Managing financial sector risk: the advantages of human intelligence

As multi-million pound – and in some cases multi-billion pound – fines continue to stack up for leading multinational banks and other financial sector institutions in both North America and Europe as a result of breaches of sanctions, compliance or other regulatory policies, a reflex response has been to ‘de-risk’ by way of blanket policies. Such a blunt approach has, in many cases, resulted in that particular financial institution pulling out of certain jurisdictions, cancelling relationships with all correspondent groups in a certain class, or withdrawing its banking services wholesale from certain sectors. Unsurprisingly, such policies can often undermine both profitability and business growth.

Underpinning such measures are often concerns among internal financial intelligence units, risk managers and money laundering reporting officers about their ability to successfully differentiate between current and potential clients in high-risk jurisdictions subject to sanctions, or who pose a genuine reputational or legal risk – whether due to criminality or other such factors – and those that are simply seeking to conduct legal business in countries upon which the regulatory spotlight is focused.

Accompanying such blanket measures has also been a tendency among Western financial institutions to base their decision-making upon data provided by open-source compliance databases. Even while the information provided can serve as a useful first step in any more in-depth research process, without recourse to further investigative measures such an approach is increasingly inadequate. For example, in 2013 the inter-governmental Financial Action Task Force (‘FATF’) criticised financial institutions for what it described as an over-reliance upon database software for the purposes of identifying Politically Exposed Persons (‘PEPs’), since financial firms were incorrectly assuming that if a current or prospective client name did not appear in the database, they were not a PEP. In one widely-publicised case illustrative of the consequences of a minimalist approach to PEP screening, in November 2015 Barclays was fined over £72m for its so-called ‘elephant deal’ transaction; this was a structured finance deal backed by underlying third-party bonds, which came under the spotlight for the bank’s failure to properly screen the Middle Eastern PEPs associated with the transaction.

As these and similar cases demonstrate, there are risks and pitfalls for financial institutions relying upon either of the approaches outlined above: either blanket de-risking, or potentially incorrectly assessing that an individual is not a risk, on the basis that their name does not appear in an open-source database. The first approach shuts down profitable revenue streams, in many cases unnecessarily, while the latter risks incurring fines on the basis that regulatory authorities deem that the firm has not conducted a sufficient level of due diligence.

But for financial organisations seeking to manage their risk exposures effectively while remaining active in potentially lucrative markets and sectors, the engagement of a broad network of knowledgeable, well-placed, and discreet in-country human sources is an increasingly essential component of their risk management process.

Whether such networks are proprietary or retained through an independent global business intelligence consultancy such as Livingstone & Company, the value they provide is readily evident. Indeed, where such networks are managed carefully and sufficient resources are deployed, in-country and regional human sources can provide timely, nuanced, and corroborated insight, analysis and assessment of individuals, companies, or specific situations. The aims of such research might include needs as wide ranging as the application of sanctions to a specific entity, the impact of emerging regulatory policies to one’s commercial interests, or the identification of beneficial ownership in particularly opaque jurisdictions. In all of these contexts, engaging such a diverse and knowledgeable in-country network is the only reliable and effective means of assessing the true nature of the risk in question.