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High risk of dirty money in Canadian real estate

Average house prices in the red-hot Vancouver and Toronto markets now reach over a million dollars, pricing out more and more people. But some of that skyrocketing real estate growth may hold a dark secret: dirty money.

Canada’s real estate sector is at “higher risk” of money laundering compared to other sectors, says an analysis of the 2013-14 report ordered by Canada’s financial intelligence unit. The analysis was released to Embassy in July under access-to-information law.

Money laundering is the process of disguising the proceeds of crime as legitimate, for example by inflating the profits of a business to hide drug money. In practice, schemes are often much more complex and involve hiding large sums. Real estate can be attractive to money launderers because it offers several means of funneling money into the system, like mortgages or down payments.

“The purchase of Canadian real estate assets with offshore money and/or by offshore persons was noted as a significant risk factor” for money laundering, reads a federal analysis of the report, written by Grant Thornton LLP for the Financial Transactions and Reports Analysis Centre of Canada.

At the smaller end of the market for real estate, “there is often no quality and ethics infrastructure in place,” there is a “high number of cash transactions,” and “significant portions of the sector are apparently unengaged” in complying with the anti-money laundering regime that FINTRAC administers.

The report also says the “banking and securities” sectors aren’t seeing real estate as high risk, and that “the use of legal trust accounts was noted specifically as an area of concern” for the real estate sector.

Anti-money laundering experts contacted by Embassy agreed that the Canadian real estate sector is high risk. “There’s lots of questions and discussion about the source of this money,” said Jennifer Fiddian-Green, the national managing partner for forensics at Grant Thornton and an executive on the Toronto chapter of the Association of Certified Anti-Money Laundering Specialists, in an interview.

But without much hard data to back up claims, there’s little consensus on the specifics of the problem or the weak points—the real estate industry, the banks, or FINTRAC itself.

‘A huge risk’

FINTRAC, Canada’s national regulator for financial crime, hired Grant Thornton in 2013-14 to produce the report, confirmed Renée Bercier, FINTRAC senior communications officer in an email. The firm pulled from international risk assessments, news reports, Statistics Canada data and its own interviews with industry insiders and domestic and international specialists, the analysis said.

Its finding of a high-risk real estate sector is in line with recent reports. The Paris-based Financial Action Task Force, an intergovernmental organization, warned in 2008 that real estate, as well as several other money laundering methods, were being used in Canada. FATF is due to re-examine the effectiveness of Canada’s anti-money laundering regime this October.

“Permissive property investment rules and loose reporting compliance in the real estate industry make Vancouver homes the perfect vehicle for illicit offshore investment,” reported the Vancouver-based newspaper The Province on Aug. 4. Former diplomat David Mulroney has also argued in a recent book that Canada should do better at blocking the “hot money” pouring into real estate.

“I do agree that the real estate sector is a huge risk for money laundering, especially on the West Coast,” said Christine Duhaime, who manages a specialized counter-terrorist financing and anti-money laundering law practice in Vancouver and Toronto. She said in an interview that the sector as a whole has “issues with understanding the regime and complying with it, and they don’t think they have issues.”

Ms. Fiddian-Green said there were parts of the sector that were doing a “really impressive” job trying to understand suspicious activity. “And then I have come across many other groups that—just the level of awareness that they have of even the requirements for their sector is very low, and that still continues.”

There’s a cost to compliance; as companies become aware of the rules and start to put people on their staff who can file the right forms, it adds to the company’s costs, she noted. Saying no to lucrative clients is also hard to do in a competitive market.

No data

Yet try to point to any specifics, and you quickly come up short. There are no official Canadian statistics on foreign investment in residential property, legitimate or not, so detailing the extent of the problem is hard. (Update: Scroll to bottom).

The FINTRAC analysis provides no specific numbers. In fact, there’s “no direct evidence systematically linking financial crime to foreign real estate investment in Canada,” concluded Kerry Sun, a research associate with the University of Alberta’s China Institute, in a recent paper.

The real estate industry pointed to this lack of data when questioned by Embassy. “We aren’t aware of the study to which you make reference,” wrote Pierre Leduc, spokesperson for the Canadian Real Estate Association, in an emailed response referring to the study FINTRAC examined.

“In general we are not aware of any quantitative research that has been done on the issue in question and that lack of information is what leads to baseless speculation. Indeed, when it comes to policy making, qualitative research might as well be creative writing, it makes a good story but is indicative of nothing.”

Matthew McGuire, National Anti-Money Laundering Practice Leader at MNP LLP, said there were very few prosecuted money laundering cases in Canada, and scarce rigorous analysis. Canada throws hundreds of millions of dollars a year at the problem, but convictions typically come up with just tens of millions of dollars in blocked funds, he said.

In that environment, it was understandable that the real estate sector might be unengaged, he said. “My experience in consulting with hundreds and hundreds and hundreds of these reporting entities is that nobody wants to do a bad job…these are people that have been levied a monstrous administrative burden, ostensibly just to be put in place to satisfy international bodies. Their apathy is understandable.”

Uneven coverage

In the absence of hard data, Canada’s regulator FINTRAC should be doing a better job at educating the sector about its obligations, he said.

Ms. Duhaime also argued the sector itself isn’t subject to enough regulation over so-called politically exposed persons, for example offshore government officials. “[The] federal government has to change the law and make realtors be responsible for identifying politically exposed people like everyone else is,” she said.

