AML? Without the paperwork? Really?

Written by: Paul Bryant Posted: 28/03/2019

BL61_KYCA less painful and more efficient process for client checks is on the horizon – but getting there will be difficult

We’ve all been through the pain of collating documents to open a bank account – copies of passports, utility bills, payslips and so on. So, imagine how much more complicated the process will be for offshore clients of Channel Islands private banks or investment funds. These are often high or ultra-high-net-worth individuals, or institutions, with complicated affairs structured through trusts or corporations.

And imagine their frustration when they have to go through the same process all over again when they make their next investment, with a different bank or fund.

It’s tempting to vent at the financial services providers, but they are only fulfilling their legal obligations. In industry jargon, they are conducting anti-money-laundering or AML checks. (‘KYC’, or know-your-customer, and ‘onboarding’ are also common terms, but are really subsets of AML, referring to specific processes when taking on a new client.)

The good news is that financial regulators and financial services providers all over the world, including in the Channel Islands, are making an enormous effort to improve the situation.

Nick Vermeulen, a Partner in the Innovation and Technology practice at PwC in Guernsey, says: “Hypothetically, where this should end up is that, with one click, I’m able to share my (previously used) electronic KYC file with the next financial institution that I do business with.”

The bad news is that in practice, what Vermeulen describes is incredibly difficult to achieve. “The million-dollar question,” he continues, “is how we get from where we are today, where processes are still very manual, to that KYC utopia. It’s a long way away.”

Worth the effort 

It’s a problem that financial executives have every reason to tackle head-on, however. The reputation risks of an AML slip-up are huge. Vermeulen says no one on the islands wants to be that person or organisation that inadvertently facilitates a criminal transaction. And manual checks lead to more errors.

There are also opportunities to cut costs. Dr Andy Sloan, Deputy Chief Executive, Strategy, at Guernsey Finance, says his research reveals that financial institutions can often reduce their AML costs by as much as 20% if they move to more digital processes. This can be significant considering the number of people who are employed in due diligence, risk and compliance functions. 

A slick AML process can help to win and keep clients. Stefano Finetti, a Senior Private Banker at ABN Amro in Guernsey, says: “There is a genuine risk of frustrated clients saying ‘this process is just too difficult’ and opting to go with another bank when trying to open an account. 

“People are also creatures of habit. Once they’ve had a good experience with a bank, they’ll use them again for any future accounts they require. So AML is not just a back-office function, it’s absolutely an area of competition between banks.”

Patchy progress

One of the more commonly touted visions for the future is the creation of a central ‘utility’ – a single data repository – where governments and financial institutions can pool and access customer data. If a customer gets cleared by one bank and then wants to open an account with another, the second bank can simply access that same information. 

Variants of the utility idea already operate in some markets, such as the UAE, where the backbone of that system is a compulsory ‘smart’ ID card. A customer wanting to open a bank account in a branch places their ID card into a reader, which feeds the bank’s systems with their personal data. Identity verification is then done with a fingerprint reader.
This process is far quicker than providing paper copies of passports and utility bills, and more accurate than having a bank employee verify that the person in front of them matches an (often outdated) passport photograph. 

The utility solution can appear elegant at first glance, but it’s no panacea. It can work well where a local resident is opening an account with a local bank. However, its application is probably limited for the highly international Channel Islands market. And because many financial institutions see AML as an area of competition, they are unlikely to be inclined to share client information with a central database, accessible by competitors. 

Further problems with the utility concept arise from how responsibilities and liabilities are assigned when it comes to the accuracy of client data. For example, if bank A mistakenly clears a client they shouldn’t have, and then bank B uses that (already verified) KYC file to clear the same client, which bank takes responsibility? That’s a tricky issue for financial institutions and regulators to grapple with.

However, variants of the utility theme are gaining traction. Guernsey-based platform The ID Register provides private equity funds and their investors with a ‘centralised’ onboarding solution. It has created a database of investor records – mostly institutional investors such as pension funds, family offices, trusts and sovereign wealth funds – which allow different funds to tap into the same records of an investor.

Director Tim Andrews draws a parallel with an invitation to connect on LinkedIn. A fund can invite a potential investor to complete the KYC process with The ID Register. This information can then be accessed by another fund (with the permission of the investor), if they make an investment in that second fund. Likewise, an investor who has used the service before can ask a fund to use the already collated KYC information on The ID Register, rather than submit it all again.

