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Money laundering in capital markets

All financial institutions are now aware of mirror trades, but what else should they worry about?

An enforcement action by the UK Financial Conduct Authority (FCA) in 2017 revealed that a financial institution (FI) was used to move approximately USD10 billion cross border through mirror trades in securities. While all FIs are now aware of the mirror trading typology, how else are they addressing money laundering (ML) risks in capital markets?

In June 2019, the FCA published a report designed to assist firms in identifying and assessing the capital market ML risks they are exposed to.1 This was based on the FCA’s thematic review of ML challenges in capital markets transactions and is a topic that globally regulators are paying increased attention to, as evidenced by the recent wave of guidance papers issued.2

Here, we highlight three key areas in the report that have also been emphasized by other regulators, such as the Monetary Authority of Singapore, Hong Kong Securities and Futures Commission, or the USA Financial Industry Regulatory Authority. For each area, we have provided our observations on the issue based on our experience with clients in the capital markets sector and suggested actions to manage these risks.

Regulatory findings frequently involve FIs having inadequate automated AML systems for detecting suspicious trades

Capital markets customers, products and delivery channels historically have not been assessed as having high inherent ML risk in FIs’ enterprise wide risk assessments, while some have not even established a formal risk assessment process.

Efforts to fight financial crime in capital markets have also mainly targeted market abuse, with relatively limited consideration for ML.

The FCA recommendations create a clear expectation that FIs need to formally assess the risk of capital markets ML as part of their enterprise wide risk assessment. The report also creates an awareness for FIs that any existing mitigating controls are not sufficient.

Steps to manage the risks

  • Conduct a current state assessment to identify the ML risks the FI is exposed to. Review what typologies are relevant to the business and understand existing controls in place to mitigate such risks
  • Leverage potential synergies between existing market surveillance controls and ML monitoring
  • Evaluate transaction monitoring system capabilities required to address typologies identified - are more advanced capabilities such as artificial intelligence and network analysis required, and what risks will need to be covered by manual monitoring
  • Formally document these findings in the enterprise wide risk assessment and ensure proper senior management oversight on the residual risk faced. Where required obtain support for further enhancement of mitigating controls

Proper understanding of the customer is pivotal for an effective defence against money laundering

Some FIs hold the presumption that ongoing monitoring is only required for end investors and that if their customers are other regulated FIs there is little requirement to establish the expected trading activity of the relationship, or to conduct subsequent transaction monitoring. This presumption may result in partial, or in certain cases, full reliance placed on third party FIs to perform ongoing monitoring, a practice not permitted by AML regulations.

The emphasis of this in the report and the significance of the fine on ‘Linear Investments Limited’ serves to remind FIs that regardless of checks being undertaken by other firms, all FIs are responsible for undertaking their own checks using information available to them, and calibrated in accordance to its business nature.

Steps to manage the risks

  • Review processes to ensure a sustainable risk-based approach is applied and that customer due diligence (CDD) conducted is in line with the nature of relationship, e.g. CDD requirements for a prime broker, broker, or custodian, will be specifically tailored for the type of customer, with focus areas designed to mitigate the risk factors associated with each
  • Ensure that CDD requirements build a meaningful profile of the customer that allows detection of activity outside the identified expectations of the customer - CDD applied should include understanding the customer’s business model and expected trades
  • Transaction monitoring performed should be based on the profile of the customers and business undertaken i.e. thresholds should be calibrated in accordance to the customer base and where alerts are generated the triggering activity is compared against the customer profile

Generally, there has been a low level of Suspicious Activity Reports raised

We have seen FIs with the mindset that their capital markets customers are sophisticated and deal in highly regulated products, so therefore present a lower ML risk.

Where FIs have recognized the ML risk, they frequently struggle with implementing controls and raising risk awareness in the first line of defence, due in part to the lack of readily available case studies and typologies for ML through capital markets.

For this reason, to help inform FIs where vulnerabilities may lie, the report identified seven main trade features that may act as a red flag to prompt further investigation. FIs will be expected to have incorporated these into their risk assessments and training - any subsequent failings for such will likely be viewed as being more serious.

Steps to manage the risks

  • Raise the overall risk awareness of the FI by leveraging recent guidance papers issued by various regulators to include best practices and ML typologies into risk assessment and training
  • Incorporate learning points from enforcement actions into senior management discussions
  • Drive cultural change through an appropriate tone from the top, increasing first line of defence ownership and awareness of ML risks
  • Appreciate the differences between market abuse risk and ML risk, with each having different requirements for compliance with the governing regulations. Understand that sufficient awareness of one does not equate to sufficient awareness of the other

How we can help you

At PwC, we understand the ML issues faced in capital markets are very specific to the business and complex. To address them requires strong industry and product knowledge as well as financial crime subject matter expertise. PwC's Financial Crime Unit has the right experience and capabilities to advise you as you navigate these capital markets ML challenges. Speak with us to find out how we can help your fight against financial crime.

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1 UK Financial Conduct Authority (FCA) (2019, June). Understanding the money laundering risks in the capital markets. Retrieved from https://www.fca.org.uk/publications/thematic-reviews/tr19-4-understanding-money-laundering-risks-capital-markets.

2 USA Financial Industry Regulatory Authority (FINRA) (2019, October). 2019 report on examination findings and observations. Retrieved from https://www.finra.org/rules-guidance/guidance/reports/2019-report-exam-findings-and-observations/anti-money-laundering.; Monetary Authority of Singapore (MAS) (2019, January). Guidance to capital markets intermediaries on enhancing AML/CFT frameworks and controls. Retrieved from https://www.mas.gov.sg/regulation/guidance/guidance-to-cmi-on-enhancing-amlcft-frameworks-and-control.; Hong Kong Securities and Futures Commission (SFC) (2018, August). AML/CFT measures and controls inspection findings. Retrieved from https://www.sfc.hk/edistributionWeb/gateway/EN/circular/aml/doc?refNo=18EC64.; Financial Action Task Force (FATF) (2018, October). Risk-based approach guidance for the securities sector. Retrieved from https://www.fatf-gafi.org/publications/fatfrecommendations/documents/rba-securities-sector.html.

Contact us

Richard Major

Richard Major

Financial Crime Leader, South East Asia Consulting, PwC Singapore

Tel: +65 9117 7740

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