The real estate sector has had less regulatory oversight and has been pushed less to comply than other sectors, argued Ms. Fiddian-Green. “The banking sector in Canada, the money service business sector in Canada, they have been highly regulated, highly scrutinized…the real estate sector, the time for that is still coming, I believe.”

Another issue is that only part of the real estate industry is covered by FINTRAC regulations in the first place. So-called For Sale By Owner properties, sales not done by a licensed realtor, are not covered.

In Canada, the provinces are responsible for regulating real estate professionals, and the industry had roughly 100,000 licensed real estate brokers and sales reps, the 2008 FATF report stated—but this isn’t the complete picture.

Transactions that go through lawyers are also shielded. In February, the Supreme Court struck down a federal law that would have required lawyers and other professionals who take care of clients’ money to keep transaction records, verify identities and establish methods of checking for money laundering.

The FINTRAC-sponsored report notes that the assistance provided by lawyers’ trust accounts “can knowingly or unknowingly provide legitimacy and/or obscure the source of illegally sourced funds.”

The real estate industry also points to the uneven playing field. “There are huge gaps in the applicability of FINTRAC rules,” wrote Mr. Leduc. “CREA and its member realtors must comply with FINTRAC regulations, both at the brokerage and individual realtor level, and we have extensive compliance tools in place.”

FINTRAC distanced itself from the results of the report. The analysis notes that the results are Grant Thornton’s views, not those of FINTRAC. Spokesperson Ms. Bercier wrote that the centre has “considered the opinions in this external report—along with many other views and observations” but “does not endorse the observations of the consultant nor those who were interviewed as part of this information-gathering exercise.”

The centre maintains that the sector “must report transactions to FINTRAC, develop and implement a compliance regime, identify clients and third party transactions, monitor business relationships and keep records.” But it won’t reveal its enforcement strategy.

Pressed about its efforts to combat money laundering in real estate alongside international partners, Ms. Bercier wrote that FINTRAC “participates actively alongside our allies and partners in global efforts to combat these threats” but declined to comment further.

Bank on it

Another issue is bank scrutiny. If all the banks deny politically exposed persons access to accounts, it’s impossible for people to bring in the proceeds of crime to Canada, argued Ms. Duhaime.

“So then we’ve solved the problem. But the banks are actually not asking those questions like they should be,” she argued. “We’re not enforcing it when it comes to banks.”

A bank is in a better position to see all the information passing through, said Mr. McGuire. “It has the money and the systems and the experience with regulations to be able to sniff out transactions that are unusual. We need to focus on that aspect of monitoring as one of our principal controls,” he said.

The banking industry has focused on the money services sector for years now, said Ms. Fiddian-Green, making sure foreign exchange outlets and the like have the proper compliance regimes in place, and other controls. That sector is also very high risk for money laundering, she argued, so it was important for banks to focus on that—but it has meant less of an effort on other areas, like real estate.

In a recent anti-money laundering meeting she attended, she said, “we had bankers in the room, we had government people in the room, we had industry people in the room, saying ‘When are the bankers going to start to turn that level of scrutiny on the other sectors?’”

Questioned by Embassy, a banking industry representative said the industry is doing its job.

“The banking industry complies fully with the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and reports suspicious activity based on the requirements in the Act and its regulations to FINTRAC,” wrote Kate Payne, media relations specialist at the Canadian Bankers Association, in an email.

“Both FINTRAC and the banks’ prudential regulator, OSFI, provide guidance on their websites that are publicly available.”

Why the study?

Finally, there is the question of why this report was commissioned in the first place.

FINTRAC refers to itself as having a “unique ability” to see financial transaction reports that must be sent to it by any entity that is covered under Canada’s anti-money laundering and anti-terrorist financing regime.

As a result, it’s privy to a lot of sensitive financial information—so sensitive that keeping all that information secure while it migrates to the government’s new centralized computer network is one of its “key priorities” for this fiscal year, documents show.

So why would a Canadian regulator, which receives such sensitive information, need a study by an outside firm?

The documents retrieved through access to information noted that FINTRAC planned to combine the report’s findings with its own knowledge and its body of financial transaction reports “to internally develop the sector risk profiles” as well as help Finance Canada with its development of a “national risk assessment.” Finance Canada’s 2014-15 Report on Plans and Priorities indicates that assessment is still ongoing.

As for FINTRAC itself, it would only say that it needed an outsider’s view. “The purpose of the exercise was to get an independent perspective on how individuals within the different business sectors perceived vulnerabilities,” wrote Ms. Bercier.

But it’s a question that stumped Ms. Duhaime. “I had never heard of them going to an accounting firm for that kind of thing,” she said.

“They’re supposed to be the experts, not Grant Thornton.”

UPDATE, 1:20 p.m. August 12:

A re-elected Conservative government would collect data on certain foreign buyers in real estate, Prime Minister Stephen Harper announced Aug. 12 in Vancouver.

“In most developed economies, governments track this kind of information. But governments in Canada historically have not. And as a start, this needs to change,” said Mr. Harper to media gathered at Seaspan shipyard.

“A re-elected Conservative government will commit to collecting comprehensive data on the foreign non-resident purchase of Canadian real estate,” Mr. Harper said.

“As necessary, in co-ordination with the provinces, we will take action to ensure any foreign non-resident investment supports the availability and affordability of homes for Canadians.”

Mr. Harper was also announcing a policy to raise the limit on tax-free withdrawals from RRSPs to finance first homes. A press release from the Conservative Party about that policy also addresses the foreign buyer issue.

“Real estate commentators have suggested that speculative foreign buyers are a significant factor in driving homes out of the price range of average families in some parts of the country,” the press release states.