The Financial Conduct Authority ("FCA") recently published two documents which provide additional information about its current supervisory and enforcement approach and priorities in relation to financial crime issues. These are the FCA's Anti-Money Laundering Annual Report 2012/13 ("AML Report") and the first Financial Crime Newsletter since the transition to the FCA ("Newsletter"). This e-bulletin summarises points of particular interest in these documents.

1. Background

The AML Report is the FCA's first annual report on financial crime issues, setting out the FCA's responsibilities, supervisory approach and current and emerging trends. Whilst badged as relating to money laundering, it discusses financial crime risks more broadly.

The Newsletter provides an update on recent publications and enforcement actions, as well as a brief update on activity by the Financial Action Taskforce and the FCA's role in the ongoing negotiations for the Fourth EU Money Laundering Directive.

2. Key points

  • The AML Report sets out priority areas of financial crime risk for the FCA and examples of current trends and emerging risks – although extremely limited information is provided about practical steps that firms should take in relation to the latter.
  • The FCA provides an overview description of its work on SAMLP visits, and highlights that these may involve visits to overseas branches and subsidiaries in conjunction with local supervisors. Firms in the SAMLP will wish to be prepared for this possibility.
  • The FCA is exploring the extent to which SAMLP reviews can be refined to examine a larger sample of firms and/or review firms more frequently.
  • The reports highlight concerns arising from recent thematic work, including the thematic review of financial control systems and controls in trade finance. In the FCA's view, the root cause is "often a failure in governance… which leads… to inadequate money laundering resources and a lack of (or poor quality) assurance work across the firm. This often focusses on whether processes have been followed rather than on the substance of whether good AML judgments are being made".
  • There have been five recent enforcement actions arising from the thematic review into banks' AML controls in relation to high risk/PEP customers. A further two AML cases are said to be in the enforcement process. The FCA has also been utilising its early intervention powers in the AML area, and provides an example of such powers.
  • The FCA's thematic review on AML and ABC controls in asset management firms is now expected later this summer.
  • Thematic reviews of e-money and new payment methods are planned, together with follow up work on AML controls over high risk/PEP customers in smaller banks.
  • An update is provided on recent FATF publications, and on the FCA's role in the negotiations on 4MLD.

3. Key areas of financial crime risk

The AML Report states that the most important risks that financial crime pose to the FCA's objectives are from:

  • money laundering,
  • breaches of the UK's and other country's financial sanctions,
  • terrorist financing,
  • investment fraud (boiler rooms and similar frauds, including the associated risk that the fraudulent proceeds are then laundered), and
  • bribery and corruption.

The AML Report focusses on money laundering, financial sanctions breaches and terrorist financing.

Whilst none of this is surprising, the high priority given to financial sanctions is notable.

The FCA highlights the trend for firms to opt for higher risk funding sources in the current economic climate, the ongoing challenges of domestic organised crime, and developments in technology and international travel as increasing the risk of illicit funds being transmitted through FCA-regulated firms.

4. Current trends and emerging risks

The AML Report also highlights a number of direct and indirect emerging risks, as follows:

  • E-money issuers: e-money issuers who are new market entrants may be less familiar with the AML regime and may outsource the provision of services, creating greater money laundering vulnerability. The FCA highlights concerns about the limited volume of suspicious activity reports ("SARs") from the e-money sector (albeit that there is limited evidence on the extent of money laundering in the sector).
  • Cyber-crime: this is an important growing risk, particularly where firms lack adequate controls and processes, and staff and customers lack awareness.
  • Money services businesses: the FCA notes a recent trend (which has had some recent press coverage) for banks to remove services from MSB customers because of the sectoral risks, and for those who continue to provide services to significantly expand their monitoring (e.g. by conducting on-site visits to check AML/CTF systems and controls). The FCA flags that if accounts are denied to MSBs altogether, this may raise concerns about the risks being displaced. Perhaps unsurprisingly, however, the FCA fails to identify any views or recommendations as to the solution to this quandary. Indeed, it is difficult for the FCA, on the one hand, to laud banks for exiting high risk business with PEPs (see below) but then complain about them doing so with MSBs.
  • Digital currencies: a large proportion of trade in digital currencies has been suggested to be linked to illicit money flows – albeit that there is no firm evidence of this to date. The FCA has "concerns" about the products and will "keep them under review" and "liaise with the government" about their emerging views.
  • Alternative banking platforms: payment platforms or virtual banks offered in jurisdictions that do not have robust AML oversight present risks to regulated firms, particularly in relation to customer take on and third party payments.

