Detecting money laundering risk in capital markets is a challenge which the industry has long struggled to effectively overcome. Capital markets inherent risk characteristics, such as high volumes of transactions, cross-border activity, direct market access and complex product offerings complicates risk detection and makes the market extremely appealing for sophisticated criminals to layer or create illicit funds. A widely held view amongst anti-money laundering (AML) industry experts and regulators is that a large amount of money laundering goes undetected in capital markets. This view was further validated in 2017, when enforcement action by the UK Financial Conduct Authority (FCA) revealed that approximately US$10 billion was moved across borders using mirror trades in equity securities.
Solving a complex problem
The 2020 UK's National Risk Assessment highlighted criminal use of the capital markets to move and disguise the trail of illicit money via the use of complex financial transactions. This movement of illicit money can be readily masked within the normal high transaction volumes generated by legitimate day-to-day business in this sector. On the London Stock exchange alone, 10 to 15 million trades are reported each month.
Detecting money laundering in capital markets is challenging. The typical commercial banking risk scenarios, such as large cash deposits, are mostly not relevant to capital markets.
Further, the involvement of multiple entities in markets transactions, such as issuers, counterparties, custodians, transfer agents and clearing firms, make it harder to follow the money. Asset classes and services presented in this space can often be quite complex, making it easier for money launderers to disguise their unlawful funds.
To add to the complexity, the securities sector is unique in the way that it can be used to generate and obscure bad money (insider trading, market abuse, etc.) and illicit funds.
Access to products and exposure to risk also varies depending upon the client base. For example, institutional clients can access much more complex products, such as derivatives and leveraged products, which most retail investors cannot trade.
To overcome these challenges, the approach to transaction monitoring (TM) in capital markets needs to become more holistic. Context is critical for both the detection and investigation of money laundering activities.
From Transaction Monitoring to Contextual Monitoring
For years, financial institutions and compliance technology vendors have been focused on implementing and building rule-based AML typologies and systems that focused primarily on commercial banking. Those have not worked effectively in capital markets, as evidenced by the low number of SARs reported from markets TM systems.
The reason being that the behavior of capital markets participants is quite different to commercial banking customers. Client activity is inherently inconsistent, and patterns shift constantly due to the volatile nature of markets. Therefore, classic rules-based typologies, like rapid movement of funds, change in behavior, round amounts etc., are largely ineffective.
In Europe, the FCA thematic review was a game changer. In addition to providing example capital market specific typologies such as “Mirror Trading”, and “Free of Payment,” it also highlighted contextual monitoring as the future of transaction monitoring. The paper also observed that the participants using network analysis had seen a vast reduction in the number of false positives they received when compared to a traditional rules-based system.
This indicates that regulators are embracing the required change in approach to detect money laundering in capital markets.
Similar trends are playing out in the US and Asia as well where regulatory bodies are encouraging innovative approaches in the fight against financial crime.
It is clear that the status-quo is not working, and capital market firms need to adopt new technologies, and approaches to stamp out money laundering. Building context using disparate date streams needs to be at the core of this change to achieve enhanced risk detection and effective decision making by the investigators.
What is Contextual Monitoring?
Contextual monitoring uses multiple data sources, both internal to the organization (e.g., trades and payments) and external data sets (e.g., corporate registries) to create a holistic view of activities and identify complicated networks or links between suspected parties or ultimate beneficial owners behind a transaction. This is key to finding AML-related risk in capital markets. This approach also provides investigators with the required data and intelligence to conduct reviews, resulting in significant operational cost savings and better decisions.
Quantexa Contextual Monitoring transforms traditional transaction monitoring and is currently supporting various organizations with their AML modernization journey.
Quantexa’s Decision Intelligence platform can help institutions uncover new risk in capital markets while simultaneously gaining operational efficiencies and improving decision-making.
Don't miss our short Fireside Chat Session discussing the evolution of transaction monitoring landscape and how contextual monitoring and advanced technologies can help organizations in enhancing their capital markets AML controls.