CYPRUS: 2006-2007 INTERNATIONAL NARCOTICS CONTROL STRATEGY

UNCLAS NICOSIA 001889

SIPDIS

SIPDIS

STATE FOR EB/ESC/TFS, INL, AND EUR/SE

JUSTICE FOR AFMLS, OIA, AND OPDAT

TREASURY FOR FINCEN

DEA FOR OILS AND OFFICE OF DIVERSION CONTROL

E.O. 12958: N/A
TAGS: EFIN KCRM KTFN PTER SNAR CY
SUBJECT: CYPRUS: 2006-2007 INTERNATIONAL NARCOTICS CONTROL STRATEGY
REPORT (INCSR) PART II, FINANCIAL CRIMES AND MONEY LAUNDERING

REF: STATE 157084


1. Per Reftel request, Post submits in para 2 below Part II
(Financial Crimes and Money Laundering) of the 2006-2007 INCSR. The
report is based on an update of last year's published version. As
requested Reftel, we will also e-mail a track-changes version of
this report to the officials requested. We will forward statistics
for 2006 on the number of SARS, prosecutions, and freezing and
confiscation orders via e-mail when this information becomes
available in January.


2. BEGIN TEXT

Cyprus

Cyprus has been divided since the Turkish military intervention of
1974, following a coup d'etat directed from Greece. Since then, the
southern part of the country has been under the control of the
Government of the Republic of Cyprus. The northern part is
controlled by a Turkish Cypriot administration that in 1983
proclaimed itself the "Turkish Republic of Northern Cyprus (TRNC),"
recognized only by Turkey. The U.S. Government recognizes only the
Government of the Republic of Cyprus, and does not recognize the
"TRNC."
Government-controlled area.

The government-controlled area of the Republic of Cyprus is a major
regional financial center with a robust financial services industry,
contributing 6.6 percent to the country's Gross Domestic Product.
Like other such centers, it remains vulnerable to international
money laundering activities. Fraud and, to some extent, narcotics
trafficking are the major sources of illicit proceeds laundered in
Cyprus. Casinos, Internet gaming sites, and bearer shares are not
permitted, although sports betting halls are allowed.

The development of the financial sector in Cyprus has been
facilitated by the island's central location, a preferential tax
regime, double tax treaties with 40 countries (including the United
States, several European Union (EU) nations, and former Soviet Union
nations),a labor force particularly well trained in legal and
accounting skills, a sophisticated telecommunications
infrastructure, and relatively liberal immigration and visa
requirements. In recent years, Cyprus has introduced tax and
legislative changes effectively abolishing all legal and substantive
distinctions between domestic and offshore companies. All Cypriot
companies are now taxed at a uniform rate of 10 percent,
irrespective of the permanent residence of their owners or whether
they do business internationally or in Cyprus. A transition period
allowing preferential tax treatment to offshore companies that
existed prior to 2002 expired on January 1, 2006. Additionally,
the prohibition from doing business domestically has been lifted and
companies formerly classified as offshores are now free to engage in
business locally.

Over the past decade, Cyprus has put in place a comprehensive
anti-money laundering legal framework. The GOC continues to revise
these laws to meet evolving international standards. In 1996, the
GOC passed the Prevention and Suppression of Money Laundering
Activities Law, which mandated the establishment of a Financial
Intelligence Unit (FIU). This law criminalizes both drug and
non-drug-related money laundering, provides for the confiscation of
proceeds from serious crimes, and codifies the actions that banks,
non-bank financial institutions, and non-financial businesses
(including lawyers, accountants, real estate agents, and dealers in
precious metals and stones) must take (including customer
identification). The anti-money laundering law authorizes criminal
(but not civil) seizure and forfeiture of assets. Subsequent
amendments to the 1996 law broadened its scope by eliminating the
separate list of predicate offenses (now defined as any criminal
offense punishable by a prison term exceeding one year),addressing
government corruption, and facilitating the exchange of financial
information with other FIUs, as well as the sharing of assets with
other governments. A law passed in 1999 criminalizes counterfeiting
bank instruments, such as certificates of deposit and notes.

