A centralised system
06 December 2022
The Know-Your-Client process is the backbone of a successful compliance and risk management programme, but market participants are voicing concern over the labour-intensive process. Transparency, centralisation and automation are key to tackling the complexity of KYC, writes Carmella Haswell
Image: stock.adobe.com/Kenjo
The Know-Your-Client (KYC) process is a major barrier to entry in the securities lending space. With limited tech dollars to tackle the complexity of the KYC process, it remains imperative for firms to prioritise automation to boost the efficiency of the lifecycle. “Unless firms start focusing on post-trade and onboarding, we are not going to grow this industry,” warns Andy Krangel, director of agency securities finance at Citi Securities Services.
Seventy-one per cent of market participants believe the KYC process needs fixing, according to a poll taken at the International Securities Lending Association (ISLA) AGM & 12th Annual Post-Trade Conference. This is one area of the securities lending lifecycle, respondents indicate, that is in desperate need of attention.
The introduction of new regulations — including the Securities Financing Transactions Regulation (SFTR) and the European Market Infrastructure Regulation (EMIR) — and pressure from geopolitical events, such as Brexit and sanctions imposed during the Russia-Ukraine conflict, has led to banks moving toward an increasingly centralised KYC function across asset classes and jurisdictions. This wave of evolution has largely passed by the securities lending sector, primarily due to idiosyncrasies unique to the industry, according to ISLA’s whitepaper, The Future of the Securities Lending Market: On the Cusp of Transformation.
This missed opportunity has proven to be costly when comparing the experiences of new regulations for derivatives to securities lending. While recognising the differences in data collected prior to transaction reporting for Dodd-Frank Rewrite and SFTR, the derivatives industry took the opportunity to centralise and standardise counterparty data sets, while the securities lending industry could not. As a result, the cost of data collection was upwards of five times greater per client in preparation for SFTR.
While, arguably, the securities lending sector is lagging behind the derivatives market in this respect, it is now looking to address this deficit.
The backbone of compliance
KYC standards are designed to protect financial institutions against fraud, coruption, money laundering and terrorist financing. This embraces a set of processes that allow banks and other financial institutions to confirm the identity of an organisation and individuals they do business with, and ensures those entities are acting legally.
Unfortunately, the securities lending market is faced with a higher degree of complexity compared to other segments, says Fenergo’s chief strategy officer Stella Clarke. For instance, a large number of securities providers or custodians may be based in a jurisdiction which is a hotspot of financial crime and, therefore, have to deal with more complex investor arrangements, as well as evolving regulatory environments.
A number of firms have been hit with fines in the past few years for not applying appropriate KYC procedures. Commerzbank AG, for example, was fined £37, 805, 400 by the Financial Conduct Authority (FCA) after “failing to put adequate anti-money laundering (AML) systems and controls in place between October 2012 and September 2017”.
The FCA’s investigation of Commerzbank identified a failure to “conduct timely periodic due diligence on its clients, which resulted in a significant number of existing clients not being subject to timely know-your-client checks”.
ABN AMRO also fell short of regulators’ expectations and agreed a €480 million settlement with the Dutch Public Prosecution Service (DPPS) in April 2021, following “serious shortcomings” in ABN AMRO's processes to combat money laundering in the Netherlands, including the client acceptance, transaction monitoring and client exit processes in the period between 2014 and 2020.
“Compliance and regulation are everything, you have to follow that before you onboard,” says Krangel. “You cannot just start trading with someone, you have to make sure they have the authority to lend, you have to deal with credit risk and documentation on both the borrower and lender side. You have to go through all of these loops internally to make sure you are meeting every piece of regulation.”
Clarke indicates that the KYC process is incredibly time-consuming and cumbersome for securities providers. In cases where digitalisation solutions are not deployed for continuous compliance monitoring, this can make it difficult to spot changes in circumstances and lead to “down-stream compliance impacts”.
Until necessary standards are agreed and adopted across the market, KYC evaluation is likely to remain a manual and labour-intensive process.
She adds: “Our recent research describes a function that is highly manual and people-driven with risk of human error. In this case, KYC compliance becomes more of a tick-box exercise than an effective approach to financial crime prevention.”
