The time has come for the Financial Conduct Authority (FCA) and other regulatory bodies to prioritise tackling money laundering by endorsing particular applications of technology.
The European Supervisory Authorities (ESAs) recently published its new Opinion on the Use of Innovative Solutions by Credit and Financial Institutions in the Customer Due Diligence Process.
In the document, the ESAs endorse the use of regulatory technology (RegTech) by financial services companies to help them comply with strict anti-money laundering (AML) and know your customer (KYC) legislation.
The Opinion explicitly states: “Meeting customer due diligence (CDD) obligations can be challenging for firms, as this process is often associated with significant costs and customer inconvenience.
“Additional challenges arise from the fact that in an increasingly digitised environment, where most services are accessible online, firms may have to move away from traditional face-to-face interactions to non-face-to-face online channels.
“CDD therefore offers considerable scope for financial innovation that can improve the effectiveness and efficiency of AML and terror financing (TF) controls”.
So far so good, but regulated entities need more than this. They need to have the confidence that, if they do adopt a specific new technology, their regulator will support them.
The ESA Opinion also highlights the potential risks of some innovation, stating: “Nevertheless, there is a risk that innovation in this field, if ill understood or badly applied, may weaken firms’ ML and TF safeguards and subsequently, undermine the integrity of the markets in which they operate”.
FCA's position
These comments certainly reinforce the position of the FCA in its guidance relating to AML.
The FCA has explicitly approved of RegTech to optimise KYC checks. Also, the FCA specifically advises banks and other financial institutions to monitor media – as well as other news sources, such as international watchlists and databases – to identify adverse information on existing and potential customers.
Both recent JMLSG guidance and ESA guidance are even more specific on this point, asking companies to consider: “Are there adverse media reports or other relevant sources of information about the customer, for example are there any allegations of criminality or terrorism against the customer or the beneficial owner?
If so, are these reliable and credible? Firms should determine the credibility of allegations on the basis of the quality and independence of the source of the data and the persistence of reporting of these allegations, among other considerations.
"Firms should note that the absence of criminal convictions alone may not be sufficient to dismiss allegations of wrongdoing.”
A timely intervention
The endorsement by the ESAs and the FCA of innovative RegTech in the fight against money laundering is certainly good news for banks and other institutions looking for cost- and time-effective ways to meet regulatory requirements and prevent financial crime.
However, while both bodies endorse the use of RegTech in general, neither explicitly approves or recommends specific RegTech solutions that companies can use to optimise their AML processes.
A PA Consulting Report on New Technologies and AML Compliance that was commissioned by the FCA in 2017 was critical of this unspecific blanket approval of RegTech.
The study itself found that: “(respondents) felt that the FCA would be well placed to showcase promising new technology and promote a broader innovation culture through a variety of mechanisms.”
The problem is that the ESA’s opinion and the FCA’s guidance are far too generalised. There are too many categories of "innovative solution" and they are discussed as an undifferentiated whole, as if the same risks and safeguards apply to them all.
We know that there are at least six or seven areas where RegTech can help compliance, as can be seen from this analysis by KPMG:
The PA Consulting report specifically highlights that the vast majority of respondents across all sectors felt that areas 3 and 4 in the chart – Client Onboarding, as well as Monitoring and Surveillance – offer “the most promise, both in minimising operational costs and potentially improving the customer experience”.
Inevitable results
The consequence of this lack of specificity by the FCA, as well as other regulators in the EU and beyond, is that many banks and other financial institutions are wary of making changes to their compliance processes. Organisations look to these bodies for guidance, which is currently lacking.
Exacerbating the issue, the ESA’s Opinion plainly advises financial institutions to consider whether new technology is compatible with their existing protocols and legacy systems.
This has the effect of limiting companies’ options when they select new solutions, preventing them from understanding modern alternative methods of transforming their AML processes, just because they may require a more radical overhaul of the systems they already have in place.
As a result, too many organisations are still using outdated, 20th Century protocols to meet the complex requirements of 21st Century legislation.
In doing so, they may be failing in their duty to support regulators in tackling the growing threat from financial crime, providing gaps in the system that could be exploited by money launderers.
Finding solutions
The PA Consulting Report highlighted a number of possible mechanisms that the FCA could use to address this reluctance in the industry to adopt innovative RegTech solutions.