Amendments passed in 2003 and 2004 implement the EU's Second Money
Laundering Directive. These amendments authorize the FIU to
instruct banks to delay or prevent execution of customers' payment

orders; extend due diligence and reporting requirement to auditors,
tax advisors, accountants, and, in certain cases, attorneys, real
estate agents, and dealers in precious stones and gems; permit
administrative fines of up to $6,390; and increase bank due
diligence obligations concerning suspicious transactions and
customer identification requirements, subject to supervisory
exceptions for specified financial institutions in countries with
equivalent requirements.

Also in 2003, the GOC enacted new legislation regulating capital and
bullion movements and foreign currency transactions. The new law
requires all persons entering or leaving Cyprus to declare currency
(whether local or foreign) or gold bullion worth approximately
$15,500 or more. This sum is subject to revision by the Central
Bank. This law replaces exchange control restrictions under the
Exchange Control Law, which expired on May 1, 2004.

Financial institutions in Cyprus are regulated and supervised by
four authorities: the Central Bank of Cyprus, responsible for
supervising locally incorporated banks as well as subsidiaries and
branches of foreign banks; the Cooperative Societies Supervision and
Development Authority (CSSDA),supervising cooperative credit
institutions; the Superintendent for Insurance Control; and the
Cyprus Securities and Exchange Commission. Designated non-financial
businesses and professions (DNFBP) are supervised as follows:
attorneys are supervised by the Council of the Bar Association;
accountants are supervised by the Institute of Certified Public
Accountants; and real estate agents and dealers in precious metals
and stones are supervised by the local FIU. The supervisory
authorities may impose administrative sanctions if the legal
entities or persons they supervise fail to meet their obligations as
prescribed in Cyprus's anti-money laundering laws and regulations.

The Government-controlled area of Cyprus currently hosts a total of
40 banks: 14 locally-incorporated, of which 11 are commercial banks
and three are specialized financial institutions. Of the commercial
banks, six are foreign-owned, and two are branches of foreign banks.
The remaining 26 are foreign-incorporated banks that conduct their
operations almost exclusively outside of Cyprus. At the end of
August 2006, the cumulative assets of domestic banks were $53.9
billion, while the cumulative assets of subsidiaries and branches of
the foreign-incorporated banks were $22.8 billion.

Since May 2004, when Cyprus joined the EU, banks licensed by
competent authorities in EU countries may establish branches in
Cyprus or provide banking services on a cross-border basis without
obtaining a license from the Central Bank of Cyprus, under the EU's
"single passport" principle. By the end of 2006, four EU banks were
operating a branch in Cyprus under the "single passport"
arrangement. Cyprus hosts six licensed money transfer companies, 40
international independent financial advisers, six international
trustee services and 200 feeder funds. There are also 47 investment
firms, two UCITS management firms, 43 licensed insurance companies,
238 licensed real estate agents, 1,858 registered accountants, 1,631
practicing lawyers and around 350 credit institutions.

In October 2006, the IMF released a detailed assessment of the
"Observance of Standards and Codes for Banking Supervision,
Insurance Supervision and Securities Regulation." Among other
things, the report noted that the SEC was legally unable to
cooperate with foreign regulators if the SEC did not have an
independent interest in the matter being investigated, and that the
SEC was experiencing difficulty obtaining information regarding the
beneficial owners of Cypriot-registered companies. The SEC is
working to resolve both of these issues. The report also noted that
commitments emerging from EU accession had "placed stress on the
skills and resources" of the staff of the CSSDA and the Insurance
Superintendent and recommended additional training.

