UK: Financial Crime Controls

FCA Loses Patience
Last Updated: 20 November 2014
Article by Emma Radmore, Luca Salerno and Tom Harkus

In November 2014, FCA published the results of two thematic reviews into how firms manage their financial crime risks, together with proposed guidance on financial crime systems and controls. The clear message from the papers, and the press release that accompanied them, is that FCA is losing patience. It found many practices that continue to show significant weakness, and accused firms of not using common sense or getting the basics right. In this article, we look at the reviews and guidance, and what firms should do to get financial crime prevention compliance right.

THE BACKGROUND

Firms should not be strangers to FCA's interest in financial crime controls. It and its predecessor had conducted various reviews over the past few years, including:

  • private banks' anti-money laundering (AML) systems and controls in 2007;
  • implementation of a risk-based approach to AML in 2008;
  • UK financial sanctions controls in 2009;
  • bribery and corruption in insurance broking in 2010;
  • small firms' financial crime review in 2010;
  • bank management of high-risk money laundering situations in 2011;
  • anti-bribery and corruption (ABC) systems and controls in investment banks in 2012; and
  • banks' control of financial crime risks in trade finance in 2013.

Many significant fines have either pre-empted or followed the reviews. There are now too many to list, but their common themes have been:

  • failure to conduct proper customer due diligence (CDD) and specifically failure to recognise when to conduct enhanced due diligence (EDD);
  • over-reliance on head offices in other jurisdictions, instead of independent risk assessment;
  • failure to understand the nature of intermediary or distributor relationships and therefore inability to properly assess bribery and corruption risks; and
  • the only action taken under the Money Laundering Regulations 2007 (MLR) for failure to have in place adequate sanctions systems and controls.

A further theme, common across the final notices, is that there is no need for FCA to find actual incidences of money laundering, sanctions breaches or bribery. Firms (and sometimes their Money Laundering Reporting Officers (MLROs) also) can suffer heavy fines when FCA considers their procedures, systems and controls would not have been good enough to detect a breach of the law.

THEMATIC REVIEW – AML AND SANCTIONS RISK MANAGEMENT IN SMALL BANKS

FCA carried out its review on how small banks manage money laundering and sanctions risks as an update to the 2011 review. It wanted to see how the sector had responded to the issues it had raised and how small banks' AML systems and controls had improved as a result of the review.

What did FCA look at?

The review covered 21 smaller banks, five of which had been part of the 2011 review. The 21 included seven wholesale banks, six retail banks and eight wealth management and private banks. The review addressed:

Governance, culture and management information

FCA found some improvement here.

  • It still found weaknesses in governance but on the whole saw improvements in senior management engagement on AML issues. It was disappointed it had taken many banks more than a year from the 2011 report to assess their systems and controls and found many reviews had in fact followed FCA taking enforcement action against similar firms. Generally, though, FCA found one third of the banks it surveyed did not have sufficient AML resources. In most firms, the MLRO was also the compliance officer and sometimes also the internal auditor. While this need not be a problem, it often meant there were inadequate AML resources to oversee compliance and keep up to date with standards.
  • Of more concern, perhaps, was the finding that UK operations of overseas banks still adopted their parent's or head office's culture, even where this did not align with UK law and regulation. This was a particular problem where the UK CEO came from the home country office on a short-term posting – although one bank embedded a good culture through overall management support despite the fact that it changed its branch manager regularly.
  • FCA found most firms produced regular management information but presented it only in the MLRO annual report, and not in a way that would enable senior management to make use of it to properly manage money laundering risk.

Risk assessment

FCA found over half the banks had not assessed their overall inherent money laundering risk, and had focused only on individual customers. Even then, FCA was not impressed with the quality of individual customer risk assessments, and found only three of the banks had adequate assessment procedures. FCA stressed it expects banks to take a holistic view of risks of business relationships, rather than, for example, just assessing whether the customer was connected to a Politically Exposed Person (PEP) or basing an analysis solely on the Financial Action Task Force (FATF) lists. In the worst cases, senior management and the MLRO could not discuss the risks their business presented.

CDD

Most banks do carry out CDD and use software to carry out PEP checks. FCA was particularly impressed with one MLRO who refused to waive CDD despite pressure from the overseas parent bank. However, it was disappointed that many banks did not capture enough information on the purpose of the business relationship.

EDD

FCA found banks still often fail to conduct EDD consistently on their high-risk relationships, and struggled particularly with the requirement to identify source of wealth and funds of PEPs. There was misunderstanding as to what "source of funds" meant, and often failure to carry out basic searches on publicly available information on high-risk customers. FCA also found banks recognised the need for EDD on correspondent banks, but their diligence was poor and did not provide the banks with enough information.

Reliance

FCA found that banks that relied on others to carry out CDD often did not check whether the CDD on which they relied matched their own risk assessment and did not have enough information to carry out appropriate ongoing monitoring.

Enhanced ongoing monitoring

FCA found some banks had not established the expected pattern of customer transactions at the beginning of a relationship and so could not identify when transactions were suspicious. Half the banks had no "red flags" other than based on the size of transactions, but two banks had introduced better monitoring into their automated systems to reduce reliance on Relationship Managers (RMs) spotting unusual patterns. In most cases, RMs had not received proper training on spotting red flags. On periodic reviews, FCA found good practices in two private banks, but in many other banks in the sample found no evidence of periodic reviews.

Sanctions

FCA found banks were generally aware of their obligations under sanctions laws, but that where compliance was not responsible for screening there was lack of oversight on currency of systems and weak quality assurance. Many banks did not understand how their systems were calibrated and some had excluded certain types of payment transactions from screening altogether.

