Following on from its 2018 thematic review on money laundering risks in the e-money sector, the FCA has continued its sector-specific review of money laundering control frameworks by publishing a further thematic review which this time considers the risks, vulnerabilities and potential harm from money laundering in the capital markets.
Prompted by the publication of the UK National Risk Assessment of Money Laundering and Terrorist Financing in October 2017 (the 2017 NRA), the FCA’s latest review focused on the capital markets, defined within the report as “financial markets where shares, derivatives, bonds and other instruments are bought and sold”.
Background to the review
The 2017 NRA assessed capital markets to be exposed to high risks of money laundering. Seen as an emerging risk, this assessment was based on the complexity of the activities involved, the cross-border nature of the market and the relative lack of compliance controls in place.
However, whilst the 2017 NRA commented that the understanding of the capital markets money laundering risk had developed since the previous national risk assessment was undertaken in 2015, it also admitted that there is an intelligence gap around the precise nature and scale of this risk. The FCA therefore sought to narrow this intelligence gap by further informing its view of the risks and vulnerabilities in the capital market through a diagnostic review involving 19 participants from different segments of the secondary market. This included investment banks, recognised investment exchanges, trade bodies, clearing and settlement houses, inter-dealer brokers, trading firms and a custodian bank.
The FCA’s findings
Overall, the FCA found that the risk of money laundering arising in capital markets is, in part, mitigated by the nature of the firms involved (with most being regulated, institutional firms), as well as the nature of the products and markets which may be considered less attractive to launderers due to barriers to entry, levels of scrutiny and the complexity of the products. However, the review did flag that participants were generally at the early stages of their thinking in relation to money laundering and that there is a need to do more to fully understand money laundering exposure.
Based on this, the report identifies a number of risks specific to capital markets. These risks include:
- Customer due diligence (CDD) – the review identifies the customer as the primary driver of money laundering risk, as opposed to product or delivery channel risk. As such, whilst the need to implement effective customer risk assessments is pervasive across sectors, it is particularly important in the capital markets where orders will likely be routed through multiple different firms and there will often be a lack of visibility beyond the firm’s own customer. However, the report notes that some participants had failed, either adequately or totally, to identify and assess the financial crime risks which they are exposed to and instead, a number of participants had focused solely on identifying market abuse and therefore had not considered that market abuse suspicions could also be indicative of money laundering.
A number of key points in relation to CDD in a capital markets transaction arise from this:
- it is particularly important to understand a customer’s business model and intended trading strategies to be able to identify suspicions in relation to a customer’s trading activities;
- given the number of players in any one trading chain, it is important that each firm in the chain fulfils its CDD obligations – the recent Upper Tribunal case involving Linear Investments Limited highlights the need for firms to have an effective surveillance system for transactions in place, rather than leaving it to others to monitor transactions; and
- effective communication between firms is essential when considering how to reduce the potential harm from money laundering, particularly where firms are part of the same transaction chain. To that end, the FCA encourages the industry to work together and share information where possible (subject of course to all applicable confidentiality and data protection requirements).
- Transaction monitoring – the report identifies a potential disconnect between trade surveillance for market abuse and anti-money laundering transaction monitoring which means that the correlation between market abuse and money laundering can again not be recognised. Options for mitigating this may include the use of both manual and automated monitoring, as well as the existence of a lead relationship manager where larger firms have multiple touch points with a customer. Firm’s should also take on board guidance provided by the FCA in respect of suspicious transaction and order reporting (STOR) relating to potential market abuse. In this regard, the FCA has considered it helpful to revisit relevant matters on market abuse surveillance and transaction reporting issues in recent issues of its Market Watch newsletter. Key considerations which would apply equally to anti-money laundering transaction monitoring include appropriate calibration of surveillance systems and ensuring surveillance is effective across all asset classes (STOR submission relating to potential market abuse is predominantly in the equities space with submissions being relatively low across fixed income asset classes).
- Suspicious activity reporting – the FCA found limited reporting by capital markets firms on suspicions of money laundering and the findings identify a lack of understanding or knowledge of obligations to submit suspicious activity reports (SARs). Where SARs had been submitted, the FCA noted that the quality of those reviewed varied and reminds firms of the availability of guidance from the National Crime Agency. However, this is a persistent and cross-sectoral problem and is one which the Law Commission is seeking to address through its report, ‘Anti-Money Laundering: the SARs regime’ which was published on 18 June 2019. The report sets out a number of recommendations, designed to improve the quality of reporting and reduce the number of inadequately detailed SARs, which include the creation of an advisory board, a standardised form for the submission of SARS as well as guidance on key statutory concepts.
- Behaviour and training – further work is needed to change behaviours within firms operating in the capital markets. In particular, the review highlighted that there is inadequate accountability and ownership of money laundering in the first line of defence (i.e. first-line sales and trading teams), with participants instead viewing it as a second line (i.e. compliance) responsibility. Further training and subject-matter awareness are also needed across the participants as the review flags that some participants merely provide basic money laundering training which is not tailored towards the money laundering risks faced by the participant.
During interviews, participants suggested that they found the FCA final notices a useful guide to help build their understanding of money-laundering risks in the sector, but said they would appreciate further guidance. As a result, the Annex to the review sets out a non-exhaustive set of typologies which are intended to help inform risk assessments, transaction monitoring and training.
Firms are now expected to consider their approaches to identifying and assessing the money laundering risks they are exposed to in light of this report, including by reference to the typologies included within the Annex.