In recent years the Central Bank has introduced many new regulations
aimed at strengthening anti-money laundering vigilance in the
banking sector. Among other things, banks are required to (1)
ascertain the identities of the natural persons who are the
"principal/ultimate" beneficial owners of corporate or trust
accounts; (2) obtain as quickly as possible identification data on
the natural persons who are the "principal/ultimate" beneficial
owners when certain events occur, including an unusual or
significant transaction or change in account activity; a material

change in the business name, officers, directors and trustees, or
business activities of commercial account holders; or a material
change in the customer relationship, such as establishment of new
accounts or services or a change in the authorized signatories; (3)
adhere to the October 2001 paper of the Basel Committee on Banking
Supervision on "Customer Due Diligence for Banks"; and (4) pay
special attention to business relationships and transactions
involving persons from jurisdictions identified by the Financial
Action Task Force (FATF) as non-cooperative. This list is updated
regularly in line with the changes effected to the list of
non-cooperative countries and territories by the FATF.

All banks must report to the Central Bank, on a monthly basis,
individual cash deposits exceeding approximately $21,200 in local
currency or approximately $10,000 in foreign currency. Bank
employees currently are required to report all suspicious
transactions to the bank's compliance officer, who determines
whether to forward the report to the Unit for Combating Money
Laundering (MOKAS),the Cypriot FIU, for investigation. Banks
retain reports not forwarded to MOKAS, and these are audited by the
Central Bank as part of its regular on-site examinations. Banks
must file monthly reports with the Central Bank indicating the total
number of suspicious activity reports (SARs) submitted to the
compliance officer, and the number forwarded by the compliance
officer to MOKAS. By law, bank officials may be held personally
liable if their institutions launder money. Cypriot law partially
protects reporting individuals with respect to their cooperation
with law enforcement but does not clearly absolve a reporting
institution or its personnel from complete criminal or civil
liability. Banks must retain transaction records for five years.

In November 2004, the Central Bank issued a revised money laundering
guidance note that places several significant new obligations on
banks, including requirements to develop a customer acceptance
policy; renew customers' identification data on a regular basis;
construct customers' business profiles; install computerized risk
management systems in order to verify whether a customer constitutes
a "politically exposed person"; provide full details on any customer
sending an electronic transfer in excess of $1,000; and implement
(by June 5, 2005) adequate management information systems for
on-line monitoring of customers' accounts and transactions. Cypriot
banks have responded by adopting dedicated electronic risk
management systems, which they typically use to target transactions
to and from high-risk countries. Cyprus's Exchange Control Law
expired on May 1, 2004, ending Central Bank review of foreign
investment applications for non-EU residents. Individuals wishing
to invest on the island now apply through the Ministry of Finance.
The Ministry also supervises collective investment schemes.

The Central Bank also requires compliance officers to file an annual
report outlining measures taken to prevent money laundering and to
comply with its guidance notes and relevant laws. In addition, the
Central Bank is legally empowered to conduct unannounced inspections
of bank compliance records. In July 2002, the U.S. Internal Revenue
Service (IRS) officially approved Cyprus's "know-your-customer"
rules, which form the basic part of Cyprus' anti-money laundering
system. As a result of the above approval, banks in Cyprus that may
be acquiring United States securities on behalf of their customers
are eligible to enter into a "withholding agreement" with the IRS
and become qualified intermediaries.

MOKAS, the Cypriot FIU, was established in 1997. MOKAS is
responsible for receiving and analyzing SARs and for conducting
money laundering or financial fraud investigations. A
representative of the Attorney General's Office heads the unit. In
June 2006, MOKAS hired an additional six financial investigators,
giving it a permanent staff of 20. MOKAS cooperates closely with
FinCEN and other U.S. Government agencies in money laundering
investigations.

