Private Equity Fund KYC Interpretation
KYC/AML has been a topic that has left many of us hesitating in recent years. Broadly speaking, KYC is a part of AML, and almost any dealings with formal financial institutions require KYC. But why do KYC, when to do KYC, and how to do KYC? These are the questions that private equity fund managers are most concerned about. In this issue, we will share with you what you need to know about KYC in private equity funds.
What is KYC?
KYC stands for Know Your Customer, which means understanding your customers. It is a series of procedures aimed at preventing, detecting, and reporting money laundering activities. Currently, almost all government regulatory authorities in various countries and regions require KYC in activities related to finance and investment.
What is Global KYC Regulation?
The Financial Action Task Force (FATF), established in Paris in 1989, is an organization consisting of 39 member countries/regions, including mainland China and Hong Kong. Its purpose is to establish a global institutional framework to combat money laundering, prevent financial support for terrorist activities, and coordinate the efforts of countries to combat money laundering. FATF first published 40 recommendations in 1990 as international standards for member countries to revise their relevant laws. After the "9/11" event in 2001, FATF added 8 "Special Recommendations," including policies to combat terrorist fundraising activities, further improving the policy framework for anti-terrorism and anti-money laundering among nations.
Why Is There Money Laundering Risk in the Operation of Private Equity Funds?
If the source of the investor's funds is not identified through KYC, the funds invested in the fund may be "black money" of unknown origin. 2) The fund uses the investor's funds for legitimate investments, and after the project exits, the relevant portion of the profit is returned to the investor. 3) In this way, investors who invest "black money" in the fund use the fund investment to "clean" illegal gains into legal gains, completing the money laundering process.
Who Is Responsible for KYC in the Operation of Overseas Private Equity Funds?
The General Partner (GP) of the fund is responsible for KYC at the fund level, but the specific work can be entrusted to the Fund Administrator.
When and How Is KYC Conducted?
Since private equity funds are "closed-ended," once an investor becomes a Limited Partner (LP) of the fund, they cannot easily withdraw during the fund's term, even if the "black money" is involved. Therefore, KYC should begin during the fund subscription period and be completed before the fund closing.
How Is KYC Done?
The main tasks of KYC for private equity funds with a Cayman LP/GP structure include: 1) Confirmation of the identity of investors/entities: Is the investing entity and intermediary entity real? 2) Control of investors/entities: Who are the actual controllers/managers? It needs to penetrate to the actual controllers/directors. 3) Ultimate beneficiaries: Who will receive profit distributions? Every shareholder holding 10% or more of the shares in the investing entity. 4) Confirmation of the source of funds: Where does the original funds come from? There are different requirements for corporate income and personal income sources. Although the specific documents to be provided may vary depending on the type of investing entity, the main purpose of KYC is to clarify the four aspects mentioned above.
What Is a "Certified Copy"?
KYC documents generally require a "certified copy." So what is the concept of a "certified copy"? A "certified copy" is an endorsement (declaration) provided by a professional lawyer/accountant based on personal observation to confirm that the copy is a true copy of the original. This endorsement does not prove the authenticity and validity of the original document. It should be clarified that witnessing and notarization are two different concepts. Notarization refers to the activity where a notary organization certifies the authenticity and validity of documents. Therefore, the requirements for KYC related to fund investment are that individuals with professional qualifications as accountants/lawyers endorse the copy of the document, and there is no need to go to a notary office to pay for document notarization.
In Summary
To complete the relatively simple yet complex task of KYC within a limited time, close cooperation among all parties is particularly important, especially at the critical moment when the fund is about to close. Both prospective investors and GPs hope to complete KYC as soon as possible. Sloppiness in KYC for offshore US dollar funds can be detrimental, as KYC is the cornerstone of the entire fund operation. Any slight mishap can lead to the fund's overall failure. At the same time, the KYC work reminds us to consider the overall investment environment and do the right thing. Only when each "cell" of financial investment and operation remains clean and healthy can the entire global investment system operate smoothly, benefiting not only investors and fund managers but also all service providers in the fund's ecosystem.
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