On September 9th, 2021, the FCA sent a ‘Dear CEO’ letter to firms carrying out trade finance businesses. The letter informed these organisations of their requirement to conduct a financial crime risk assessment based on the FCA’s significant issues exposing them to unnecessary risks. Given this recent activity by the FCA, trade finance organisations should expect greater surveillance and monitoring from the FCA in the coming months and years ahead. This signals that firms must address the FCA’s concerns by implementing the right policies, procedures and technology, particularly with respect to anti-money laundering controls.
The letter also signaled a commitment to a more proactive approach to combating financial crime and money laundering within the trade finance space. The current letter follows a previous ‘Dear CEO’ letter sent in May
2021, written to retail banks in the UK. The FCA shared common control failings in AML frameworks exposed in their assessments, including governance and oversight, risk assessments, due diligence, transaction monitoring and suspicious activity reporting. The letter required retail banks to complete a gap analysis in each area with the threat of regulatory intervention for firms whose response was deemed inadequate.
Trade Finance and Financial Risk
The nature of trade finance presents an inherent financial crime risk. Some suggest that global trade could be facilitating the laundering of up to USD 2 trillion per annum. Global trade is complex, involving the movement of large volumes of goods and funds using multiple currencies. Additionally, trade is disjointed with potentially numerous parties involved, from shippers to freight forwarders to financiers. It is clear why this is a method of choice for a vast number of organised crime groups.
Accordingly, the FCA expects firms to demonstrate a risk-based approach to mitigate financial crime risks effectively. During recent assessments, the regulator discovered multiple persistent issues relating to credit risk analysis and financial crime controls, exposing firms to unnecessary risks. The letter details the FCA’s expectations for carrying out a financial crime risk assessment.
These expectations are not exhaustive, and firms are expected to consider them alongside relevant rules and guidelines such as Joint Money Laundering Steering Group guidance, the PRA Rulebook and the FCA’s Financial Crime Handbook.
Trade Finance’s Compliance Risk
The FCA found multiple areas of concern within risk assessment, including an insufficient focus on identifying and assessing financial crime risk factors. The FCA also noted inadequate evidence of migrating controls and felt that genericized assessments at the client risk level failed to cover the different risk exposures in the trade finance client relationship. All of these are areas that firms must assess and implement changes that boost the focus on these concerns. Additionally, the FCA found a lack of evidence in the checks taken to properly assess client and transaction-specific risk along with insufficient due diligence, lacking checks such as additional pricing checks, vessel tracking, and independent document verification tools.
The FCA expects firms to undertake a holistic assessment of financial crime risks, including money laundering, sanctions evasion, terrorist financing and fraud. For organisations that have not done so already, the review should be overseen by the Money Laundering Reporting Office (SMF17), ensuring appropriate governance, oversight and challenge and be documented within the business-wide financial crime risk assessment. The assessment should also identify transactions types and customer profiles that require enhanced due diligence. Organisations can expect that the FCA may ask to review the risk assessment in the future with follow-up action possible where necessary.
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Before approving individual transactions, firms need to determine if additional analysis is necessary. This further analysis includes but is not limited to considering the financial/non-financial risk on the end-buyers and the rationale for the transaction. They must also identify instances of higher risk requiring greater due diligence and conduct more structured assessments of risks and red flags. Last, firms must ensure adequate oversight and that the firm’s policies are operating effectively. This oversight could include monitoring operations, including such factors as when red flags are discounted, when transaction approval rationale is clear and when the standard of escalations to the second line is followed.
If the trade finance transaction makes the end-buyer the primary source of repayment, firms should undertake prudent risk management. This risk management includes obtaining a formal written acknowledgement that the amount due under the transaction is payable to the financing firm and not the borrower.
This is a critical risk to be monitored as the transfer of funds is the stage where money laundering is complete. Transactions between parties must be appropriately monitored, even after the trade finance was approved. Are the suitable entities receiving payments in line with the agreed terms and figures? It is also essential to understand if the payments to the correct accounts are in line with expectations. The risk of facilitating payments from third parties, which are not parties in the trade or receiving, settling payments with third-party countries, not associated with either the source or destination of the goods or involved parties is high if not appropriately monitored. If there is insufficient monitoring at this stage of the process, organisations are at significant risk of facilitating money laundering.
Technology to Overcome AML Compliance Challenges
Given the complex and disparate nature of trade finance operations, accurately identifying instances of suspicious activity where money laundering may be present is hugely challenging. However, many firms are finding greater success utilising digital strategies that move the industry away from manual and paper-based processes.
Digitising trade finance’s paper trail allows for the automation of risk and compliance processes through AI, machine learning, and other intelligent technologies. Automating these processes can dramatically improve the accuracy of spotting money laundering red flags and provide an efficient ongoing solution for trade finance firms to respond to the growing regulatory pressure and ever-changing threat landscape.
Meeting financial crime compliance requirements and accurately identifying red flags in trade finance is a complex problem. With the FCA signaling more intrusive surveillance and monitoring to come, it is prudent to review and invest in more advanced AML technology to better monitor and detect Trade-Based Money Laundering.
Adam McLaughlin, Global Head of AML Strategy and Marketing, NICE Actimize