These included encouraging culture change in firms to allow them to innovate in a controlled environment, without fear of regulatory censure for failures.
Respondents also suggested taking greater steps to highlight the regulatory and operational benefits of emerging technologies as they become proven. Extending the FCA’s existing Sandbox initiative – where businesses can test innovations in RegTech to find effective solutions to tackling financial crime – was mooted in order to allow a wider range and larger number of interested firms to participate.
The FCA needs to encourage innovation from RegTech firms of all sizes not just from existing or large industry players – many of the smaller companies have developed cutting-edge solutions far in advance of those offered by established organisations.
Hopefully, the FCA will give consideration to the expansion of its Sandbox initiative to encourage and support testing activities in the future. Consulting with individual RegTech companies directly, rather than simply engaging with industry bodies, could go a long way towards addressing this issue.
This is something that the FCA is already doing with regards to improving the regulatory reporting process – just this week, it announced that it is seeking businesses’ views on how technology can simplify reporting requirements and improve the quality of information they provide.
A similar initiative, then, should be launched to provide the FCA with insight into how it can promote the use of specific technology to enhance finding and analysing adverse information.
All of these can play an important role in helping to encourage greater uptake of technologies capable of optimising AML compliance. For me and my colleagues at Kompli-Global, however, the most important step is for the FCA and other regulators to be more specific in their RegTech endorsement.
Regulatory bodies should be advising the companies under their care which applications they have identified that can make companies’ compliance processes more effective and more efficient. After all, we have the same aim – to stop money laundering.
Fostering innovation and competition
Endorsing applications in this way does not mean regulatory bodies need to favour any one RegTech provider over another – indeed, the FCA in particular has a commitment to promoting competition within the sector.
By identifying recommended applications for technology, however, regulators can encourage more regulated entities to test new solutions with the potential to help them carry out AML and KYC processes quickly and accurately. Hopefully, the FCA will give consideration to the expansion of its Sandbox initiative to encourage and support testing activities in the future.
There are a number of applications that can significantly benefit from the use of RegTech, including the search for adverse information for KYC checks.
It is clearly time for the ESAs and the FCA to take a stand and provide more specific guidance to regulated entities on the applications of technology to streamline and enhance their compliance.Solutions such as Kompli-Global’s kompli-IQ search platform – which is designed to enable continuous, thorough, automated searches for adverse information – have the potential to enable companies to significantly improve their KYC checks, while saving time and money.
Such systems are easy to implement and incorporate into companies’ existing compliance measures, complementing them to improve their overall effectiveness.
Regulators can, therefore, perform one of their main functions – helping companies reduce the burden of meeting legislative requirements.
This is vital for all the companies struggling with growing costs of compliance. According to a survey of 183 senior staff at asset managers, brokers and banks by professional services firm Duff & Phelps. “Financial institutions' regulatory costs could more than double over the next five years”.
Time for a change
It is understandable that regulatory bodies – and the FCA in particularly, with its mandate to support competition – have not previously supported specific firms, but they must see that specific applications of technologies can be endorsed.
Failure to do so is currently discouraging banks and other financial institutions from acting to improve their AML systems, potentially undermining all our efforts in the fight against financial crime.
In fact, the respondents in the FCA-commissioned PA Consulting Report stated outright that they wanted regulators to provide more support in identifying effective RegTech.
According to the report, “participants recommended that the (FCA) take additional steps to upskill its staff around new and emerging technology.
"This would enable a more rapid and accurate assessment of new approaches, but also build confidence among industry participants that the FCA will be able to effectively review its new technology approaches once built.”
Banks and other financial institutions have a key role to play in preventing money laundering, taking steps to ensure their customers are who they say they are and not associated with criminal activity.
However, the ESAs, FCA and other regulators all need to play their full part in supporting and encouraging the sector to upgrade their compliance protocols through the use of RegTech and similarly advanced tools.
It is clearly time for the ESAs and the FCA to take a stand and provide more specific guidance to regulated entities on the applications of technology to streamline and enhance their compliance.
They are already doing so when it comes to technology for reporting and by improving advice relating to specific technology for compliance as well, they can go a long way towards helping us step up the fight against money laundering and other financial crime.
Jane Jee is chief executive of Kompli-Global
