From new digital technologies to the rise in cryptocurrency fraud, market developments are altering the future of financial crime compliance in novel ways. (Note: This is a companion article to “7 Industry Trends From 2019 Impacting Financial Crime Compliance in 2020,” Part 1 and Part 2.)
aintaining a strong and flexible Financial Crime Compliance program has never been more crucial than it is today — or more challenging. As financial institutions partner with new digital upstarts, for instance, the risks of money laundering, cyber crime and other financial crimes escalate alongside. Cross-border transactions, even with global business patterns evolving, continue to test the abilities of compliance officers to guide stakeholders smoothly through a complex web of national regulations.
Staying abreast of key developments likely to impact compliance response is critical for dealing with coming challenges. What follows are four such developments, along with insights on their applications.
1. New supervisory tools
Faced with a shortage of resources and often slow response rates, supervision remains a fairly analog process, with reliance on past data and lengthy onsite inspections. However, a growing number of authorities have been looking to improve efficiencies by exploring the use of innovative technologies — commonly known as SupTech. These applications leverage big data architecture and AI technology to create a predictive, forward-looking process that relies on sophisticated data analytics.
Rollout has been slow. Industry research shows that the majority of such initiatives are still in either the experimental or development stages. Less than a third are actually operational. One such case is in the anti-money laundering (AML) area, where machine learning seems to be the common denominator supporting supervisory efforts through anomaly detection, network analysis and risk-scoring processes.
Tech-savvy rivals Hong Kong Monetary Authority (HKMA) and Monetary Authority of Singapore (MAS) will continue heavily investing in IT systems, data infrastructure, technical skills and engagement with the industry sector. A revolutionary breakthrough is not on the horizon yet — new solutions will be part of a more gradual and strategic shift in line with the long-term view. As noted futurist Roy Amara once said, “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.”
Eye to the Future: Continued improvements to the supervisory approach through enhanced technologies and tools will inevitably lead to more questions and additional regulatory scrutiny for regulated entities. For example, financial institutions that lag behind technically should be prepared to answer the question of why they file significantly fewer suspicious transaction reports (STRs) in comparison to peers of similar size, customer base and risk exposure.
2. Data is the new oil
Key AML risk management processes such as transaction monitoring, screening, risk scoring and regulatory reporting are only as good as the quality of data that underpins them. In 2020, fragmentation of the financial services landscape and further development of the “open banking” concept continued to pose new challenges for banks concerning data and risk management. With more reliance on data generated and processed externally, and often through multiple layers, many banks had very little or no control over the quality of the data.
That elevated established players with mature data governance frameworks and abilities to leverage data analytics and AI technologies above others. They gained a competitive edge by repurposing traditional financial crime prevention tools for commercial use, allowing them to identify new business opportunities and potential revenue streams of inherently lower risk that would have otherwise gone unnoticed.
The continued adoption of more data-intensive solutions in risk management will lead to a major paradigm shift in the approach to fighting financial crime. As the number of solutions rapidly increases — and regulators grow more comfortable with them — the ability to gather intelligence from both structured and unstructured data (and explain how the algorithms reached decisions based on that same data) will become the centerpiece of a new tech-fueled compliance reality.
Eye to the Future: The ability to collect, store and gain insight from the large and disparate data sets will be the primary differentiator between the winners and losers in the technology race. Establishing a data governance framework, embedding data quality controls into existing risk management framework and treating data as an asset, rather than a liability, are the prerequisites for success.
3. Cryptocurrency risk
The fight against financial crime is relentless as criminals and terrorists continue to exploit loopholes or find new methods of raising, moving and using funds. Within this realm, cyber-enabled crime, particularly fraud involving cryptocurrencies and payment processors, is becoming particularly acute.
The use of cryptocurrencies, or virtual assets, by criminals and terrorists has risen to the top of the political agenda in the G-20 economies. Regulators have responded with increased scrutiny and gradual tightening of rules for the virtual asset space. In a display of rarely seen unity, Facebook’s cryptocurrency project, “Libra,” faced an unprecedented global regulatory backlash, bringing the future of the project into question. Bad actors are responding as well, with shady companies engaging in regulatory arbitrage often under the pretext of “stifling innovation” while they look for more-favorable climates in which to conduct illicit activities.
Outside the private sector, rogue state actors have grown fond of targeting a crypto industry that is inherently vulnerable because it places cultural value on transacting pseudonymously. Placing reliance on using cryptocurrencies and other virtual assets allows them to bypass the traditional dollar-dominated financial system and avoid crippling sanctions.
Eye to the Future: In guidance published in December, Hong Kong regulators recognized there is no “one-size-fits-all” solution for banks to use to manage risk today. Whether looking to establish business relationships or offer new products and services involving virtual assets, the guidance stressed the need to manage money laundering task force (ML/TF) risks in line with a risk-based approach. This is one solution, as opposed to avoiding the approach altogether through de-risking.
4. Illegal wildlife trade
Estimated to be worth as much as US$23 billion annually, illegal wildlife trade (IWT) is big business. Beyond the devastating impact on our biodiversity, however, this crime threatens the health of millions of people across the world (and economies, too), as witnessed by the COVID-19 pandemic, which is believed to have originated in a market in China that had IWT. The Financial Action Task Force (FATF) under the Chinese presidency has made it a priority to help countries fight back by disrupting the criminal networks that profit from the crime. Financial institutions in Asia should be extremely cautious of their potential exposure as the government crackdown looms.
Eye to the Future: Compliance professionals should expect more-detailed guidance from FATF in June to assist them in tackling and investigating financial flows from IWT. In anticipation, financial institutions with a global presence and risk exposure should be prepared to take appropriate action. One idea is to provide bespoke “red flag” training to frontline staff in trade finance departments in those countries deemed to be the sources or destination markets for IWT. They could expand their screening to include known IWT-related parties or use data analytics and network analysis techniques to increase detection of suspicious activity based on the actionable intelligence provided by law enforcement and conservation groups.