Reviewing the current state of the KYC process, Sharegain’s head of operations Matthew Barnett says: “Right now, the KYC process is a major barrier to entry in the securities lending space — not because of any regulatory implications or potential for the underlying beneficial owners to participate in this market, but because of the inefficiency and time it takes to conduct the onboarding process.”
Barnett says KYC should not be “one-hat-fits-all”, despite being treated as such. Whether a firm is onboarding a new custody account or opening a new securities lending account, the KYC process is the same, but the two exhibit different considerations. “It should be defined by the activities intended under any new relationship — and provided with definition from compliance and regulators which is currently too opaque and open to interpretation.”
The transition period
As a provider of vendor solutions S&P Global Market Intelligence indicates that it is important to centralise KYC information and to improve coordination across business areas and systems. Lansing Gatrell, managing director of risk and compliance at S&P Global Market Intelligence, explains that information needs to be centralised in a location that is interoperable with other services and client systems. In terms of speed, he indicates that the average time to onboard an account using centralised tools was 15 days, while accounts not using those services took 80 days to onboard.
Completing KYC checks on all customers and entities has proven to be a costly burden for financial institutions. Adding to this burden, KYC checks are not a one-time affair. Firms must contact their customers frequently to request KYC information as company details and regulations evolve.
SWIFT, the Brussels-based financial messaging network and technology specialist, indicates that the creation of a central KYC registry may be an important step forward in improving the efficiency of KYC validation. The registry would store up-to-date, necessary KYC information for a business, where an institution could log into and consume the data they need at any time.
The challenge for the industry, similar to other industries, is that there is “so much to be fixed”, and that firms cannot “fix this in isolation”, according to Krangel. Although steps to improve this stage of the lifecycle will make the system more efficient overall, the industry should focus on the whole process and decide if it needs to be re-engineered from start to finish.
Krangel says: “We are all on different systems and the complexity of clients being on different systems means vendor solutions that link systems are key. The industry needs globally consistent processes.”
Market participants and vendors could utilise a single repository as a golden source of truth, utilising the information to conduct the necessary KYC checks and balances defined by the services they are intending to provide, suggests Sharegain’s Barnett.
“The single repository and a common adoption of standards then shift the conversation into the digital space – at that point, we can begin to look at real automation and improved efficiency in KYC and the benefits and wider participation that will bring,” he advocates.
Following this train of thought, S&P Global Market Intelligence’s Gatrell says that making data shareable across platforms, thereby removing the need for firms to manually insert the data themselves, would improve the system. “We are all competitors, so it needs to be done in a way that is not anti-competitive, but ‘success’ is impossible without it,” he says.
Providing solutions
A push from clients, and encouragement from borrowers and lenders, is likely to be the catalyst that will help drive through changes to the current KYC process.
For the time being, firms are providing their own solutions to aid their clients in navigating this complex process. Speaking to SFT, Gatrell says S&P Global Market Intelligence is tackling the issues surrounding the KYC and onboarding process through two initiatives.
Firstly, the firm added functionality to its Onboarding Accelerator tool that is specific to securities lending, masking client names from the front office while enabling trading desks to prioritise accounts for onboarding. Secondly, the firm integrated the Onboarding Accelerator tool into its securities finance service to allow borrowers to review a lender’s credit rating and equity inventory alongside onboarding documentation.
“Sending a portfolio of documentation and then not hearing anything for months is incredibly frustrating and creates a poor first impression – whatever way you look at it,” Barnett explains. “[Sharegain] are now looking at partnering with and developing in-house supporting solutions in this space that can create a better first impression – supporting trust and transparency – while meeting this incredibly important regulatory provision.”
Clarke says the current economic climate has put “an even greater emphasis” on cost control. In turn, more financial institutions are looking for ways to streamline the client lifecycle process to drive much needed efficiencies.
Fenergo’s automated regulatory rules engine aims to reduce through-put rates, which is expected to lead to higher conversion rates and reduction in onboarding costs. “Our KYC solution incorporating perpetual KYC (Smart Review) removes the complexity from KYC for the onboarding and maintenance of funds and investors for securities providers and custodians. This ultimately improves operational efficiencies, improves client experience while reducing operating costs and regulatory risk,” Clarke explains.