Training and awareness

FCA found most banks gave annual computer-based training. Staff understanding of AML and sanctions requirements was generally weaker in smaller banks than in larger ones, although private banks' staff on the whole had notably better knowledge. Worse, FCA found MLROs in a quarter of the banks visited had inadequate knowledge and sometimes made their institutions' AML systems and controls less effective rather than more. It says several banks have replaced their MLROs since FCA visited them.

Actions taken since the 2011 review

FCA found that three of the five banks also involved in the previous review had studied the results of that review and of the subsequent enforcement notices and had taken, or were taking, action. Two banks had done nothing, and FCA is following up with them. Of the remaining banks, nine had reviewed the report and notices and were taking action but the others had done nothing.

Conclusions

Although FCA found, and highlighted in its report, some pleasing examples of good practice, on the whole it was disappointed that many of the banks had made little or no progress since the 2011 review. It found the private banks were generally better than the other banks. It says the good practices it noted show it is possible for small banks to manage their business in line with legal and regulatory AML requirements. FCA has given feedback to all the banks it visited. Six banks concerned it particularly and it has started enforcement investigations into two of them. It has required three of the banks to appoint skilled persons, while the other three are conducting remedial work using external consultants. Four of the six have agreed to limit business activities with certain high-risk customers while they address their failings.

MANAGING BRIBERY AND CORRUPTION RISK IN COMMERCIAL INSURANCE BROKING

In its other review, FCA visited 10 small or medium-sized insurance intermediaries, nine of which were Lloyd's brokers and half of which had been part of the review that led to the 2010 report. It wanted to see not only how industry had responded to the report but also to see whether intermediaries were addressing bribery and corruption risk properly across their businesses.

What did FCA look at?

As with the bank review, FCA covered several key areas.

Governance and management information (MI)

FCA found eight intermediaries in its survey had appointed senior managers to take control of ABC systems and controls but many of them did not receive the right MI to allow them to have proper oversight of the bribery and corruption risks to which their businesses were exposed.

Risk assessment

The 2010 review had criticised firms for taking too few factors into account when assessing the risks of individual relationships, and FCA found the quality of assessments had not improved.

Business-wide risk assessments

Only half the intermediaries surveyed had carried out proper business-wide reviews, with others at best restricting their review to certain key relationships. On the whole, firms failed to consider their overall exposures, or risks beyond immediate relationships.

Risk assessments and due diligence on individual relationships

Again, firms showed little improvement from the previous review, often reviewing relationships merely from a geographical perspective, without looking at the relationship holistically, or varying the due diligence carried out in line with the risk classification. Firms did not seek approval for higher-risk relationships and often did not have enough understanding of the risks to focus their resources on the highest-risk areas of business.

Ongoing monitoring and review

FCA found there had been slow progress towards any meaningful ongoing monitoring.

Payment controls

Again, FCA found poor quality diligence continues and this reduced effectiveness of insurance broking payments systems as a risk mitigant. For accounts payable, there are now better gifts and entertainment policies, but many intermediaries could not explain why thresholds in their procedures had been set at particular levels.

Recruitment and remuneration

FCA saw improvement in this area. Firms had put in place remuneration and bonus structures that did not depend solely on business generated and did reward compliance. Also intermediaries now carry out a range of appropriate pre-employment checks.

Training and awareness

Most intermediaries now deliver training, but some deliver it on a one-off basis only, or deliver the same training to all staff. FCA noted that the firm that used scenario-based training, followed by a test, and accompanied by training plans appropriate to the employee's role, had staff who were notably better informed than in other firms.

Whistleblowing

FCA found most respondents had a whistleblowing procedure in place, but that it was rarely, if ever, used.

Action since the 2010 report

FCA found the five intermediaries that were part of the previous sample had all carried out gap analyses based on the previous report and guidance. They had also considered the impact of enforcement actions. But two firms were still in the process of implementing changes. Of the other intermediaries, two had carried out a gap analysis and were working on improving procedures, while three had not considered the previous report, guidance or enforcement cases.

WHAT NEXT?

The overriding message from FCA is disappointment. It is clear some firms have carefully considered the previous reports and enforcement notices. From the banking report, it seems private banks have taken FCA's concerns on board to a greater extent than the other banks surveyed and have correspondingly made more progress towards change. From the insurance report, many intermediaries have implemented the easier fixes, and those involved in the previous review have gone further.

What is clear, though, is that both sectors reviewed, in both areas of financial crime prevention reviewed, still have a long way to go to fix the difficult matters. In particular, firms still struggle to understand the due diligence they must carry out in order to assess all relevant risks – customer risks, product risks and overall risks. And, once they do this, understanding the right MI to present to senior management in a way that gives senior management a clear picture of where the largest risks lie.

So, now, FCA has started enforcement investigations into some of the firms surveyed and imposed skilled persons or business limitations on others. It has also published a guidance consultation proposing additions and amendments to the Financial Crime Guide (FC). The changes will set out the examples of good practice it observed in the reviews, and will clarify what it expects. Many of the changes it proposes to part 1 of FC are high level, focusing on what MI firms should provide, and how they should carry out business-wide risk assessments.

THE MESSAGE FOR FIRMS

Firms ignore any thematic review at their peril, regardless of whether it is aimed at their sector or not. Now, FCA has carried out reviews of reviews, and found many firms have done just that. Its message is clear that these firms will pay the price. It is imperative that all firms, regardless of their size, business or risk profile, consider these reviews, FC and the proposals for change. It is equally imperative that they act to conduct a gap analysis and, if they find their policies, systems and controls lacking in a way that FCA has criticised, take immediate and decisive action to remedy the fault. FCA showed from the last batch of thematic reviews the level of enforcement action that may follow and has given clear signs it is prepared to do the same again.

This article was written for Financial Regulation International.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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