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The impact of regulation on KYC transformation

By Dr Henry Balani | May 16th 2022
The impact of regulation on KYC transformation | Encompass blog

Transformation projects mean changes to processes that are fundamental to any organization.

With Know Your Customer (KYC) transformation, onboarding and remediation processes must adhere to regulatory requirements to ensure anti-money laundering (AML) compliance. As part of customer onboarding, financial institutions (FIs) need to review potential customer details against sanctions lists to determine their eligibility status. In the EU, the 5th Money Laundering Directive ; in the UK the Money Laundering & Terrorist Financing Regulation; and in the USA the Bank Secrecy Act all require FIs to screen their customers to identify sanctioned entities, or risk enforcement action. As such, regulatory compliance is key to a KYC transformation project.

The role of technology

While regulations are the main driver for customer onboarding and remediation processes, technology enables KYC transformation projects. Technology continues to improve over time, with developments like Artificial Intelligence (AI), Machine Learning (ML) and Intelligent Process Automation (IPA) driving efficiency and reducing the cost of customer onboarding operations.

AI and ML have improved the accuracy of matching in the screening review process. FIs manually review false positives arising from inaccuracies in matching names to a sanction list, compounded when common names like Mohammad or Rodriguez are selected. When legacy search engines raise an alert from a close match, likely to be a false positive given the closeness of the spelling, it must still be reviewed. AI and ML ‘learn’ the profile of the customer base incorporating additional decision parameters to reduce false positives beyond inaccurate spellings and the manual review workload for the FI. Using IPA, tolerance thresholds can be further refined, with improved workflow processes to ensure matching decisions are clearly recorded for audit purposes. Deployment of this technology improves effectiveness and drives down compliance costs. KYC transformation initiatives leveraging technology can go a long way towards improving regulatory compliance.

The complexity of regulatory requirements provides both a barrier to and opportunity for KYC transformation. Countries like the USA use sanctions programs as a political pressure tool to change the behavior of rogue nations. An increasing number of entities are being added to the OFAC list and new rules require further identification of majority owned subsidiaries of sanctioned entities. This means compliance departments must now identify the sanctioned entity listed and all 50% or greater owned subsidiaries, even if they are not explicitly identified on the sanctions list, bringing regulatory need to identify the beneficial owners of a corporation, irrespective of the percentage ownership to determine their risk status.

FIs need to be able to ‘unwrap’ the corporate structure to determine the levels of subsidiaries and percentage of ownership down to the beneficial owner, including an actual individual where possible. Large corporations can have multiple holdings across multiple regions, requiring comprehensive investigation to reveal layers of ownership. Even smaller corporations can have a global footprint, with professional services groups forming partnerships with foreign firms. Here, technology can be leveraged to identify complex corporate structures and ownership trails more efficiently and effectively, as well as the beneficial owners of these firms.

The invasion of Ukraine by Russia has resulted in multiple, coordinated sanctions across the major Western powers, including the USA, UK and EU, who have imposed sanctions on Russian banks, corporations and individuals known to have supported the invasion. The sheer number and complexity of these sanctions has created significant complications for FIs’ AML programs.

As events change, FIs subject to western nations’ jurisdictions will have to continually monitor global news and stay alert for additional sanction activity that requires immediate incorporation into their compliance screening processes, or risk sanctions violations and negative impact on their public reputations.

These complexities make efficient identification of ‘bad guys’ difficult for compliance departments. Compliance processes will continue to be complex as sanctions are used as political tools across multiple jurisdictions. This highlights that KYC transformation projects incorporating new technology can play an important role in reducing the compliance burden.

Bring internal teams along with you

As in any transformation project, the human cultural element is key to the success of a KYC transformation project. As a failed project will directly impact reporting requirements, senior management and compliance teams are extra vigilant to increased risk when undergoing a project of this nature.

Another group of internal stakeholders that must ensure efficient successful compliance is IT and operations. The introduction of KYC transformation projects potentially disrupts traditional activity, which can threaten existing teams or provide advancement opportunities. Considering both dimensions is critical, given the regulatory implications around new processes.

There has already been extensive review and acceptance of existing compliance processes by external stakeholders, including regulators and auditors. This means any potential change, including improvements, will be treated cautiously. Without relevant buy-in and acceptance, transformation projects can fail – regardless of how innovative the technology is. There is also greater onus on ensuring regulators understand the scope and impact of projects, to reduce the risk of projects crashing to a halt, if not well understood by these stakeholders.

While KYC transformation projects offer significant benefits for FIs, there are additional regulatory aspects to consider here, when compared to other types of transformation projects and, while regulations may be the primary driver for these, implementing technology can have a positive material impact on compliance operations.

Read our whitepaper, Embracing KYC transformation, to find out more.

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Embracing KYC transformation

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Author: Dr Henry Balani

Dr. Henry Balani is Global Head of Industry and Regulatory Affairs at Encompass. He is a noted industry thought leader and commentator on Regulatory Compliance issues and trends affecting the financial services industry. As a published academic, Dr. Balani also lectures on international business, economics, and regulatory compliance courses globally. Dr. Balani holds a Doctorate in Business Administration from the University of Wisconsin, an M.B.A. from Northern Illinois University in the USA, and a B.S. in Economics from the London School of Economics.

LinkedIn Profile | Dr Henry Balani

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