When an institution initiates a transaction, the UBO, or Ultimate Beneficial Owner, is the person who is the ultimate beneficiary. The definition of a UBO varies by jurisdiction, but in general, a UBO is defined as an individual who owns at least 10% (depending on jurisdiction) of the underlying entity’s capital or voting rights.
Concept of the Ultimate Beneficial Owner
The leak of over 11.5 million confidential documents from a Panamanian law firm, Mossack Fonseca, highlighted the issue of beneficial ownership, which became the center of global media attention. Since then, they have been supplemented by many new journalistic investigations, such as Paradise Papers, Bahamas Leaks, and Offshore Leaks investigations.
In 2016, it was exposed how the rich, powerful, and famous may have used elaborate corporate ownership and control structures to ring-fence their assets. The choice of offshore companies in lightly regulated tax havens was made based on the belief that such activities would remain beyond regulatory and public scrutiny. The public response to the disclosure of this information has been anger. At least for some of those implicated, the consequences were swift and dramatic.
Several political leaders and public persons faced unwelcome questions about their personal and family finances. Especially, against a background of budget cuts in such services as healthcare insurance, the revelation that political elites and their families were avoiding the consequences of such cuts met with widespread castigation.
The standard response of policymakers looking to calm the public in the wake of such scandals has been the introduction of more regulation. Large publicly listed firms, for instance, resulted in ever-stricter corporate governance, compliance, and sustainability rules. The inevitable result has been the regulation that requires large modern corporations to make a much more significant investment in compliance and legal risk management.
The regulatory strategies focus on disclosing “ultimate beneficial ownership” or UBO as a prerequisite to preventing tax evasion, tax avoidance, money laundering, and corruption. The offshore leaks have been interpreted as an opportunity for regulators, including the regulators of tax havens, to develop a coordinated global solution that ensures greater transparency in the ownership of firms.
It is obvious that public trust in corporations and markets largely depends on an accurate disclosure regime that provides transparency in companies’ beneficial ownership and control structures. Beneficial ownership information is necessary to detect and prevent tax evasion, corruption, money laundering, terrorist financing, and other illicit behavior involving one or more companies.
The offshore leaks discussion shows that the public increasingly finds the misuse of corporate structures unacceptable. Moreover, investor confidence in financial markets depends on accurately disclosing ownership and control structures and the UBO of publicly listed companies. This is especially important in corporate governance systems characterized by concentrated ownership.
Large investors with significant voting and cash-flow rights may facilitate long-term growth and firm performance in such systems. Such a structure allows them to make business decisions without additional procedures and is generally considered more inclined to control the allocation of resources. However, there is a risk that controlling beneficial owners with large voting blocks may also have the incentive to divert corporate assets and exploit opportunities for personal gain at the expense of minority investors and the company’s detriment. Protecting minority investors and ensuring the most efficient capital have been seen as important issues in regulating capital markets.
In addressing this issue, most jurisdictions have passed legislation mandating shareholders to disclose and report the accumulation of significant share ownership. The rationale behind disclosure requirements seems clear: by alerting minority or potential investors to material changes in control and ownership structures, we allow them to make a more informed assessment of the company’s prospects.
However, devising a practical legal framework that facilitates the disclosure of the ultimate beneficial owner has not proven easy. Even with a system of disclosure rules and regulations, the actual ownership of a company can remain opaque or, in many cases, impossible to establish.
In markets characterized by small and widely dispersed shareholdings, the corporate governance discussion has created mechanisms intended to curtail agency problems, notably those that arise between self-interested management and passive investors. These problems are usually explained by the “vertical agency relationship,” in which the managers are the agents, and the shareholders are the principals.
This type of agency problem stems from shareholders being disengaged from the task of monitoring and, if necessary, disciplining management. The separation of ownership and control allows those in management to exploit their informational advantage regarding a company’s strategies, policies, and prospects without the risk of being detected.
In the concentrated ownership systems, the scale of the “vertical agency problem” is mitigated because some investors tend to hold a disproportionately more significant stake in listed companies and have both the incentive and the capacity to monitor and discipline management. In block-holder systems, we can distinguish two types of listed firms. First, there are listed companies, such as those “controlled” by institutional investors, in which the substantial voting rights and cash-flow rights are identical and based on the proportion of total shares held.