The FCA is assisting the government in producing the national risk assessment, identifying money laundering and terrorist financing risks. This is due to be published in summer 2014.

5. The FCA's supervisory approach

The FCA states that its focus is on protecting consumers, and seeking out firms that are being used for financial crime, particularly money laundering and bribery/corruption. It aims to be "proactive, intensive and intrusive" with an emphasis on early intervention and credible deterrence where serious risks are identified.

So far, so generic. However, the FCA goes on to provide some more detailed information about its personnel and their activities.

Responsibility for AML supervision is shared between firm supervisors and a specialist financial crime supervision team, whose resources are being increased from 19 to 22 by the end of 2013. The support provided by the specialist financial crime supervision team includes:

  • Dealing with cases of money laundering risk and/or serious weaknesses in firms' AML controls (around 100 cases a year).
  • Conducting systematic anti-money laundering programme ("SAMLP") assessments of major banks.
  • The SAMLP has been running since early 2012 and currently covers 14 major retail and investment banks. The reviews involve detailed testing and extensive interviewing of key staff responsible for the business, implementing AML processes and AML controls.
  • Interestingly, the FCA notes that it often visits branches and operations outside the EEA (there is a requirement under regulation 15 of the Money Laundering Regulations 2007 ("MLR") for firms to extend certain controls to non-EEA branches and subsidiaries); so far the FCA has visited five UK banks and in respect of three has conducted overseas work in Switzerland, Singapore and India. Firms who are subject to the AMLP will wish to ensure, therefore, that their preparation for supervisory visits is not limited to their UK businesses.
  • Carrying out thematic reviews on high risk issues.
  • The next financial crime-themed review to be published, which relates to AML and anti-bribery and corruption ("ABC") controls in asset management firms, is now expected later this summer.
  • Assisting with financial crime aspects of risk assessments carried out by firm supervisors.

The specialist team's work assesses financial crime systems and controls in around 150 firms a year, with most of the focus on AML systems and controls.

6. International co-operation

As noted above, the FCA highlights in its description of the SAMLP the prospect of undertaking work in banks' non-UK branches and subsidiaries. In a section on international co-operation, the AML Report also highlights work with AML supervisors in other jurisdictions, both through discussions in colleges of supervisors, and in bilateral discussions with overseas counterparts about individual firms. Reviews of banks' overseas operations are said to be undertaken in close conjunction with local supervisors.

The AML Report also provides an overview of the FCA's participation in various international bodies and co-operation with UK law enforcement and other MLR supervisors.

7. Firms' systems and controls

In the Newsletter, the FCA reports on key themes from its recent financial crime conference. In addition to the FCA's intention to work in partnership with law enforcement partners and other regulators, and its role in formulating policy, it highlights in particular:

  • "The FCA wants to see more accountability at board level for financial crime issues"; and
  • "Firms should use their AML resources effectively to address the highest risks, rather than focussing on demonstrating mechanistic compliance".

These priorities chime with the FCA's findings in its recent thematic review of banks' control of financial crime risks in trade finance, emphasised in both the Newsletter and the AML Report. Highlights from this review include:

  • an inconsistent approach to risk assessment,
  • an absence of clear policies or procedures for dealing with relevant risks,
  • failures to make adequate use customer due diligence information, and
  • as well as weaknesses in relation to controls over financing dual used goods.

The FCA expressly identifies the root cause of these problems as "often a failure in governance of money laundering risk, which leads, among other things, to inadequate money laundering resources and a lack of (or poor quality) assurance work across the firm. This often focusses on whether processes have been followed rather than on the substance of whether good AML judgments are being made". These risks are said to play out differently amongst different types of firms: small firms often fail to collect enhanced due diligence information, whilst large firms might collect adequate information but fail to assess it properly or make poor judgments on the back of it.

Weaknesses have been found in firms of all sizes in establishing and corroborating customer's source of wealth or funds, with too much reliance placed on customers' own explanations.

