AML, KYC & Blockchain – Assisting the Compliance Officer!
Today’s Compliance Reality
If anyone of you have access to a compliance and money laundering reporting officer, ask them, what is their greatest nightmare? Their answer – the handling of the perfect storm of challenges in today’s regulatory environment. The level of unprecedented uncertainty, risk and the complexity of transactions coupled with the need to find robust solutions towards the adherence to anti-money laundering and funding of terrorism and regulatory legislation, is tantamount to climbing the tallest mountain known to man.
Anti-Money Laundering (AML) and the risk of fraud has dramatically increased over time. The need of effective identity management systems is real. Legacy systems are no longer the solutions, yet not everyone sees the need to invest, which does not help the cause. The time has however come to eliminate stop-gap solutions and implement a robust compliance and AML system.
Are Blockchain Technologies and Compliance Compatible?
Blockchain and compliance are a potential match made in heaven. Is this the reality?
Compliance officers, make use of isolated systems, which store information, just like our ancestors stored wheat – in a silo. Social media giants for example provide centralised servers which are full of valuable information, making them very attractive and valuable for hackers.
This has led to identity theft and fraud. The introduction of the EU General Data Protection Regulation (GDPR) is already reflecting widespread concerns regarding privacy issues.
In an ever increasing interconnected, borderless and digital world, one of the biggest issues being faced by compliance officers is identity management.
Large volumes of transactions are happening on a continuous basis. The number of digital payments (just to mention an example) could very well reach 726billion by 2020. The volume of information and concerns about privacy will reach dazzling heights.
Clients are getting frustrated in using multiple systems and solutions. The want to deal with a single seamless solution, whilst at the same time be sure that their privacy is maintained.
Can the latest technology on everyone’s mind, tongue and heart help? Can blockchain and DLT solutions and eventually artificial intelligence help the compliance function?
The answer may very well be yes.
The inherent nature of blockchain and DLT is that of being a decentralised infrastructure. It is not controlled by a central body or authority. By placing one’s digital identity on the blockchain, this gives the owner of such information, control, ownership and responsibility of such. The focus of trust is shifted onto an immutable database.
In doing so companies will no longer need to obtain, verify and store identity information. They will be able to access a specific distributed ledger (permissioned/hybrid) which would contain such information. Information which is updated on the fly and is immediately available!
Can the Compliance Officer go on holiday?
At EU Level a study is being undertaken in relation to virtual currencies and terrorist financing to assess the risks and evaluating responses. In the meantime, the 5th AML Directive has been introduced. It encompasses crypto currency exchanges and providers of electronic wallets for virtual currencies such as Bitcoin, Ether or Ripple throughout Europe as subject persons.
An Australian watchdog stated that cryptocurrency fraud is now the second most common investment scam in Australia.
The United States has set up a task force between the SEC, DoJ & CFTC to provide guidance for investigations, as well as recommending ways to improve cooperation amongst the agencies.
The compliance officer may have to face more sleepless nights, rather than a holiday on some tropical island, if no action is taken.
Yet, through the introduction of a blockchain AML/KYC system, compliance officers could eliminate several manual processes. Information on ones identify would already exist on an immutable and secure distributed ledger. Such shared ledger would also eliminate the costly processes of reconciling data, reduces duplications of information and human error.
Other documentation, such as certificates, or certified true copies of standard KYC documentation, could be readily available at the click of button. Why? It is already on the blockchain – uploaded by recognised parties making using of the shared ledger. This would significantly reduce the time spent on undertaking mundane compliance checks. It facilitates the client onboarding process as well as client experience. The client would not need to reproduce the same documentation, certified, stamped and notarised several times for different reasons.
Through the use of smart contracts, which are hard-coded with specific rules, companies can ensure compliance through automated means with a number of different regulations. Such smart contracts would then be able to provide compliance teams with reports of suspicious transactions, based on the pre-set parameters encoded in the smart contract. Automatic Suspicious Transaction Reports (STRs) could also be generated for review and filing to the Financial Intelligence Units by the MLRO.
Can Blockchain enhance regulatory reporting?
Basel II, PSD2 MiFID2, GDPR, Dodd-Frank, BRRD are a mouthful and just a handful of the numerous regulations in force. Such laws, require banks as well as other financial institutions to direct significant non-fee generating resources towards ensuring ongoing compliance with their requirements. Globalised firms, will face differing regulations & requirements making the situation even more complex.
The aggregation & automation of large volumes of information required by regulators is not only time consuming, it is also problematic! Many firms are faced with disparate legacy IT systems and stone age record keeping mechanisms.
Blockchain & DLT solutions may provide the sweetener to the pains of both regulatory bodies and industry participants. By having transactions documented and time-stamped on a distributed ledger (blocks are linked together through the previous and current hash) a perpetual audit trail is readily available. Whilst compliance officers will have an automated system alerting them to any unusual transactions, the technology could also allow regulators to have access to real time information.
This would revolutionise the communication of regulatory reporting as we know it today.
From an industry perspective, it could lead to significant cost savings, and the redeployment of resources to better serve the needs of their clients.
From a regulatory perspective, such reporting could give regulatory authorities an immediate picture of the economic direction being taken by an industry or an economy as a whole. This could allow the regulator to visualise signs of systemic risks and enact stabilising mechanisms with near foresight information, rather than with historical data. A game changer for the industry which would lead to increased investor confidence and sentiment.
We are living in a world which is totally different and is rapidly evolving. The risks, uncertainties and complexities of today’s world are poles apart from what our forefathers experienced 100 years ago.
Mankind is now digital man. Interconnected, dependent on his technology which communicates at the speed of light. A blip in one ecosystem has a domino effect on all others. The financial crisis of 2008 was a timely reminder. The crisis of the future may very well arise due to our inability to make good use of existing technologies for their prevention.
Businesses can avert the next crisis by allowing compliance and AML officers to concentrate on the real-world problems, rather than the tedious but necessary checks. The reduction of manual processes, safeguarding of privacy and data, and real-time regulatory reporting would result in significant benefits throughout. Compliance can be, an intelligent tool rather than a ball and chain.Author: Nicholas Warren
This article has been authored by Nicholas Warren – Senior Manager Financial Services and Blockchain. He holds over 16 years of consultancy experience to international clients on the various possibilities presented by Malta as a Financial Services Centre.
For more information please do not hesitate to contact our Fintech Team at email@example.com or +356 2557 2557.