These investors, generally called “outside block-holders,” make listed companies susceptible to a three-way conflict between controlling shareholders, managers, and minority shareholders. Since outside block-holders usually mitigate the problems related to managerial opportunism, it is not surprising that policymakers and regulators focus on possible conflicts that may occur in the “horizontal agency relationship” between outside block-holders and passive minority investors
There are listed companies, such as the many family-owned and sometimes even state-owned companies, with “inside block-holders” who hold management positions or serve as the directors of the companies they invest in. “Vertical agency problems” are irrelevant in this context, but “horizontal agency problems” are a significant concern in listed companies with sizable inside block-holders.
In this context, the controlling shareholders may use several strategies to extract resources and assets from firms they control, thereby significantly increasing horizontal agency costs.
Obvious risks include the following:
- Dilutive share issues,
- Insider trading,
- Important withholding information from prospective investors,
- Allocation of corporate opportunities and business activities, and
In dealing with beneficial ownership and control issues, countries have implemented an array of legal and regulatory instruments aimed at information disclosure. In most jurisdictions, these instruments are included in their securities laws and regulations.
At the core of most disclosure laws is a definition of the beneficial owner. Generally, a beneficial owner can be defined as the legal or natural person entitled to benefits from the beneficial ownership of securities and/or having the power to control the voting rights attached to the shares. Different jurisdictions fill out this barebones concept in different ways.
There are jurisdictions where the definition of beneficial ownership is restricted to certain benefits, most obviously the financial benefits attached to the shares. There are also jurisdictions where a beneficial owner is defined as the ultimate owner of the deposited securities and is entitled to all rights, benefits, powers, and privileges.
There are three groups of natural persons or legal entities for which the disclosure of beneficial ownership information is required.
- In the first group are directors and chief executives or senior officers, who must disclose their interests in the company, regardless of their actual shareholding percentage.
- The second group includes substantial shareholders, classified by a minimum shareholding percentage (usually fixed at 3 percent, 5 percent, or 10 percent) and required to report their beneficial ownership.
- The third group is grounded on the difference between de jure and de facto beneficial ownership and consists of de facto owners. Because it is the rule rather than the exception to look at de facto beneficial ownership and de jure beneficial ownership, a pertinent issue is the content of such de facto ownership. Applying such a concept will result in shares held under the name of third parties also being counted as under the control of the beneficial owner.
- The first and most straightforward ownership category is when the shareholders are natural persons. Applying the concept of de facto beneficial ownership results in the securities held by a person’s relatives or family members being counted as securities held by that person. This is a common practice adopted in most jurisdictions worldwide.
The second category is when another company holds the shares of a listed company. The de facto approach would undoubtedly require that disclosure be made beyond the signatory level of the “institutional” shareholder. Still, the critical issue here is how far the disclosure could reach. Is a beneficial owner recognized first, second, or ultimate layer of beneficial ownership of shares in listed companies? Although most jurisdictions mandate that disclosure be made to the ultimate beneficial owner level, their answers to this question still vary greatly regarding the technical particularities of reaching the ultimate beneficial owners.
De facto beneficial ownership also covers situations where two or more people jointly hold shares. Most jurisdictions also impose a disclosure obligation on beneficial owners acting like one. Also, there is a different kind of shareholder, like a trust. Consistently, if a jurisdiction requires disclosure of beneficial ownership up to the ultimate level, this requirement usually already covers the obligation of disclosing trust arrangements.
A shareholder may use a set of control-enhancing mechanisms to attain more voting or control rights above cash-flow rights. Typically, such mechanisms include pyramid structures, cross-shareholdings, dual-class shares, nonvoting shares, derivative products of shares, and shareholder coalitions and agreements. Indeed, while using mechanisms to enhance control, in general, is not uncommon, one jurisdiction can differ from another in the extent of regulatory acceptance of these mechanisms, resulting in one or more of them being illegal or at least somehow conditioned in certain countries.
The Ultimate Beneficial Owner, or UBO, defines the legal entity of the company’s beneficiary, which requires significant control in terms of KYC processes. Banks, investment firms, insurance companies, and other financial institutions must detect UBOs, according to the regulator. The primary reason is to prevent serious crimes like money laundering and terrorist financing. The lack of disclosure of UBOs allows people to launder money through corporations. As a result, countries should pay attention to UBOs in order to combat money laundering and terrorist financing.