All banks and non-bank financial institutions, insurance companies,
the stock exchange, cooperative banks, lawyers, accountants, and
other financial intermediaries must report suspicious transactions
to MOKAS. Sustained efforts by the Central Bank and MOKAS to
strengthen reporting have resulted in an increase in the number of
SARs being filed from 25 in 2000 to 168 in 2005. During 2005, MOKAS
received 206 information requests from foreign FIUs, other foreign
authorities, and INTERPOL. Nine of the information requests were


related to terrorism, although not specifically involving Cyprus.
MOKAS evaluates evidence generated by its member organizations and
other sources to determine if an investigation is necessary. It has
the power to suspend financial transactions for an unspecified
period of time as an administrative measure. MOKAS also has the
power to apply for freezing or restraint orders affecting any kind
of property at a very preliminary stage of an investigation. In
2005, for the first time, MOKAS issued several warning notices,
based on its own analysis, identifying possible trends in criminal
financial activity. These notices have already produced results,
including the closure of dormant bank accounts. MOKAS conducts
anti-money laundering training for Cypriot police officers, bankers,
accountants, and other financial professionals. Training for
bankers is conducted in conjunction with the Central Bank of Cyprus.
Since late 2003, the MOKAS computer network has been connected with
that of the central government, thus giving MOKAS direct access to
other GOC agencies and ministries.

During 2005, MOKAS opened 388 cases and closed 188. Reportedly,
there was an undetermined number of successful prosecutions. During
the same period, it issued 17 Information Disclosure Orders
(typically involving judiciary proceedings in courts abroad),12
administrative orders for postponement of transactions, and nine
freezing orders, resulting in the freezing of $1,680.000 in bank
accounts and 11 pieces of real estate. Additionally, during 2005,
MOKAS issued two confiscation orders for a total amount of $42,000
(in one of the cases, the GOC shared the money with another
jurisdiction that had been involved). Government actions to seize
and forfeit assets have not been politically or publicly
controversial, nor have there been retaliatory actions related to
money laundering investigations, cooperation with the United States,
or seizure of assets. There have been at least ten convictions
recorded under the 1996 Anti-Money Laundering law, and a number of
other cases are pending.

On November 30, 2001, Cyprus became a party to the UN International
Convention for the Suppression of the Financing of Terrorism. The
implementing legislation amended the anti-money laundering law to
criminalize the financing of terrorism. The parliament passed an
amendment to the implementing legislation in July 2005 eliminating a
loophole that had inadvertently excused Cypriot nationals operating
in Cyprus from prosecution for terrorism finance offenses. Cyprus
has yet to criminalize, however, collecting funds in the knowledge
that they are to be used for any purpose by a terrorist organization
or an individual terrorist, as required by FATF Special
Recommendation II. In November 2004, MOKAS designated two employees
to be responsible for terrorist finance issues. MOKAS routinely
asks banks to check their records for any transactions by any person
or organization designated by foreign FIUs as a terrorist or a
terrorist organization. If a person or entity is so designated by
the UN 1267 Sanctions Committee or the EU Clearinghouse, the Central
Bank automatically issues a "search and freeze" order to all banks,
both domestic and IBUs. As of November 2006, no bank had reported
holding a matching account. The lawyers' and accountants'
associations cooperate closely with the Central Bank. The GOC
cooperates with the United States to investigate terrorist
financing.

There is no evidence that alternative remittance systems such as
hawala or black market exchanges are operating in Cyprus, at least
on a significant scale. The GOC believes that its existing legal
structure is adequate to address money laundering through such
alternative systems. The GOC licenses charitable organizations,
which must file with the GOC copies of their organizing documents
and annual statements of account. Reportedly, the majority of all
charities registered in Cyprus are domestic organizations.

Cyprus is a party to the 1988 UN Drug Convention and the UN
Convention against Transnational Organized Crime. Cyprus is a member
of the Council of Europe's MONEYVAL, and the Offshore Group of
Banking Supervisors. MOKAS is a member of the Egmont Group and has
signed memoranda of understanding (MOUs) with the FIUs of the United
States, Belgium, France, the Czech Republic, Slovenia, Malta,
Ireland, Australia, Ukraine, Poland, Canada, Russia, Bulgaria, South
Africa, and Israel and Romania. Although Cypriot law specifically
allows MOKAS to share information with other FIUs without benefit of
an MOU, Cyprus is negotiating MOUs with Venezuela, and Italy. A
Mutual Legal Assistance Treaty between Cyprus and the United States