It is apparent, therefore, both from these observations and from the FCA's recent AML enforcement actions, that firms will need to be prepared to explain and provide documentation of:

  • governance issues – demonstrating senior management engagement and sufficient management information on financial crime issues;
  • meaningful risk assessments which then drive other elements of the financial crime programme;
  • compliance by the firm with its own policies and procedures – a perhaps surprising feature of a number of the recent enforcement actions was a basic failure to collate information which the firm's procedures required;
  • substantive reviews of customer due diligence information, particularly for higher risk customers;
  • documentation of all aspects of the financial crime compliance programme, including enquiries made as part of the due diligence process, as well as documentation of other elements such as risk assessments, training, monitoring and approval for periodic re-reviews of higher risk customers.

8. Enforcement activity

There have now been five cases arising out of the 'high risk customers' thematic review. The latest fine (imposed on Guaranty Trust Bank (UK) Limited – see our e-bulletin here) post-dates the publication of the AML Report. The AML Report states that a further three banks are currently being investigated for AML weaknesses, and we can therefore anticipate a further two Final Notices in due course.

In the enforcement context, the FCA also notes its use of its early intervention powers. In the past year the FCA has intervened with four banks, one of which has also been referred to Enforcement. One of the interventions arose from an assessment of a large bank where serious control weaknesses over high risk PEP customers was identified; the bank provided a voluntary undertaking that it would not open new accounts for customers of this type until the deficiencies were corrected, and the bank is said to have reviewed its existing book of high risk PEP customers and exited over a quarter of some 1,500 relevant relationships, in around one-third of cases because of the high money laundering risk they posed.

9. Future work

The FCA is exploring the extent to which its approach, including SAMLP reviews, can be refined to allow the use of existing resources to examine a larger sample of firms and/or review firms more frequently, particularly smaller firms that might present higher levels of money laundering risk.

The FCA is also working with the PRA to ensure that AML risks which may be important in resolution and other situations, are tackled appropriately.

The FCA notes that it will continue its thematic work with reviews of e-money and new payment methods planned, along with some follow up work on AML controls over high risk/PEP customers in smaller banks.

10. Consumer credit

On 1 April 2014 the FCA will take over the regulation of consumer credit from the OFT, including the supervision of those "consumer credit financial institutions" that fall under the MLR but are not authorised firms. The FCA plans to publish detailed proposals about its regulation of this sector in the autumn.

11. Financial Action Task Force

In the Newsletter, the FCA highlights the recent publication by FATF of best practices papers on PEPs, repayment products and services, targeted financial sanctions related to terrorist financing, and financial provisions relating to the proliferation of weapons of mass destruction.

The FCA also notes that the UK is likely to be assessed in the FCA's fourth round of mutual evaluations in 2016.

12. Fourth Money Laundering Directive

The proposed Fourth Money Laundering Directive ("4MLD") remains under negotiation at EU level. The FCA is supporting HM Treasury in negotiating 4MLD through European Council working groups.

In the Newsletter, the FCA also highlights the importance of the guidance to be issued by the European Supervisory Authorities ("ESAs") which will support 4MLD. This includes guidance on key aspects of the customer due diligence process, administrative sanctions and a risk based approach to supervision, technical standards on the measures firms should take where a third country's legislation does not permit the application of equivalent AML/CTF measures, the provision of an opinion on AML/CTF risks facing the European internal market, and the collection, analysis and dissemination of information in relation to non-equivalent third countries.

The FCA is a member of the Anti-Money Laundering Committee ("AMLC"), a sub-committee of the joint committee of the ESAs, and the AMLC is currently chaired by a senior FCA employee. One would hope, therefore, that the FCA will be in a good position to provide input on these very important aspects – the draft guidelines on aspects of customer due diligence (including new guidelines in relation to simplified due diligence) are likely to be of significant importance to the UK financial sector. Neither the AML Report nor the Financial Crime Newsletter gives any colour on the substance of the discussions on these important issues.

In terms of timing, the Newsletter appears to envisage that the Directive will come into force in late 2015, with the technical guidelines to be delivered within two years thereafter. If adopted, 4MLD will be transposed into UK legislation through new money laundering regulations.