Trade Compliance in the Financial Services Sector
Entitles involved in proliferation must access the international financial system to conduct trade and access services, just like legitimate businesses do. The primary function of proliferation financing controls is to deny known proliferators access to such services. The secondary purpose is to detect illicit proliferation financing. Compliance with proliferation financing is usually implemented through banks existing financial crimes and anti-money laundering systems which include entity screening and due diligence measures.
Recognising the importance of financial services in the conduct of both legitimate and illicit business governments have long required banks to implement measures to combat financial crime and money laundering. Increasingly since the beginning of the “War on Terror”, authorities have required financial institutions to implement sanctions against individuals and entities known to be involved in activities of concern.
Sanctions in this context include a range of measures. At the UN level sanctions are adopted against individuals involved in terrorism, human rights abuses, and WMD proliferation. These measures are amplified in many capitals around the world. Also at the national level are economic sanctions adopted against countries such as Iran. Sanctions encompass a range of measures from denying access to services to freezing bank accounts. Sanctions may also prohibit the financing of certain activities, such as the financing of investment in Iran’s oil and gas sectors to give one specific example.
Financial services organisations are required to implement a broad range of trade compliance measures, from anti-money-laundering to due diligence. To meet these obligations, banks in particular usually have a well-developed compliance function which includes an extensive designated entity screening system. Trade compliance measures are usually implemented through this system.
Primarily to comply with money laundering regulations, banks usually conduct due diligence to confirm clients bona fides. For personal back accounts this may include verifying a client’s identification papers, whereas for business accounts this may include verifying a business’s registration, premises, or credit score.
Compliance in action
The structure of a bank’s compliance system may vary significantly depending on the size and structure of the bank. Nonetheless, banks usually appoint a ‘head of compliance’ who oversees the function of compliance. This individual may oversee elements of the compliance function based elsewhere in the bank. For example, the designated entity screening is usually centralised in a specific country to leverage IT expertise. The due diligence function is usually dispersed throughout the bank's operations, perhaps with a functional head in each operating jurisdiction.
Banks may deal with hundreds of thousands of accounts each day. To ensure that banks do no clear a transaction to an entity of known proliferation concern, the bank must implement a “designated entity screening system” whose purpose is to identify matches between account holders and listed entities.
There are numerous lists of suspect entities. The following page (see below) provides a link to most relevant lists. Banks usually opt to integrate all lists even when they do not operate in the issuing jurisdiction.
Entity screening is an imprecise system. It is good practice to incorporate fuzzy logic and phonetic matching into screening systems. This inevitably results in false positives – potential matches that when investigated prove not to link the transaction with a designated entity. It is typical for the rate of false positives to exceed 2%, thus potentially requiring thousands of manual checks per week.
Certain restrictions are activity-based and thus require banks to know more than the bona fides of account holders. Examples include banks on investment in Iran’s oil and gas sectors. To fully comply with such restrictions, banks typically require clients to answer questionnaires about their business.
Banks are encouraged to reveal suspicions about illicit financing. In the non-proliferation sphere, this could include where firms provide credentials that prove to be false or attempted transactions that were in fact prohibited.