The compliance problems that have been encountered by a number of European banks vividly illustrate the levels of diligence that must now be applied to trade finance and other banking operations, writes Kevin Godier.


Early August saw Standard Chartered run into accusations from New York regulators that it had hidden more than US$250bn across the course of some 60,000 illegal transactions with Iran for nearly a decade. A report from the New York State Department of Financial Services (NYSDFS) claimed that Standard Chartered moved money through its New York branch on behalf of Iranian financial clients that were subject to US sanctions – and that a Standard Chartered subsidiary in New York had also sought to do business with other US-sanctioned countries, including Libya, Burma and Sudan.

Standard Chartered – which agreed a reported US$340mn settlement to draw a line under the affair – is the sixth foreign bank since 2008 to be implicated in dealings with sanctioned countries in investigations led by federal and New York law enforcement officials. In June 2012, ING ran into the biggest-ever fine levied against a bank for sanctions violations, agreeing to pay US$619mn to settle allegations that it violated US sanctions against Cuba, Iran and other countries. Others to have fallen foul of US regulations include HSBC Holdings, Barclays, Lloyds, Crédit Suisse and the Dubai-based Noor Islamic Bank.

In addition to sanctions and the know-your-customer (KYC) requirements, there are also other challenges for financiers to address in the fight against fraud, anti-money laundering and terrorism financing, not least a swiftly expanding regulatory environment that is inserting itself increasingly into trade finance deals.

“Regulations in areas such as money laundering have increased to the extent that a whole new industry is being created, as banks are having to become more and more vigilant,” says Peter Sargent, head of transaction banking, Europe, at ANZ. “Very clear policies are needed so that banks are seen to be doing the right thing. Just as importantly, it is critical to document our actions accordingly,” he stresses.

Such is the sensitivity over compliance issues that many of the bankers approached for comment for this piece were unable to contribute, having been overruled by their global compliance departments.

“While compliance issues have long been accorded high priority by the vast majority of banks and other financial institutions, it would nonetheless probably be fair to say that recent developments have raised the profile of compliance issues to an even higher level,” says Robert Large, head of compliance at ABC International Bank (ABCIB). “It is increasingly evident that regulators are seeking to ‘raise the bar’ in terms of the minimum standard of compliance conduct they are expecting to see embedded within financial institutions, both large and small. It seems inevitable that banks and financial institutions will, as a result, face increasing pressures and obligations on the compliance front.”

Is this a resource drain? “Yes, there is a significant impact on resources, and the recent press regarding a certain bank’s money laundering breaches certainly doesn’t help the arguments to relax some of the requirements,” notes Martin Hodges, head of trade at Santander Corporate, commercial and business banking, who explains that the increasing compliance requirements usually means an increase in headcount and/or an increase in workload for existing teams.

He adds: “But it’s not just resources that are affected. Onerous compliance requirements have a negative impact on client service in terms of turnaround times – you don’t hear of ‘straight-through processing’ much these days in the trade finance arena. Also, rightly or wrongly, compliance teams can be viewed by the front line as ‘business prevention units’ so there can be internal tensions to manage.”

Large sees a distinct growth in compliance requirements. “It is certainly the case that the level of time and resources currently being devoted to compliance-related risks within financial institutions has become a significant one. It is now a material factor in business decisions. One might say that there has been an inexorable rise in the compliance costs of compliance.”

Another anonymous trade financier elaborates on this. “The critical issue is that there are so many new regulations, some of which are not yet fully drafted, while some do not dovetail completely with other existing regulations. It can therefore take time for staff to gain the requisite understanding and expertise that allows them to create and suitably deploy the most effective measures to ensure compliance. In addition to the significant human resource requirements, there are also substantial costs associated with developing the technology that will be needed to support these compliance requirements,” he says.

Crisis trigger

According to Sargent at ANZ, the advent of the global financial crisis, in 2007/08, brought about a sea-change in attitudes towards compliance. “Because of the education process that ANZ has put in place around compliance, the sales teams are now the first line of defence in the whole field of KYC, anti-laundering, due diligence and so on. We improve our staff with regular training plus an annual test, which they have to pass, so that when you get to a deal, it becomes obvious straight away whether it can be done, because our staff now understand which individuals, countries and industries are sanctioned. The case then goes to the professional compliance people who sit elsewhere in the bank, and are in turn connected to compliance bodies, such as the Financial Services Authority, as well as the legal profession. As a result, compliance fits very easily into our strategy in the business that we do.”

Where do banks turn for their initial advice? Large acknowledges that there is extensive information from both public and private sources with regard to, for example, sanctions regimes. “However, such is the complexity of sanctions-related compliance in particular – and indeed the extent of potential financial and reputational costs of even inadvertent non-compliance – that there has been a growing tendency for closer engagement with external professional legal opinion and expertise,” he says.

Sargent makes the point that KYC is “relatively easy when it comes to cargo on an Iranian vessel, but much harder when something falls into a grey area”.

