A year has passed since the FCA levied the largest fine in its history against Deutsche Bank. The bank was fined over failings in its anti-money laundering controls relating to a series of 'mirror trades' originating in Russia. Despite the FCA's continuing focus on the topic, firms continue to find it hard to show they can detect and prevent similar activity. Mirror trading activity which spans legal entities and jurisdictions remains highly complex and difficult to monitor.
Last year, the FCA requested information from a number of firms regarding their controls around mirror trading. The Regulator has also stressed repeatedly that it expects market abuse and financial crime to be addressed together, and that they have no qualms in investigations.
Any firm with a regional or global footprint, or who employs remote booking or regional/global booking models should be revisiting their AML and market abuse controls to make sure they are not exposed to mirror trades.
Mirror trading is effectively a type of wash trading, a well-known form of manipulation which can be used to give the market a misleading impression around the liquidity, volume and supply of a financial instrument. It involves trading between two different legal entities. One of the entities buys and the other sells the same number of financial instruments at the same time, giving the impression that the transaction is undertaken by two different parties. In reality, the beneficial owner of both legs of the transaction is the same. The transaction is only conducted to mislead.
With mirror trading, the wash trade is conducted across two jurisdictions, and two legal entities of a financial institution, to further obfuscate the true ownership of the financial instruments. Those seeking to launder money effectively take advantage of the complex intra-group booking arrangements, such as remote booking or regional booking models, to maximise their chances of transferring funds out a jurisdiction without detection.
Even if your processes are up to scratch in each of your legal entities you might not be able to detect mirror trading, especially where different entities are involved, and remote booking is used. You need to look at all aspects of the process together, from governance, onboarding policies and procedures, data standards and monitoring capabilities.
The greatest challenge presented by mirror trading is a need to connect the dots between clients of different legal entities and jurisdictions. This is the weakness that mirror traders seek to exploit – firms typically can't identify that clients across different legal entities may be the same individual or have the same ultimate beneficial owner.
Client and transaction data must be compatible to allow joint monitoring. Even the best technology, becomes redundant if data cannot be reconciled.
Even where data is compatible and systems can spot wash trading it's vital that clients KYC information is available to the surveillance teams to connect and assess the identity of the ultimate beneficial owner. Ideally all information should be stored in a format accessible to all entities with linked transaction.
In the UK, pressure on senior managers is rising with the SM&CR regime and they are increasingly aware of the need to understand risk exposure. Firms are also expected to complete an anti-money laundering risk assessment and to have procedures and controls to mitigate the risks posed by operations, products and clients.
But, the level of senior management engagement with AML issues may vary across jurisdictions. To combat mirror trading, all legal entities must take a consistent approach to AML controls, and promote the sharing of information and intelligence. And where remote booking and regional booking centres are used, there should be clear ownership of cross-jurisdiction AML risk. This will incentivise senior management to pursue the alignment of monitoring required to detect and prevent mirror trades.
Often, global policies and procedures set a minimum standard, allowing individual entities to tailor locally. This can create differences in onboarding processes, and is likely to result in differences in how transactions are monitored and data is collected.
An incomplete picture of the transaction and the clients' profile, makes it even more challenging for firms to connect the dots between cross border transactions and identify misbehaviour, and therefore opening up opportunities for criminal behaviour. Where remote booking takes place, the most stringent frameworks should be applied across all entities.
Under the 2017 Money Laundering Directive simplified due diligence can only be applied where the client has been rated as low risk, taking into account risk factors, such as country risk rating and the client risk assessment.
Firms often place undue reliance on a client's country of incorporation or regulated status when assessing the risks, often leading to regulated entities or entities incorporated in the EU or US to be deemed low risk. An appropriately weighted multi-factor client risk assessment should be used. At a minimum this should consider: client/entity type, country exposure, product/service, industry of operation; and delivery channel.
Another complication is the reliance of many firms on outsourced or offshore onboarding services resulting in a lack of clarity in client ownership which can prevent a holistic view of the client's risk profile.
To combat mirror trading, you need to keep on top of every part of AML control framework, from onboarding to monitoring, and ensure close alignment between different subsidiaries and branches who are part of the overall trade workflow. Investing in an effective framework will work out far less expensive than a fine from the Regulator.
Bovill has expert teams in both market abuse and anti-money laundering with wide international experience. Get in touch to find out more.