“At the risk of sounding like a broken record, [the next step] is product interoperability,” Gatrell concludes. “Without this, there will be islands of efficiency (onboarding, legal negotiation, trading and settlement) separated by seas of manual intervention, thereby making automation impossible.
“It took the derivatives industry a decade to achieve the onboarding efficiencies of today. But [by] leveraging the same tools, the securities lending industry could replicate this in a few years.”
Seventy-one per cent of market participants believe the KYC process needs fixing, according to a poll taken at the International Securities Lending Association (ISLA) AGM & 12th Annual Post-Trade Conference. This is one area of the securities lending lifecycle, respondents indicate, that is in desperate need of attention.
The introduction of new regulations — including the Securities Financing Transactions Regulation (SFTR) and the European Market Infrastructure Regulation (EMIR) — and pressure from geopolitical events, such as Brexit and sanctions imposed during the Russia-Ukraine conflict, has led to banks moving toward an increasingly centralised KYC function across asset classes and jurisdictions. This wave of evolution has largely passed by the securities lending sector, primarily due to idiosyncrasies unique to the industry, according to ISLA’s whitepaper, The Future of the Securities Lending Market: On the Cusp of Transformation.
This missed opportunity has proven to be costly when comparing the experiences of new regulations for derivatives to securities lending. While recognising the differences in data collected prior to transaction reporting for Dodd-Frank Rewrite and SFTR, the derivatives industry took the opportunity to centralise and standardise counterparty data sets, while the securities lending industry could not. As a result, the cost of data collection was upwards of five times greater per client in preparation for SFTR.
While, arguably, the securities lending sector is lagging behind the derivatives market in this respect, it is now looking to address this deficit.
The backbone of compliance
KYC standards are designed to protect financial institutions against fraud, coruption, money laundering and terrorist financing. This embraces a set of processes that allow banks and other financial institutions to confirm the identity of an organisation and individuals they do business with, and ensures those entities are acting legally.
Unfortunately, the securities lending market is faced with a higher degree of complexity compared to other segments, says Fenergo’s chief strategy officer Stella Clarke. For instance, a large number of securities providers or custodians may be based in a jurisdiction which is a hotspot of financial crime and, therefore, have to deal with more complex investor arrangements, as well as evolving regulatory environments.
A number of firms have been hit with fines in the past few years for not applying appropriate KYC procedures. Commerzbank AG, for example, was fined £37, 805, 400 by the Financial Conduct Authority (FCA) after “failing to put adequate anti-money laundering (AML) systems and controls in place between October 2012 and September 2017”.
The FCA’s investigation of Commerzbank identified a failure to “conduct timely periodic due diligence on its clients, which resulted in a significant number of existing clients not being subject to timely know-your-client checks”.
ABN AMRO also fell short of regulators’ expectations and agreed a €480 million settlement with the Dutch Public Prosecution Service (DPPS) in April 2021, following “serious shortcomings” in ABN AMRO's processes to combat money laundering in the Netherlands, including the client acceptance, transaction monitoring and client exit processes in the period between 2014 and 2020.
“Compliance and regulation are everything, you have to follow that before you onboard,” says Krangel. “You cannot just start trading with someone, you have to make sure they have the authority to lend, you have to deal with credit risk and documentation on both the borrower and lender side. You have to go through all of these loops internally to make sure you are meeting every piece of regulation.”
Clarke indicates that the KYC process is incredibly time-consuming and cumbersome for securities providers. In cases where digitalisation solutions are not deployed for continuous compliance monitoring, this can make it difficult to spot changes in circumstances and lead to “down-stream compliance impacts”.
Until necessary standards are agreed and adopted across the market, KYC evaluation is likely to remain a manual and labour-intensive process.
She adds: “Our recent research describes a function that is highly manual and people-driven with risk of human error. In this case, KYC compliance becomes more of a tick-box exercise than an effective approach to financial crime prevention.”
Reviewing the current state of the KYC process, Sharegain’s head of operations Matthew Barnett says: “Right now, the KYC process is a major barrier to entry in the securities lending space — not because of any regulatory implications or potential for the underlying beneficial owners to participate in this market, but because of the inefficiency and time it takes to conduct the onboarding process.”