He continues: “OECD markets are easier for KYC diligence, as are large customers, compared to small private entities. The most ticks in the box come when a company has disclosure via its investment grade, public ownership and is multi-banked. We also understand the markets and people in places where we are represented particularly well, especially the regions of Australia, New Zealand, Pacific and Asia.”

Another trade financier concurs that the level of difficulty of KYC is to a certain degree related to a bank’s business model. “With the exception of our home markets in Europe, we are mainly focused on large corporate and FI clients in markets we have identified as core to our business. This in no way diminishes the importance of KYC, but because our clients tend to be larger, more well-known, and in countries we have determined to be core, KYC has not been materially more difficult for us,” he remarks.

The local operating and regulatory environments are key governors of the level of difficulty involved in due diligence, says Large. “KYC in parts of the CIS can perhaps be just as challenging as in Sub-Saharan Africa. Generally speaking though, emerging market jurisdictions can certainly at times present real compliance challenges in terms of obtaining an acceptable standard of due diligence information at both a relationship and transactional level,” he stresses. “Even in some of our core Middle East and North Africa markets, information can be difficult to come by, although where we have a physical presence, we are able to seek the assistance and use the knowledge of our local offices to good effect.”

Fatca advent

One major new regulatory challenge looming on the horizon is the US’ Fatca (Foreign Account Tax Compliance Act) that kicks in on January 2013, and will require foreign banks to report and disclose the US interests that they hold, allowing Washington to determine the ownership of US assets in foreign accounts, and any accompanying tax avoidance. In essence, Fatca will impose withholding on certain payments to non-US financial institutions unless they participate in a US reporting and withholding regime, or qualify for an exemption. Asset manager BlackRock has predicted that Fatca is setting up the framework for a global tax system which other countries could then implement, costing financial institutions billions of dollars in compliance and updates to computer systems.

Given that Fatca will affect deals where, for example, European bank syndications are lending into the US against the collateral of commodities held within the US, banks have already begun expending sizeable amounts of time and resources to understand the Fatca law and its implications. “This is a complex and far-reaching body of regulation that requires significant investment, not only in the development of understanding of the law and its requirements, but also in developing the technology and infrastructure required to facilitate proper monitoring and enforcement,” says one financier.

“We are aware of Fatca; as a disclosure and withholding regime it’s a big issue with a lot of global scope affecting account opening, money transmission and KYC, as well as collateralised cross-border trade,” adds ANZ’s Sargent. “The US regulators are being very specific in their requirements, and our teams are examining this and preparing to meet the December 31 deadline.”

Market observers say that one of the key challenges posed by Fatca requirements is the potential conflict between the provision of details to the US’ Internal Revenue Service (IRS) and local jurisdictional laws on data protection and confidentiality. The IRS has engaged with a number of jurisdictions on this issue, including France, Germany, Italy, Spain and the UK, and recently published model intergovernmental agreements, the concept being that the exchange of information will be at government-to-government level, thus overcoming data protection and confidentiality legal conflicts. These agreements are being reviewed by the market but there continues to be ongoing issues around confidentiality, for example the confidentiality terms in contracts between financial institutions and their clients.

“Undoubtedly, Fatca will impact on trade and commodity finance models and the immediate necessity is that market participants engage with their legal and compliance advisors to ensure they fully understand the potential impact,” recommends Mike Johnstone, director of the London-based Loan Market Association.

In South Africa, a lawyer specialising in trade finance says that the country’s domestic banks are relatively sheltered from Fatca by virtue of not lending in US dollars. “The local banks have always been very strongly regulated here, rather than internationally, but we ensure that our clients are very heavily aware of the foreign exchange regulations linked to funding in rand,” he says. “Although local banks would obviously have to be aware of Fatca, if dealing with US-based clients, two banks in the local market have told me that they are not focusing on this,” he adds.

A clause too far?

So are compliance practices excessive? “I firmly believe that if you ask anyone involved in providing a trade service to a client they will say that compliance practices are excessive, onerous and cumbersome… but they will also say they are necessary, particularly for high-risk jurisdictions,” reflects Hodges at Santander Corporate.

“But we have to strike a balance between acceptable fraud and money-laundering prevention measures and acceptable client service levels. I fear that the relationship between the two is progressively becoming unbalanced, particularly in the world of trade finance where the opportunities to identify and therefore prevent fraud and money-laundering present themselves more readily than, for example, clean international payments,” he adds.

Sargent admits that he has steadily become a pro-compliance advocate. “At a time when the Libor scandal is the latest event to tarnish the banking world, anything that gives our industry its reputation back is to be welcomed and is vitally important,” he contends.

As various new regulatory regimes bed down, “it will be important to measure the real impact of these measures on economic and other key data in markets where trade is a key growth engine, before potentially looking again at the overall effectiveness of the compliance universe”, surmises another banker.