Posted: 10th July 2017

Regulatory scrutiny and significant fines relating to anti-money laundering (AML) regulation have caused some firms in the market to undertake a process of de-risking.

Last year, the FCA published research by John Howell & Co Ltd on the ‘Drivers and Impacts of De-risking’. The report, published on the 24th May 2016, concluded with the view that banks – driven by financial crime risks and the high price associated with failure in this area – are withdrawing or deciding not to offer services to particular categories of customers.

The FCA asserted that AML requirements should not be a legitimate reason to close customers’ accounts, and that banks should focus on customers who are ‘genuinely’ high risk in order to maintain consumer access to financial services.

A misinterpretation of The consent regime

If a firm wishes to close an account due to the suspicion of money laundering or terrorist financing, it will need to seek consent from the National Crime Agency (NCA).

In June 2016, the NCA provided a statement which indicated its belief that the ‘consent regime’ had been misinterpreted by some as the act of ‘seeking permission’ or using the regime as part of its risk-based approach in order to continue with a transaction. The NCA was clear that the consent system was not a substitute for a firm-specific, risk-based approach:

“The term ‘consent’ is frequently misinterpreted. Often it is seen as seeking permission, or that where requests are granted, that this is a statement that the funds are clean or that there is no criminality involved. This is not the case.”

The NCA will no longer use the term ‘consent’ in its granted letters, instead using the terms ‘defence to a money laundering offence’ or ‘defence to a terrorist financing offence’. ‘Consent’ will still be used in refusal letters.

unusual doesn’t necessarily mean suspicious

The Joint Money Laundering Steering Group (JMLSG) advises that:

“A transaction which appears unusual is not necessarily suspicious. Even customers with a stable and predictable transactions profile will have periodic transactions that are unusual for them.”

The SAR regime needs quality information to apprehend money launderers and those involved in terrorist financing. A compliance function that focuses on writing quality SARs, achieved through identifying the red flags and discounting irrelevant information, shows a clear understanding of the definition of suspicion and their legal obligations. Any form below this level disrupts genuine customers and exhausts valuable resources for firms and law enforcement.

So, a de-risking approach can result in poor quality or ‘defensive’ SARs being submitted by nominated officers that do not distinguish between anomalous account activity and actual suspicious behaviour. This not only affects customer relations but overwhelms law enforcement with irrelevant information, making genuine SARs much harder to identify. 

Criminal Finances Act 2017 – the extended moratorium period

There have been some recent changes to the SAR regime, and in particular, to the moratorium period for those requesting a ‘defence to a money laundering offence’ from the NCA.

Careful consideration must be taken if routine de-risking occurs by ending a client relationship. Firms instead should be relying on an effective risk-based approach to identify SARs. Ongoing Customer Due Diligence (CDD) and internal reporting procedures are critical to manage risk appropriately.

The Criminal Finances Act (the Act) will make significant changes to the SAR regime. At present, when the NCA refuses a consent, the regulated institution loses their defence for 31 days to prevent the activity. The next 31 days is known as the ‘moratorium period’, which allows law enforcement agencies to investigate and gather evidence.

31 days was deemed inadequate time to progress an investigation. The Act introduces a significant change by extending the moratorium period by an additional 186 days (total 217 days). The Act will allow law enforcement authorities to make an application to the Crown Court to extend the period further than the original 31 days. The court must be satisfied that the investigation is relevant to the matter; that further time is required; that the investigation is conducted diligently and expeditiously; and that it would be ‘reasonable’ to extend the moratorium period.

The challenges of the extended moratorium period to firms

How will the extended moratorium period impact your business and customers? It is unknown how the Crown Court will interpret what constitutes ‘reasonable’ in terms of extending the moratorium period. Moreover, how much consideration will be made to a firm’s resources and capabilities in the context of what is ‘reasonable’ to a firm?

However, an important risk to consider under an extended moratorium period is the offence of ‘tipping off’, with disclosures being made to the subject of the SAR by staff within the firm. If a person alerts someone that a disclosure of money laundering has been made against them, and it is likely to prejudice an investigation, then the individual commits a criminal offence of tipping off.

Tipping off presents considerable challenges for firms who enter the new moratorium period, though the extension may not always result in a full 217 day process. A significant challenge for firms will be the lack of a set end date for the conclusion of each case. This will result in firms having to explain to the customer why their account has been frozen, or their transaction suspended, for an unknown period of time. Law enforcement will apply for the extension on an incremental basis, so it will be a difficult to manage the customers’ expectations when the end of the moratorium period is unclear.

What firms should consider when reviewing their internal reporting systems

Efficient management of SARs is crucial to balance the increased risk arising from the extension of the moratorium period and tipping off. Managing tipping off and customer expectations are not the only challenges for firms. SARs present other issues such as the volume of data being handled and maintaining data accuracy.

Firms can mitigate these risks with robust systems and controls such as:

  • Training and education to identify suspicious activity, improving SAR writing skills or dealing with authorities
  • Developing data security and controls that prevent staff from tipping off and prejudicing an investigation
  • A clear internal reporting system with defined responsibilities; escalation policies and procedures that allow the nominated officer to submit accurate reports to the NCA
  • Ongoing CDD that effectively monitors clients and their changes in circumstances
  • Transaction monitoring systems that are calibrated to identify red flags that account for specific customers’ risk profiles
  • A robust recordkeeping system to ensure accuracy and transparency that can withstand scrutiny from regulators

The future of the SAR regime

In October 2015, The UK National Risk Assessment of Money Laundering and Terrorist Financing identified that the SAR regime needed reform. Even though there are changes within the Act, there is likely to be more changes ahead. The Home Office and HM Treasury propose reforms to the SAR regime in their Action Plan, due to be completed by October 2018.

The SAR regime is the ‘eyes and ears’ of law enforcement, and without SARs it would be impossible for the authorities to monitor illicit funds flowing through the UK financial system. While there may be changes to the regime, it is highly likely that SARs will continue to be a large part of financial crime compliance.

Firms need to be cautious in the face of increasing financial crime risks. However, de-risking through defensive reporting is not effective and will present societal challenges around access to financial services. Firms that are able to recognise and manage the risks effectively will enhance overall customer experience and display their competence and compliance with their legal obligations.

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