be periodically informed through a third party about the control measures taken to address these risks. Example An institution investing in real estate invests in a closed-end real estate fund run by a real estate manager. Before joining the fund, the investor will first verify through the manager of the real estate fund that at least the same standards are observed in the latter s investor acceptance policy as are observed by the investor in question (for instance, the investor will not wish to join an investment fund that is financed (inter alia) with undeclared money, whereby we assume that this is the rule by which the investor abides). Pursuant to Article 14 of the Decree on the Implementation of the Pension Act and the Obligatory Occupational Pension Schemes Act, a pension fund that outsources its activities must conduct an adequate policy and must have procedures and measures in place. This is to safeguard control and integrity in business operations as referred to in Article 143 of the Pw. Consequently, also where outsourced activities are concerned, pension funds must be aware of the significant risks attached to commercial real estate activities and must verify that the outsourcing meets their own integrity standards. Example A pension fund invests in direct real estate through a pension administration agency which handles the management, purchase and sale of real estate for account and risk of the pension fund. In view of its direct interest, the pension fund must verify that the external party observes the same standards as the pension fund. To mitigate integrity risk, it is important that the pension fund gains insight into the external party s integrity policy and its effectiveness (through periodic monitoring). A pension fund (or an authorised pension administration agency) sells a real estate object to an external party. This party re-sells the object, within a certain period, to another party. This entails the risk of an illegitimate ABC transaction. To mitigate this risk, the pension fund shall monitor the object, e.g. until a year after its initial sale, while checking the plausibility of any sharp value increases. De Nederlandsche Bank N.V., H.J. Brouwer, Executive Director. De Nederlandsche Bank N.V., A.J. Kellermann, Executive Director. 8

1 Reference can, inter alia, be made to the following reports: FATF typology report: Money Laundering and Terrorist Financing Through the Real Estate Sector, 29 June 2007; Rapportage Project Vastgoed (Report Project Real Estate), Red flags Misbruik Vastgoed-actualisering 2010 (Red flags for improper use of real estate update 2010), Financieel Expertise Centrum (Financial Expertise Centre), July 2008; WODC rapport: Malafide activiteiten in de vastgoedsector: Een exploratief onderzoek naar aard, actoren en aanpak (WODC Report: Malpractice in the real estate sector: An exploratory study of characteristics, agents and strategy), 2007. 9