Barnett says KYC should not be “one-hat-fits-all”, despite being treated as such. Whether a firm is onboarding a new custody account or opening a new securities lending account, the KYC process is the same, but the two exhibit different considerations. “It should be defined by the activities intended under any new relationship — and provided with definition from compliance and regulators which is currently too opaque and open to interpretation.”
The transition period
As a provider of vendor solutions S&P Global Market Intelligence indicates that it is important to centralise KYC information and to improve coordination across business areas and systems. Lansing Gatrell, managing director of risk and compliance at S&P Global Market Intelligence, explains that information needs to be centralised in a location that is interoperable with other services and client systems. In terms of speed, he indicates that the average time to onboard an account using centralised tools was 15 days, while accounts not using those services took 80 days to onboard.
Completing KYC checks on all customers and entities has proven to be a costly burden for financial institutions. Adding to this burden, KYC checks are not a one-time affair. Firms must contact their customers frequently to request KYC information as company details and regulations evolve.
SWIFT, the Brussels-based financial messaging network and technology specialist, indicates that the creation of a central KYC registry may be an important step forward in improving the efficiency of KYC validation. The registry would store up-to-date, necessary KYC information for a business, where an institution could log into and consume the data they need at any time.
The challenge for the industry, similar to other industries, is that there is “so much to be fixed”, and that firms cannot “fix this in isolation”, according to Krangel. Although steps to improve this stage of the lifecycle will make the system more efficient overall, the industry should focus on the whole process and decide if it needs to be re-engineered from start to finish.
Krangel says: “We are all on different systems and the complexity of clients being on different systems means vendor solutions that link systems are key. The industry needs globally consistent processes.”
Market participants and vendors could utilise a single repository as a golden source of truth, utilising the information to conduct the necessary KYC checks and balances defined by the services they are intending to provide, suggests Sharegain’s Barnett.
“The single repository and a common adoption of standards then shift the conversation into the digital space – at that point, we can begin to look at real automation and improved efficiency in KYC and the benefits and wider participation that will bring,” he advocates.
Following this train of thought, S&P Global Market Intelligence’s Gatrell says that making data shareable across platforms, thereby removing the need for firms to manually insert the data themselves, would improve the system. “We are all competitors, so it needs to be done in a way that is not anti-competitive, but ‘success’ is impossible without it,” he says.
Providing solutions
A push from clients, and encouragement from borrowers and lenders, is likely to be the catalyst that will help drive through changes to the current KYC process.
For the time being, firms are providing their own solutions to aid their clients in navigating this complex process. Speaking to SFT, Gatrell says S&P Global Market Intelligence is tackling the issues surrounding the KYC and onboarding process through two initiatives.
Firstly, the firm added functionality to its Onboarding Accelerator tool that is specific to securities lending, masking client names from the front office while enabling trading desks to prioritise accounts for onboarding. Secondly, the firm integrated the Onboarding Accelerator tool into its securities finance service to allow borrowers to review a lender’s credit rating and equity inventory alongside onboarding documentation.
“Sending a portfolio of documentation and then not hearing anything for months is incredibly frustrating and creates a poor first impression – whatever way you look at it,” Barnett explains. “[Sharegain] are now looking at partnering with and developing in-house supporting solutions in this space that can create a better first impression – supporting trust and transparency – while meeting this incredibly important regulatory provision.”
Clarke says the current economic climate has put “an even greater emphasis” on cost control. In turn, more financial institutions are looking for ways to streamline the client lifecycle process to drive much needed efficiencies.
Fenergo’s automated regulatory rules engine aims to reduce through-put rates, which is expected to lead to higher conversion rates and reduction in onboarding costs. “Our KYC solution incorporating perpetual KYC (Smart Review) removes the complexity from KYC for the onboarding and maintenance of funds and investors for securities providers and custodians. This ultimately improves operational efficiencies, improves client experience while reducing operating costs and regulatory risk,” Clarke explains.
“At the risk of sounding like a broken record, [the next step] is product interoperability,” Gatrell concludes. “Without this, there will be islands of efficiency (onboarding, legal negotiation, trading and settlement) separated by seas of manual intervention, thereby making automation impossible.
“It took the derivatives industry a decade to achieve the onboarding efficiencies of today. But [by] leveraging the same tools, the securities lending industry could replicate this in a few years.”
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