entered into force September 18, 2002. In 1997, the GOC entered
into a bilateral agreement with Belgium for the exchange of
information on money laundering. Cyprus underwent a MONEYVAL mutual
evaluation in April 2005, the results of which were published in a
report adopted at the MONEYVAL Plenary meeting in January 2006. The
report found Cyprus at least partially compliant with all 40 of the
Financial Action Task Force's (FATF) Recommendations and all nine of
FATF's Special Recommendations on terrorism finance. It also put
forward a detailed recommended action plan designed to help Cyprus
further improve its anti-money laundering system.

The Government of the Republic of Cyprus has put in place a
comprehensive anti-money laundering regime. It should continue to
take steps to tighten implementation of its laws. In particular, it
should enhance regulation of corporate service providers, including
trust and incorporation companies, lawyers, accountants, and other
designated non-financial businesses and professions. It should
criminalize collecting funds in the knowledge that they will be used
by terrorist organizations or individual terrorists. It should
enact provisions that allow for civil forfeiture of assets. Cyprus
should also take steps to implement the recommendations of the
recent MONEYVAL and IMF evaluations.

Area Administered by Turkish Cypriots.

The Turkish Cypriot community continues to lack the legal and
institutional framework needed to provide effective protection
against the risks of money laundering. Turkish Cypriot authorities
have, however, developed a greater appreciation of the dangers of
unchecked money laundering and have begun taking limited steps to
address these risks. Nevertheless, it appears that the Turkish
Cypriot leadership lacks the political will necessary to push
through reforms needed to introduce effective oversight of its
limited and relatively isolated financial sector. It is believed
that the 23 essentially unregulated, and primarily Turkish-mainland
owned, casinos, and the 16 offshore banks, are the primary vehicles
through which money laundering occurs. Casino licenses are fairly
easy to obtain, and background checks done on applicants are
minimal. A significant part of the funds generated by these casinos
reportedly change hands in Turkey without ever entering the Turkish
Cypriot banking system, and there are few safeguards to prevent the
large-scale transfer of cash to Turkey. Another area of concern is
the roughly 500 "finance institutions" operating in the area
administered by Turkish Cypriots that extend credit and give loans.
Although they must register with the "Office of the Registrar of
Companies," they are unregulated. Some are owned by banks and
others by auto dealers. In 2005 and 2006, there was a huge increase
in the number of sport betting halls, which are licensed by the
"Prime Minister's Office." There are currently 7 companies
operating in this sector, with a total of 85 outlets. Four of the
companies also accept bets over the internet. The fact that the
"TRNC" is recognized only by Turkey limits the ability of Turkish
Cypriot officials to receive training or funding from international
organizations with experience in combating money laundering. The
Turkish Cypriot community is not part of any regional FATF-style
organization and thus is not subject to any peer evaluations.

The offshore banking sector also remains a concern. In August 2004,
the U.S. Department of the Treasury's FinCEN issued a notice of
proposed rule making to impose a special measure against First
Merchant Bank OSH Ltd in the area administered by Turkish Cypriots
as a financial institution of primary money laundering concern.
Pursuant to Section 311 of the USA PATRIOT Act, FinCEN found First
Merchant Bank to be of primary money laundering concern based on a
number of factors, including: (1) it is licensed as an offshore bank
in the "TRNC", a jurisdiction with inadequate anti-money laundering
controls, particularly those applicable to its offshore sector; (2)
it is involved in the marketing and sale of fraudulent financial
products and services; (3) it has been used as a conduit for the
laundering of fraudulently obtained funds; and (4) the individuals
who own, control, and operate First Merchant Bank have links with
organized crime and apparently have used First Merchant Bank to
launder criminal proceeds. As a result of the finding and in
consultation with federal regulators and the Departments of Justice
and State, FinCEN proposed imposition of the special measure that
would prohibit the opening or maintaining of correspondent or
payable-through accounts by any domestic financial institution or
domestic financial agency for, or on behalf of, First Merchant Bank

OSH Ltd. The Turkish Cypriot authorities have not revoked or
suspended First Merchant Bank's license, and it continues to
operate.

