Over-zealous know-your-customer rules are a risk to financial services if left unchecked, says Olivier Portenseigne of Fundsquare.

Many financial sector business lines are becoming increasingly uneconomic due to regulation. In particular, the global push towards tougher rules against money laundering and terrorist financing are being felt. So-called know-your-customer (KYC) utilities are helping, offering centralised, cheaper KYC services. However, these have yet to reach their full potential and a new bold approach might be needed, particularly in the fund sector.

Convictions for sanctions violations and money laundering have cost major international banking groups multi-billion dollar fines in the US in recent years. These penalties are indicative of a new regulatory mood of getting tough with companies that aid criminal activity, even inadvertently. This policy has strong support from voters and thus politicians and regulators, but it is making it tougher to provide the services needed.

For example, a consultative report on correspondent banking from the Bank for International Settlements committee on payments and market infrastructures, released in October 2015, said: “While the correspondent banking business seems profitable in aggregate, parts of this business are not and, as a result, correspondent banks have been dropping their less profitable customers or jurisdictions.” The report pointed to KYC and know-your-customer’s customer (KYCC) requirements as the main cause of increased costs.

Fund businesses have become more thorough in checking clients’ backgrounds, but many are still unsure how much detail they should take into account. The term ‘de-risking’ is becoming commonplace, often resulting in ‘de-banking’. Many players see it as too much work to cherrypick clients in high-risk areas. Even when the fund industry does seek to engage with new clients, the paperwork can be stifling, and new customers are often required to submit duplicate information. Moreover, handling this mass of data is complicated and costly. Some of the biggest financial institutions could have tens of thousands of vendors on which they need to conduct due diligence.

KYC utilities might be an answer for the fund industry. Information on existing customers is uploaded to a central warehouse by participating industry players, and can be accessed by others when needed. This means institutions can check whether data already exists in the utility when on-boarding clients, meaning there is no need to collect this information repeatedly. The end client would have to give permission before the data is accessed, and, if the data isn’t on the utility already, it would then be uploaded. All participants would strive to keep the information up to date when appropriate.

Advocates of this model point to successful mutualised utilities in other areas of the financial sector, particularly clearing and settlement houses. The research and advisory firm Aite Group points to one example of a global bank, using an automated KYC process, that spends approximately $400 per client. Another institution, however, using primarily manual processes, spends about $6,000 per client. A utility model should also be more convenient, more accurate, and speedier.

Several utilities have emerged recently, each run by different financial sector data providers, and each meeting different client requirements in different jurisdictions.

Thus, the market has developed various options tailored to different business segments, needs and geographical areas, but these services are not always as rich as clients would like. Moreover, regulators still insist that financial businesses make their own KYC checks even if they use utilities, meaning the full benefits cannot be realised. Also, certain business segments are not being fully catered for, and more could be done to serve the fund sector.

Unified standards would cut costs, increase speed and boost reliability as different layers of data would help the crosschecking process. Maybe there would be an external accreditation process to ensure standards are being complied with and that data is accurate. It appears that only a concerted effort could create a robust reliable utility, a process similar to that which led to the formation of the clearing and settlement utilities. More work could be done to collate information that is already publically available and match this with privately held information. It is possible that even biometrics technology could play a role.

However, there are several reasons that market forces have not previously driven utilities to achieve immediate, universal acceptance. A key factor is that different suppliers are responding to varied client needs, which depend on a range of risk appetites and commercial business requirements of how data is used. There is no doubting the size of the task. Data services provider SWIFT has suggested that its 7,000 banking clients have more than 1 million individual relationships, meaning the number of KYC-related documents it is dealing with is a multiple of this. These records will need to be kept up to date as well. This is a major task, but with the potential goal so attractive, a solution is surely feasible.

A new approach is required. Each sector needs KYC utilities dedicated to their precise needs, yet few of the KYC utility providers have worked closely with potential clients to fully understand their needs. Fundsquare is talking to the fund industry about such possibilities. There needs to be greater harmonisation and more standards related to the required freshness and detail of data kept on the utility. Data templates and procedures need to be streamlined and best practice defined.

Given that movement in this area is so important to future profitability and even viability, the fund industry will need to seek greater consolidation and harmonisation. Industry players understand it is important to impose common standards at an early stage, and seek to nudge existing utilities towards greater cooperation. However, to really make a major step forward, the fund sector, legislators and regulators may need to take an imaginative leap to help build a utility which can serve the European and maybe even the global funds industry. Fundsquare, with its long experience providing mutualised utility services, is working on finding the inclusive, practical solutions the industry needs.

Yes, there are justified concerns about the financing of crime, and KYC rules are central to combating this. However, it is important not to lose sight of the major economic and social benefits of providing financial services, given that the vast majority of people are law-abiding. This is a particular concern in the developing world, and public and private actors might need to be bold.

Asset Servicing Times, issue 140

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