Are state-owned and state-invested enterprises vulnerable to unique risks?

A widely accepted definition of a state owned enterprise (SOE) is that of a legal body formed by a government in order to engage in commercial activities on behalf of that government. Any enterprise in which the state owns a stake of 50% or more is considered an SOE. In terms of ownership, it would be considered part of the state apparatus and, in terms of control, it will usually have a management or executive board that is responsible for the day to day running of the organization. It is not unusual for the state to appoint some, or all, of the board members, which could include politically exposed persons (PEPs).

Many financial institutions (FIs) consider board members of SOEs to be PEPs, irrespective of their status in the outside world. Given that governments often issue operating licences, especially for the exploitation of natural resources, the potential issues of bribery, corruption and terrorist financing come to the fore with SOEs. There is a risk of financial crime, and consequently of money laundering. Where SOEs deal with other SOEs the risk is effectively doubled.

In terms of state invested enterprises (SIEs), as the name would suggest, the state is merely invested in the organisation and might not have effective control. Typically direct state ownership of SIEs is less than 25%, or indirect government ownership, usually by a parent SOE which is more than 50% state owned, is in a range between 25% – 49%. Depending upon the industry in which the entity operates, such as defence, it may be appropriate for licence holders to work ‘in concert’.

The SOE may be set up to allow legal agreements between shareholders, which will often limit the percentage of voting rights that that can be acquired to allow effective control. This will then need to be reviewed at least annually to ensure no significant changes have been made. It is also imperative that any sanctions implications are considered, due in no small part to OFAC’s (the Office of Foreign Assets Control) guidance around entities owned by blocked persons, sometimes referred to as the ‘50% rule’.

OFAC’s 50% rule states: the property and interests in property of entities directly or indirectly owned 50% or more in the aggregate by one or more blocked persons are considered blocked. In short, it is crucial to understand the extent and nature of your customers’ ownership and to ensure that effective screening is carried out on all entities, in terms of both companies and individuals. This intertwining of data is highly powerful and enables an FI to face regulators with total confidence, while at the same time making certain that it is adhering to the letter and the spirit of the guidance.

Adherence to OFAC’s regulations requires businesses to carry out a challenging level of research. A team of analysts dedicated to investigating changes in ownership or control of SOEs and SIEs may be unsustainable. It is also difficult, if not impossible, to apply a risk based approach in this scenario unless it is evident where the risks lie. Clearly some jurisdictions may pose a disproportionate level of risk compared to others, but that determination is based upon many factors that are also subject to change.

It is therefore vital at onboarding, and again at any regular refresh events during the client lifecycle, to ascertain that ownership, and to a greater extent control, is established. Given the complex shareholder structure of some SIEs, many of which are publicly listed, it is almost impossible to ensure that you have a solid knowledge and understanding of your client’s ownership or control structure on an ongoing basis without some form of intuitive technology. Fortunately, this technology does exist and it facilitates a rounder understanding of the status of the enterprise, which can, and naturally almost certainly will, change over time.