But extrapolating this model to markets with much larger client bases, such as private or retail banking, would be difficult. The ID Register operates in a niche market. Andrews reckons his 22,000 investor records cover a third of the potential investor base for Channel Islands private equity funds, so it already has the scale to make it worthwhile for the industry to use. 

He says building a large enough base of client data is a big problem for many of the fintech firms targeting the AML market. Many of them have impressive technical onboarding tools and elegant platforms, but struggle to get sufficient data and the permission to make it available to multiple financial institutions.

Many financial institutions have adopted a go-it-alone approach and focus on trying to make their own processes as customer-friendly as possible – often using the latest technologies (see box).

ABN Amro’s Finetti says his organisation has invested a lot in its AML processes, but he doesn’t see much potential for co-operation between banks. 

Watch this space

It’s too early to predict the endgame for AML in the Channel Islands. Sloan, of Guernsey Finance, thinks it’s quite possible for a central utility to emerge and play a big role in local AML checks – when both client and financial institution are based on the islands. But when it comes to more complicated international business with clients from all over the world – which is the bulk of Channel Islands financial services – he doesn’t see the utility as a solution. 

Instead, he stresses that co-ordination between public and private sectors will be required to encourage the adoption of new technologies and a private sector solution, but with a careful eye on protecting the rigour of AML processes and the reputation of the islands. 

He is optimistic that the working groups that have been set up will steer this co-ordination – such as the ‘fintech working group’ established by Guernsey Finance, involving representatives of industry, government and the Guernsey Financial Services Commission (GFSC). 

Sloan says: “We now have many innovative technology companies in this space, which shows we are at the technological forefront. And Channel Islands regulators have a ‘permissive’ approach to the introduction of new technologies for AML. It’s absolutely front-of-mind for them.” 

The GFSC reinforced it’s commitment to this at a Guernsey Finance event in London in January, when Emma Bailey, Director of Authorisations and Innovation, said: “The GFSC has always been supportive of the safe, secure exploitation of technology. We are happy to work with all stakeholders to look to develop an approach that creates greater certainty for providers deploying electronic AML. The introduction of a revised AML handbook provides a welcome opportunity for us to make clear our commitment to ex ante discussions over the deployment of technology in the AML process.”

Andrews says it’s much more of a human than technological challenge. “We need regulators to continue to show flexibility in their attitudes towards new solutions. To make big leaps forward, private companies – financial and tech – need to overcome a fear of being penalised if they get something wrong with a new technology. We have to overcome the fear of ‘I don’t want to be first’.” 

Technologies to look out for

BL61_onboarding tech1. Mobile scanning    
• How it works: Customer sends photograph of passport and ‘selfie’ to bank. Bank systems read and capture data from photograph of passport using optical character recognition (OCR). Bank systems scan selfie (which includes a short video clip of person blinking to verify ‘life’) and uses facial recognition software to verify match with passport.
• Benefits: Removes need for face-to-face KYC. Much faster. Reduces errors from manual input and manual facial recognition checks.
• Barriers to adoption: Few, other than banks, investing in systems

2. Algorithms and artificial intelligence 
• How it works:
Commonly used to reduce ‘false positives’, which is where the client is flagged as a potential criminal, most commonly because they share a name, triggering a second round of more detailed checks (typically a very manual and expensive exercise). Algorithms are used to clear false positives through explicit rules – for instance, same name but birth dates far enough apart to verify no match – and through ‘learning’ the factors that humans use to clear false positives.
• Benefits: Cost reductions for banks. Removes delays to KYC approvals when false positive is triggered.
• Barriers to adoption: Few, other than banks, investing in systems.

3. Blockchain
• How it works: Essentially a database, not owned by any single party, where the client owns their KYC data and can grant access to financial institutions when necessary. Institutions can record and verify information in the blockchain, and other participants receive certification that data is legitimate and has not been tampered with. A single, immutable record of KYC data.
• Benefits: Potential to remove vast amounts of duplication, with subsequent speed and cost benefits. 
• Barriers to adoption: Agreement needed from multiple institutions on questions to ask in KYC process. Parties using the blockchain need to trust each other’s verification processes. Both of these requirements have been difficult to achieve to date. Needs substantial regulatory reform.

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