Seven money-laundering red flags in capital markets: the UK FCA’s thematic review

Money laundering risks in capital markets have been a focus for regulators since capital markets were identified by the UK government as posing a high money laundering risk in its 2017 national risk assessment. Wholesale banking has, more generally, been an area of focus by regulators across the globe in AML-related enforcement action in recent years.

Following the publication of the national risk assessment, the UK's Financial Conduct Authority (FCA) conducted diagnostic work to better understand how capital markets are used for money laundering. The FCA has now published its thematic review on understanding the money laundering risks in capital markets.

The thematic review identified a lack of knowledge of AML risks by firms operating in capital markets and a lack of understanding of obligations under the Proceeds of Crime Act 2002, leading to under filing of suspicious activity reports (SARs).

The FCA’s report sets out seven examples of typologies of money laundering in capital markets and identifies some of the key risk areas and red flags. This guidance will be useful to firms in enhancing internal training for front-line and financial crime teams, informing internal AML risk assessments and enhancing transaction monitoring systems.

Fraud typologies and red flags in capital markets

The FCA identified a lack of adequate training as being an issue in some firms, including a lack of understanding as to how money laundering could manifest itself in capital markets. Money laundering problems in capital markets are often as much the product of a culture where AML is regarded as a compliance rather than business responsibility as they are the product of systems problems.

In order to assist firms, the FCA’s report explains seven money laundering typologies particular to capital markets, explaining how each of the typologies operates and the risk areas and red flags in each.

The FCA identified the following points as being potential indicators of financial crime:

• the remote booking of trades between group entities;
• pre-arranged trading where the customer has already agreed the trade with a specified counterparty;
• instructions from or involvement of third parties;
• ‘free of payment’ asset transfers, such as from an account held by a customer with a broker in a high risk jurisdiction to an account held by the same customer with a broker in a low risk jurisdiction;
• non-standard settlement arrangements (in the context of the customer’s usual settlement instructions), such as instructing delivery of a security to an account held with a third party broker;
• trading strategies which appear to be uneconomic or irrational; and
• unusual trading patterns, such as:
  • counterparty concentration where a customer trades disproportionately with the same counterparties;
  • unusual win/loss rates or flat/neutralising activity; and
  • no trading on an account followed by cash withdrawal.

Under reporting of capital market SARs

Whilst the FCA identified that firms understood the importance of detecting insider dealing or market manipulation, some firms failed to spot that such conduct may also be indicative of money laundering.

Siloed market abuse surveillance and AML teams was seen as putting firms at particular risk of failing to consider the full spectrum of risk and leading to inconsistent or inadequate steps being taken in response to threats.

In some cases, firms have been failing to comply with their legal obligations to file SARs to the National Crime Agency, risking criminal exposure. The low volume of SAR filing has been attributed to:

• lack of awareness of typologies of money laundering in capital markets;
• insufficient knowledge or capability to detect suspicious activity;
• believing money laundering is occurring elsewhere in the market or trading chain and that the firm is not required to file a SAR;
• failing to consider whether market abuse also gives rise to a suspicion of money laundering;
• believing that obligations are fully satisfied by filing suspicious transaction and order reports (STORs) to the FCA; and
• believing that it is not necessary to file a SAR where there is a suspicious attempted transaction which does not proceed.

Firms are recommended to ensure their market abuse and AML teams are coordinated and that when filing a STOR consideration is given as to whether a SAR should also be filed. If not, the rationale for concluding a SAR should not be filed should be clearly documented.

Focus of future enforcement activity

Following the completion of the FCA’s diagnostic work, and given the failings identified and attention of Government, we anticipate that the FCA will be actively seeking to initiate enforcement activity in capital markets and firms operating in this area should anticipate increased regulatory attention.