Financial Crime Challenges and Opportunities for the Year Ahead

In a recent webinar, financial crime compliance experts Radish Singh, Richard Carrick, Oonagh van den Berg and Michael Meadon discussed challenges and opportunities for the year ahead.

The adoption of new technology to combat financial crime picked up speed during the Covid-19 pandemic, an acceleration that opened the door for financial institutions to re-examine their existing approaches and further automate their processes.

According to panellists speaking at a recent webinar co-hosted by Refinitiv and Regulation Asia, recent efforts to further enhance financial crime compliance functions have not only been aimed at monitoring for and responding to financial crime after it occurs, but to also try to anticipate and prevent it.

“There has been a huge shift towards … advancing capabilities in the use of technology to improve the way we detect risk and manage risk,” said Radish Singh, a partner at Deloitte and the firm’s Financial Crime Compliance Leader for Southeast Asia.

“Ultimately it’s all about ensuring that today, financial crime compliance programmes that are put in place are embedded with effective capabilities to make sure that we are able to detect the risk and prevent the risk, rather than looking from a post-mortem perspective once something has occurred.”

A more defensible way

One change that makes the process of adopting new technologies easier is that regulators have become more understanding and willing to work with market participants and provide them a bit more flexibility than they did previously, according to Richard Carrick, CEO at Crime Research Agency.

This opens the door to different remote technologies that banks can use to identify and verify clients. Specifically, the panellists highlighted that multiple countries are exploring the use of digital identity and new biometric authentication approaches, amid much greater buy-in from regulators on the use of technology than in previous years.

At the same time, regulators are eager to promote good governance and ensure processes are in place to promote effective decision making, escalation policies and risk assessments. In general, regulators have been allowing institutions to innovate faster, as long as they can explain why they make decisions and those decisions are auditable, Carrick said.

MAS (Monetary Authority of Singapore) was singled out as one regulator that quickly and effectively adapted to the pandemic, and has additionally been engaging in dialogue with the industry to understand the challenges financial institutions face in addressing financial crime, given their different skillsets and financing capabilities in relation to technology adoption.

“This transparency and dialogue that we’re beginning to see across the board is such a positive change as we move forward,” said Oonagh van den Berg, Founder and Managing Director at RAW Compliance, also highlighting the increasing activity of public-private partnerships in bringing together industry and enforcement agencies to combat financial crime.

Among the key benefits of public-private partnerships, in Singapore as well as other jurisdictions, Singh pointed to their ability to facilitate industry sharing of best practices, collectively address challenges, and achieve greater transparency and clarity on how to design financial crime compliance frameworks in a more defensible way.

Plagued by false positives

While the panellists acknowledged the increasing sophistication of technology approaches to address financial crime, they pointed to transaction monitoring and sanctions screening as two key areas where significant challenges remain. Both continue to be plagued by continued high levels of false positives that require significant efforts to remediate.

On transaction monitoring, van den Berg pointed to what she called “horrendous” statistics from rules-based and scenario-based systems, some of which only register an 8 percent accuracy rate for detecting positive matches and consistently failing to flag risk associated with complex networks or detect trends in client account activity.

False positive rates have been similar for at least the past ten years, due to a lack of a concerted effort to initiate change, Carrick said. Regulators were not previously pointing to any adverse findings in their reviews of transaction monitoring systems, so “banks carried on going that way”. However, in recent years, regulators have been more focused on efficacy rather than a tick-the-box-approach, which is helping to promote change in the industry, he said.

Indeed, Singh noted that she has encountered many financial institutions today that do have “good quality technology” in place to reduce false positives by leveraging artificial intelligence and machine learning. “It is achievable, but it requires a lot more investment and time,” she said, describing a years-long journey by one bank.

Michael Meadon, Proposition Sales Director for Risk at Refinitiv, pointed to similarly high volumes of false positives in sanctions screening, which the industry tries to address through the use of ‘fuzzy matching’ algorithms. A key consideration for financial institutions typically involves their settings for “how fuzzy” they want the fuzzy matching to be.

A financial institution with ‘overly fuzzy’ matching does not generate what Meadon calls a “productive alert”, i.e. one that has some potential of actually being a true alert. “If you’re so fuzzy in your screening settings that you’re throwing up potentially hundreds or even thousands of results … it’s just not a productive approach to screening,” he said.

According to Meadon, having a consistent and a disciplined design mindset when it comes to screening programmes is crucial to dealing with these issues. A financial institution needs to understand its own risk appetite, as well as the material risk that a false negative would present. Based on this, different fuzzy thresholds may be set for different risk areas, but extensive testing is key, as is having a thorough understanding of the fuzzy logic being applied.

An expanding universe

In sanctions screening, the key factor has been that the universe financial institutions have to screen against keeps expanding, Meadon said. As of end-January, over 40,000 individuals and entities were explicitly sanctioned, representing a near doubling of what sanctions lists looked like just two years ago. This does not yet include individuals and entities that may be implicitly sanctioned, such as through OFAC’s Fifty Percent Rule, he noted.

Further complicating matters are the conflicts of law situations that arise in sanctions, notably visible in the past year as the US and China sparred over Hong Kong. In addition, sweeping sanctions orders like Executive Order 13959, which blocked investment by US persons into certain so-called ‘Chinese military companies’, have involved large amounts of data to determine which assets and securities are impacted.

According to Meadon, tens of thousands of financial instruments – including ETFs, derivatives, warrants, loan participation notes, ADRs, GDRs – have been impacted by the one Executive Order. “The challenge of sanctions keeps increasing, and I don’t think technology is keeping up, because the sanctions bodies just keep expanding their sanctions programmes at a faster rate than we can innovate.”

Somewhat encouragingly, the panellists agreed that US sanctions policy will likely become more predictable under the Biden administration. But, to Meadon, the most notable trend in the sanctions landscape in the last five years is what he calls “a fracturing of the global consensus”, which has resulted in the UN sanctions programme grounding to a halt. “This fracturing is likely to continue,” he said.

Carrick believes a switch to nationalist governments will mean that new sanctions will continue to be imposed on a regular basis. Given the “sheer volume of change”, however, he wonders whether the onus should actually be 100 percent on financial institutions, or whether governments should be doing more to provide complete, authorised sanctions lists.

Arms race

In addition, given that any individual can evade sanctions by merely setting up a shell company through a nominee directors service in as little as 20 minutes and at minimal cost, Carrick asks whether governments could be doing more to establish transparency around beneficial ownership.

“Transparency around ultimate beneficial ownership is one of the most preeminent problems in the world today, and probably the preeminent policy problem from a compliance perspective,” Meadon said.

Each panellist acknowledged that any criminal, sanctioned individual, or PEP with any sophistication will not simply use their own name to transfer millions of dollars through their own bank accounts. They would likely use family members or associates, whose names will be obscured behind complex webs of legal structures.

“Until that problem is solved, we’re not going to solve some of these other issues,” Meadon said. “Sadly, the criminals are winning that arms race right now.”

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A recording of the above-mentioned webinar is available here.

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