How many of these six FCA expectations for trade finance are you failing on?
The FCA and PRA have written to a number of firms who offer trade finance products reminding them of the regulatory expectations in relation to financial crime and credit risk management. Strongly alluding to scandals such as the one involving Greensill, they have reminded firms that there can be a significant level of money laundering, sanctions and fraud risk associated with trade finance.
It has been a busy preceding 18 months for trade finance related guidance. There have been numerous pieces of guidance issued by FATF on trade based money laundering scenarios and COVID related fraud risks, ongoing cases on trade based sanctions evasion in the US and more guidance from the Asia Pacific Group on Asian based regional trade based money laundering risks.
With all of this information available to firms, we have pulled out the key things that firms must do off the back of the FCA’s letter:
1) Ensure your risk assessment for trade finance is effective
In addition to the FCA and PRA’s observations we have also observed generic and high-level risk assessments of trade finance businesses through our work as skilled persons and with global monitorships. This isn’t the first time they have made this observation, and it was also included in TR13/3, the trade finance thematic on banks in 2013.
Often these assessments identify that trade finance is high risk but do not go into the actual reasons why, or:
consider actual risks or differentiate between different types of trade products (particularly the differentiated risk between documentary and open account facilities)
take into account different financial crime risks such as nuclear proliferation (through dual use goods exposure assessment), sanctions or fraud risks.
assess where controls may be missing (based on industry best practice and guidance)
Lots of the banks we help offer similar documentary trade instruments. The underlying risks posed by the types or locations of clients are different in every bank. Your risk assessment should capture the specific risks your firm faces whether that be a particular shipping route, sector or jurisdiction and the controls you have in place to mitigate those risks.
2) Assess your customer’s customers
The PRA and FCA have made the point that financial crime and credit analysis should also be performed on the other parties to a transaction not just the principal customer. This will put an additional burden of firms to assess both financial crime and credit concerns with entities that are not their actual customers.
Many firms we have helped will perform some form of ‘Know Your Customers’ Customers’ (KYCC) on parties to trade transactions, however the letter has made this requirement even clearer for firms. The FCA have stated that this additional due diligence is expected to enable the identification of unusual or unfeasible trading activity. Good practice should include at least the screening for sanctions and adverse media on all relevant parties.
While the FCA’s expectations are clearly set out in the letter, there is an additional risk that firms may bring into scope too many or not enough related parties for additional checks. We suggest that firms maintain a clearly documented process and rationale for identifying who is in scope for KYCC across all relevant scenarios.
3) Assess transactions on their own merits
While all trade finance firms are likely to perform some form of transactional due diligence , there remains a significant number of firms who are performing low quality and/or ineffective manual monitoring of trade transactions. Transactional risk assessments and red flag checking are called out as clear expectations of the FCA and PRA. This should be risk based and focused on higher risk products, customers, shipping routes and underlying goods. Where potential red flags are identified this should trigger additional checks such as price checking, vessel and voyage checking as well as enhanced due diligence and screening on parties to the transaction.
4) Ensure oversight of transaction processing teams
The letter also sets out clear expectations for oversight of trade operations teams. Firms will need to be able to evidence how first line teams ensure operational effectiveness of their transactional controls and how compliance team monitor this activity as well. We see lots of firms perform limited second- and third-line oversight of trade operations either due to a lack of product understanding, expert resource or the often-isolated nature of trade finance (and processing teams) within the commercial arms of larger firms.
5) Assess payment arrangements for transactions
In a clear nod to the Greensill scandal, the FCA and PRA have set out what they feel are prudent checks on the requirements for firms to get paid by clients’ end customers. This is reasonably straightforward for firms offering traditional documentary trade products but will be more involved for firms offering large scale receivables products where the exposure to end buyers is greater and the relationship is further removed from the primary client. We advise firms to revisit the exact payment terms they have for their trade facilities.
6) Get expert external advice
We have helped lots of banks and firms offering trade finance products with their financial crime arrangements. We have also delivered skilled person reviews on behalf of the FCA and NY DFS focusing on trade finance operations. Too often we see firms relying on generic risk assessments and reviews of often complex trade finance departments delivered by individuals who have limited product knowledge. Our in depth product knowledge, combined with our financial crime systems and controls experience places us above the competition in helping you get this right.
If you would like to discuss any of the above with our team who have extensive global experience in delivering a wide variety of trade related projects then please get in touch.
Oliver
