Historically, the broker-dealer market has received less regulatory pressure through fines, and thus less investment in areas of anti-money laundering (AML). And it’s not just broker-dealers; its also banks in general with investment banks and capital markets divisions. But the tables are turning.
In recent months, leading investment banks including Morgan Stanley and UBS have been hit with hefty fines by regulators for insufficient money laundering controls within their markets and broker-dealer business. Now, under greater regulatory scrutiny, banks are looking at their AML obligations a lot differently.
The hidden risk in plain sight
This journey began when institutions recognized their exposure to these markets. The watershed moment that woke up the industry was the Deustche Bank “mirror trading” scheme. An embroiled web of security trades that had “no economic purpose and could have been used to facilitate money laundering or enable other illicit conduct,” offered proof that this bad behavior was just not being caught – not that it didn’t exist.
But of course, it always existed. Low-priced securities, by their very design, are associated with small, easy-to-set-up companies in some of the highest risk industries. Also, foreign exchange and precious metals are just vehicles to transfer money or goods between people, companies and across borders. Is that so different to a cash deposit or wire?
This risk is compounded by the complexity of financial markets in comparison to traditional banking. Every organization in this space is different. The types of products they trade, the customers they have on board, the countries in which they operate, their business processes on how they move money around and how they conduct trades, all of these elements effect where their risk exposure lies. And what we’re seeing in the markets business is that traditional AML approaches aren’t even identifying the high-risk activity in the first place so there has to be a complete review of monitoring in this space. The only way to pinpoint high-risk activity is to take a step back and look at the much broader context of data and behavior.
Putting it all into context
Understanding the interconnected web; the transactions and trades, the issuers and products, the customers, broker-dealers and counterparties network and its wider context is the first step in becoming more efficient and effective in identifying and managing risk.
But how is this accomplished?
Contextual monitoring provides gains in AML effectiveness and efficiencies. In effect, it replicates the laborious parts of the investigative process, but does so in an automated, yet fully transparent and understandable manner. Furthermore, a contextual approach naturally capitalizes on the big data and open analytics strategies that banks are heavily invested in. This results in far less data replication, re-use of existing security models, and an open and extensible architecture.
Contextual monitoring has proven to more effectively and efficiently identify risks within foreign exchange, equities and commodities. This is achieved by:
- Wider use of available data as part of a risk assessment, including using improved company and Know Your Customer data, as well as third-party sources to fully understand company structures;
- Extensive use of analytical methods such as behavioural analytics, peer group analysis and anomaly-based detection to provide a greater assessment of normal versus abnormal transactions; and
- Use of dynamic entity and network-based techniques, so that activity can be risk assessed holistically across connected people, companies and related entities.
Through this approach, institutions are able to proactively stop criminals abusing this market, with some of the very first regulatory Suspicious Activity Reports now being reported.
Low-priced securities, foreign exchange and precious metalshave always been notoriously risky, but it’s not until recently that organizations have finally woken up to the potential AML risks. As banks look to minimize their exposure within these markets, they would be well served to take a holistic look at all the elements that effect where their risk lies and create a tailored approach based on contextual insights to close the gap.