Pandemic poses compliance conundrum for capital markets

Published by: Radish Singh, Financial Crime Compliance Leader, Deloitte Southeast Asia Jul 2020

(These views expressed by Radish Singh, Financial Crime Compliance Leader, Deloitte Southeast Asia, are her own.)  

Capital markets are essential to any economy as they allow access to capital and provide vibrancy with regards to investment options.

The unforeseen risk of Covid-19 poses numerous challenges to capital markets and their ecosystems. Globally, we have seen a number of regulatory “alignments” where standard setters, policy makers and regulators have been responsive to the issues faced by the industry because of this risk.

Transactions and funds are flowing rapidly, increasing vulnerability to risks in the process; and yet investors still look for credible and efficient markets to design their trading strategies with confidence.

Increased competition

In these unprecedented times, the industry is not only managing and balancing compliance and business challenges, but also dealing with increased competition, the need for innovation and digitization to compete, and addressing financial crime compliance (FCC) risks.

As the impact of the pandemic deepens, more opportunities arise for criminals to launder funds or devise new ways of diverting their illegal gains. Correspondingly, cybersecurity and fraud risks have also increased.

Capital markets and the broader financial services sector face challenges that impact their operations and test the resilience of compliance architecture.

When lockdowns started, institutions had to address issues around remote working affecting their operations and the efficient use of resources. There were also technology and governance challenges around compliance risk management.

With regard to FCC, the key issues continue to be:

  • adapting to emerging typologies and changes in customer behaviour;
  • re-engineering processes for remote connectivity to carry out compliance tasks; and
  • adopting innovative solutions and digitizing with use of artificial intelligence (AI), machine learning (ML) and robotic process automation (RPA) to achieve higher levels of efficiency and effectiveness. 

Digital focus

As a response to the COVID-19 pandemic, the Financial Action Task Force (FATF) has encouraged use of responsible digital customer onboarding and delivery of digital financial services, electronic and digital payment options, and Anti Money Laundering (AML) transaction-monitoring approaches such as AI, behavioral analysis and wider contextual and networking approach to automated monitoring.

Granted, these issues cannot be fixed overnight. However the pandemic has cemented the benefits of and accelerated the pace for obtaining “buy-in” to help sustain FCC or compliance processes in a more seamless fashion in case of a disruption.

Key to enhancing a compliance programme is, among other things, to address the following risks in capital markets, especially when businesses are under pressure to perform in an economically challenging environment:

  • Intermediation in securities transactions that provide anonymity;
  • High liquidity of most securities products, allowing swift conversion to cash or other forms of liquidity to exit the market;
  • Transaction speeds across jurisdictions and financial markets and the ease of global interoperability;
  • Complexities in products that are offered before being regulated or not regulated, and not undertaking product risk assessment for vulnerabilities and risks (e.g. crypto-assets);
  • Pricing volatility of some products, particularly low-priced securities;
  • Potential use of securities transactions for laundering illicit gains or even generating illegal income via market abuse, manipulation techniques or fraud;
  • Environment that encourages competition and incentive-driven mechanism, leading to higher appetite for risk and lack of adherence to internal controls;
  • Challenges in pricing some securities products because of their bespoke nature or complexity;
  • Capital markets, especially the securities sector can be used to launder and generate illicit funds. Transactions and techniques associated with money laundering and securities offences can be difficult to separate out, as with developing indicators for insider trading, market manipulation and securities fraud; and
  • Over-the-counter transactions or use of alternative trading venues.

Moving forwards, focus on compliance risk management needs to be sharpened. The pandemic has taught us that the programmes designed today should cushion the impact of any future unforeseen risks.

The value of adapting to the so-called new normal should be with a view of long term gains to better manage risks. There seems also to be a need for institutions to assess vulnerability to risk on a continuous basis. This has to include an impact analysis on compliance by unforeseen risks and disruption that may impair the ability to meet regulatory obligations.

Policy considerations should also be balanced so as to minimize compliance friction and barriers to business. The cost of compliance is mounting to ensure seamless access to liquid markets. With information and intelligence in easy reach, investors may adopt other means to raise capital, resulting in liquidity being flushed to shadow markets. These unintended consequences require a fine balance to manage.