UK: UK Financial Conduct Authority Issues Report Following Thematic Review Of Money Laundering Risks In The Capital Markets

Last Updated: 16 July 2019
Article by Chris Chapman, Sam Eastwood and Stephen Moi

On 10 June 2019, the Financial Conduct Authority ("FCA") published a report (the "Report") following its Thematic Review of the money laundering risks in the capital markets1 . The review involved 19 participants covering different segments of the market. Although the review was broad in terms of the participants, which included investment banks, custodian banks, inter-dealer brokers, and clearing houses, it did not include assessment of the participants' systems and controls. This alert highlights some of the key findings from the Report, and seeks to extrapolate points of practical guidance that may arise out of it.

Key findings

1. The Report recognises that the capital markets are generally less attractive for money launderers than traditional (i.e. deposit-taking, payment-processing) banking services. This is due to greater barriers to entry, levels of scrutiny, and complexity of product. However, the Report finds that there could be greater awareness amongst participants of the nature of money laundering risks within capital markets and the typologies of such schemes. The Report includes an Annex of a number of relevant typologies that will assist market participants in better understanding some of those risks.

2. Fundamentally, effective KYC and CDD are at the heart of managing money laundering and other financial crime risks arising out of capital markets (or any banking) activities. To be able to identify suspicious transactions or activity, a holistic view of the financial crime risks posed by a customer and its business is required, given that the ultimate driver of the risk is the customer rather than the product or delivery channel.

3. There is some confusion in the market regarding the obligation to file Suspicious Activity Reports (SARs) to the National Crime Agency, particularly where a Suspicious Transaction and Order Report ("STOR") has already been submitted to the FCA in respect of the same transaction for suspected market abuse (such as insider dealing or market manipulation). This is consistent with the UK Law Commission report on the SARs regime2 , which finds that there does not seem to be a consistent approach to the filing of SARs, and a lack of guidance on, and understanding of, the circumstances in which a SAR needs to be filed. The Report clarifies that SARs and STORs should be considered separately, and the obligation to file a SAR arises as soon as one knows or suspects that a person is engaged in money laundering or dealing in criminal property. Filing a STOR is merely a civil requirement and therefore does not discharge a firm from its legal obligation to file a SAR. If a transaction is reviewed but the decision is taken not to file a SAR, the rationale for reaching that conclusion should be documented.

4. Further, a relatively small proportion of SARs filed relate to capital markets transactions. The Report attributes this to:

  1. the erroneous belief that the suspicious activity was market abuse and therefore reporting was limited to a STOR;
  2. insufficient knowledge of the transaction or capability to detect suspicious factors. In this regard, it is noted that there are relatively few case studies and typologies on which to draw;
  3. the belief that the money laundering would have occurred elsewhere in the transaction chain and therefore that submission of a separate / further SAR was unnecessary.

5. The nature of transactions and activities in the secondary markets means that in many cases no one firm will have a holistic view over the entire transaction and the risks arising out of it. There is similarly a lack of visibility of the customer's customer or the ultimate beneficial owner of the asset being traded, because there is no obligation to know the customer's customer. This renders good KYC even more important. The Report finds that some participants "perceive that others in the transaction chain, such as the exchange or the custodian bank, were more responsible than them for preventing money laundering".

6. This apparent complacency is mirrored in the Report's observation that the business, as the "first line of defence", should generally take a greater degree of ownership and responsibility for managing the financial crime risks arising out of capital markets transactions. Given the complexity of the transactions, often involving multiple jurisdictions and parties, it is the front office whose awareness and knowledge of customers, products, and markets are key in identifying suspicions, as they also have the clearest line of sight into each transaction. The Report finds that the participants' front line staff often view AML and other compliance issues as purely a second line concern, and that their sense of responsibility for these matters was insufficient. In other words, a stronger culture of compliance needs to be embedded.

Footnotes

1 https://www.fca.org.uk/publication/thematic-reviews/tr19-004.pdf

2 https://www.lawcom.gov.uk/project/anti-money-laundering/

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