Third-Party Source of Funds: What Legal Professionals Need to Know in 2025
Published
Harriet Holmes
AML Services Manager
Key Updates Summary:
New guidance effective from 23 April 2025 strengthens third-party source of funds verification requirements
This guidance contains significant changes from the addendum issued in 2023
Legal professionals must conduct risk-based assessments for third-party funding sources
Third-party source of funds checks should match the same level of scrutiny applied to primary clients
Risk profile determines the extent of required source of funds documentation
Source of wealth understanding may be necessary to properly verify source of funds
All due diligence measures must be demonstrably appropriate per regulation 28(16) </aside>
The latest revision of the LSAG Guidance, effective from 23 April 2025, has received HM Treasury's approval. These revisions impact how legal professionals must approach source of funds checks, particularly regarding third-party contributions to transactions. Third-party funding is common in conveyancing transactions and other retainers, but the use of a third party can serve as a method for layering criminal property. The changes strengthen due diligence requirements and emphasise the need for risk-based assessment when verifying third-party funding sources. Legal professionals should carefully review these updates to ensure compliance with the new guidance.
Section 6.17.2.1 - Establishing Source of Funds, page 90.
When reviewing the schedule of amendments within the new guidance, strikethrough text indicates deletions and underlined text shows additions (this relates to the original text and not the addendum). The changes include the removal of one paragraph, the addition of two new paragraphs, and amendments to an existing paragraph regarding the source of funds.
In circumstances where a client declares that they have been given funds for a transaction from a third party you may wish to record information relating to that original transaction too. You may verify this by requesting bank statements and other relevant documentation relating to this transfer.
In circumstances where it becomes known that a third party is to contribute to funds for a transaction, you should consider also seeking to understand and obtain evidence relating to the third party’s underlying SoF, in the same way you would on the client themselves, with the extent of such measures increasing with risk level. Whether and the extent to which you should obtain, review and evidence third party SoF is dependent upon the risk profile of the client or matter, bearing in mind that accepting payments from unknown or unassociated third parties is a specific risk factor pursuant to 33(6)(b)(iv).
The need for and extent of source of funds checks should be informed by your ongoing assessment of client and matter risk under regulations 28(11) to (13), and in turn inform future assessments. You must also bear in mind your obligation under regulation 28(16) to demonstrate that the measures you have taken to carry out due diligence are appropriate, with reference to both your PWRA and the relevant sectoral risk assessment.
SoF can often be It may be difficult to determine the SoF without some basic understanding of the source of wealth underlying SoW of the individual. This can particularly be the case where the funds for a transaction have become mixed with other funds in an account. Here, to understand the SoF, you may need to have an awareness of the underlying SoW of the individual, although your level of confidence in the SoW in such a case, should be considered on a risk-based approach (see 6.17.3 and 6.18.3 for further guidance on SoW).
It is important to recognise a key change in terms of terminology used within this section from ‘may’ to ‘should’. The guidance uses specific terminology to help firms understand the various requirements and directions. The terms have the following meanings:
Must – A mandatory regulatory requirement that you must comply with, unless specific exemptions exist.
Should – Best practice recommendation for most situations. Alternative approaches must be justifiable to supervisors. If the suggested route is not followed, firms should be able to justify to supervisors why an alternative approach is appropriate.
May – Optional approach based on practice, client, or matter needs. You may be required to justify why this was an appropriate option.
The change makes it much clearer that the expectation on firms is to conduct source of funds checks on both primary clients and any third parties contributing to transaction funds, with the level of scrutiny being determined by the risk profile. This strengthened approach ensures that firms maintain consistent standards of due diligence across all funding sources. The requirements also emphasise that firms must be prepared to justify their approach to supervisors if they deviate from these expectations.
An individual's financial circumstances can be broadly categorised into Source of Funds and Source of Wealth, whether that individual is your client or a third party. This forms a fundamental part of holistic Customer Due Diligence. Understanding both source of funds and wealth serves as a crucial safeguard for regulated firms, it is an opportunity to protect a firm from being exploited for money laundering. Source of funds checks serve to limit opportunities for criminals to use criminal property - after all, money laundering cannot exist without criminal property. However, criminal activity is not limited to clients alone.
Source of Funds verification requires different types of documentation based on an individual’s circumstances. Source of Funds refers to the specific funds used in a transaction - their origin, accumulation, and legitimacy via risk-based verification.
Source of Funds refers to the funds that are being used to fund the specific transaction in hand – i.e., the origin of the funds used for the transactions or activities that occur within the business relationship or occasional transaction.
The questions to answer: Where did the money for the transaction come from, and how and from where did the client/Third party get the money for this transaction or business relationship?
Source of wealth refers to the origin of a client’s entire body of wealth (i.e., total assets).
The questions to answer: Why and how does the individual have the amount of overall assets they do, and how did they accumulate/generate these?
Action steps:
Review and update source of funds verification procedures to align with new guidance effective April 23, 2025
Consider the red flags related to a third-party source of funds (section 18.2.3 Source of Funds). Ensure your team understands these indicators and their implications for due diligence
Develop a risk-based assessment framework for evaluating third-party funding sources
Review and update internal documentation processes to demonstrate appropriate due diligence measures under regulation 28(16)
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