In 1999, a money laundering law for the area administered by Turkish
Cypriots went into effect with the stated aim of reducing the number
of cash transactions in the "TRNC" as well as improving the tracking
of any transactions above $10,000. Banks are required to report to
the "Central Bank" any electronic transfers of funds in excess of
$100,000. Such reports must include information identifying the
person transferring the money, the source of the money, and its
destination. Banks, non-bank financial institutions, and foreign
exchange dealers must report all currency transactions over $20,000
and suspicious transactions in any amount. Banks must follow a
know-your-customer policy and require customer identification.
Banks must also submit suspicious transaction reports to an
"Anti-Money Laundering Committee" that is supposed to function as a
quasi-FIU and have investigative powers. The five-member committee
is composed of representatives of the police, customs, the "Central
Bank," and the "Ministry of Finance." However, the 1999 anti-money
laundering law has never been fully implemented or enforced.

In 2005, the "Anti-Money Laundering Committee," which had been
largely dormant for several years, began meeting on a regular basis
and encouraging banks to meet their obligations to file SARs. The
committee has reportedly referred several cases of possible money
laundering to law enforcement for further investigation, but no
cases have been brought to court and no individuals have been
charged. There have been no successful prosecutions of individuals
on money laundering charges, although one foreign bank owner
suspected of having ties to organized crime was successfully
extradited. There are significant concerns that law enforcement and
judicial officials lack the technical skills needed to investigate
and prosecute financial crimes.

Although the 1999 money laundering law prohibits individuals
entering or leaving the area administered by Turkish Cypriots from
transporting more than $10,000 in currency without prior "Central
Bank" authorization, "Central Bank" officials note that this law is
difficult to enforce, given the large volume of travelers to and
from Turkey. In 2003, Turkish Cypriot authorities relaxed
restrictions that limited travel across the UN-patrolled buffer
zone. There is also a relatively large British population in the
area administered by Turkish Cypriots and a significant number of
British tourists. As a result, an informal currency exchange market
has developed.

The "Ministries of Finance and Economy and Tourism" are drafting
several new anti-money laundering laws that they say will, among
other things, establish an FIU and better regulate casinos, currency
exchange houses, and both onshore and offshore banks. Turkish
Cypriot officials have committed to ensuring that the new
legislation meets international standards. However, it is unclear
if and when the new legislation will be adopted, and if it is,
whether it will ever be fully implemented and enforced. Work on the
new bills has already taken over two years.

There are currently 24 domestic banks in the area administered by
Turkish Cypriots. Internet banking is available. The offshore
sector consists of 16 banks and approximately 50 companies. The
offshore banks may not conduct business with residents of the area
administered by Turkish Cypriots and may not deal in cash. The
offshore entities are audited by the "Central Bank" and are required
to submit a yearly report on their activities. However, the
"Central Bank" has no regulatory authority over the offshore banks
and can neither grant nor revoke licenses. Instead, the "Ministry of
Finance" performs this function. Although a proposed new law would
have restricted the granting of new bank licenses to only those
banks already having licensees in an OECD country, the law never
passed.

The 1999 Turkish Cypriot anti-money laundering law does provide
better banking regulations than were previously in force, but it is
far from adequate. The major weakness continues to be the many
casinos, where a lack of resources and expertise leave that area,
for all intents and purposes, unregulated, and therefore especially
vulnerable to money laundering abuse. The largely unregulated
finance institutions, currency exchange houses, and offshore banking


sector are also of concern. The Turkish Cypriot authorities should
move quickly to enact a new anti-money laundering law, establish a
strong and functioning financial intelligence unit, and tighten
regulation of casinos, money exchange houses, and the offshore
sector.

END TEXT

SCHLICHER