Strengthen AML risk management by learning the story of clients

_{Nick Morgan, Head of Legal Professionals Sales • December 5 2023}

There’s a shift in client onboarding that’s been happening for a while — firms are moving away from surface-level due diligence and taking a more comprehensive approach. They’re delving into the story behind database hits and adverse media. Why? To give it context, pinpoint the underlying risks, and effectively manage them.

The shift is driven by the ever-increasing pressure to boost KYC and AML due diligence efforts. In 2022, AML fines surged by 50% compared to the prior year, reaching nearly $5 billion for banks and financial institutions. These penalties stemmed from AML practice violations, sanctions breaches, and deficiencies in Know Your Customer (KYC) systems.

Compliance now demands more than ticking a box — it needs a nuanced understanding of each client’s situation. Having an in-depth understanding of every client also protects your firm’s reputation. By thoroughly assessing the risks associated with them, you can avoid being associated with illicit activities or unethical practices that might emerge later on.

Fast-changing regulations

Firms face constantly evolving regulatory expectations, particularly in AML compliance. Client risks can easily evolve with them. These changes can be sudden, making it difficult for firms to keep up. Some recent changes include:

The UK

Significant amendments to the Money Laundering and Terrorist Financing Regulations (MLRs) came into effect a couple years ago. These changes include:

• Management of Proliferation Financing Risk: New measures incorporate the FATF’s standards to mitigate the risk of proliferation financing, which involves the provision of funds for the development of weapons of mass destruction​​.
  
• Expanded Supervisors’ Powers: AML/CFT supervisors have been granted the right to view the contents of Suspicious Activity Reports (SAR) submitted by regulated firms​​.
  
• Enhanced Information Sharing: The MLRs now provide a broader scope for information sharing between authorities and supervisors, including the disclosure of confidential information held by the Financial Conduct Authority​​.
  

The EU

The EU has introduced several changes to strengthen its AML framework:

• Anti-Money Laundering Authority (AMLA): Scheduled for introduction in 2024, AMLA will supervise high-risk cross-border financial sector bodies and work alongside national supervisors to create a harmonised supervision system across the EU​​.
  
• Updates to the Sixth Anti-Money Laundering Directive (6AMLD): These updates include national risk assessments every 4 years, clarification of beneficial ownership information requirements, cross-border asset registers, and enhanced whistleblower protections​​.
  
• Single Rulebook for AML/CFT: This set of rules will establish more detailed customer due diligence (CDD) rules and clarify the rules for determining ultimate beneficial ownership (UBO)​​.
  

The US

In the US, the following changes have been made:

• Anti-Money Laundering Act 2020: This act introduces new rules for reporting beneficial ownership information, intended to combat the use of shell companies in money laundering​​.
  
• National Strategy for Combating Terrorist and Other Illicit Financing: Announced in May 2022, this strategy focuses on closing loopholes in the AML/CFT framework and enhancing the effectiveness of law enforcement in combating illicit finance​​.
  
• Responsible Financial Innovation Act (RFIA): Introduced in June 2022, the RFIA aims to create a regulatory framework for digital assets, assigning regulatory oversight to the Commodity Futures Trading Commission (CFTC) and introducing new reporting responsibilities for digital asset service providers​.

The need to go beyond surface-level checks

Compliance teams can no longer solely rely on standard checks such as PEPs (Politically Exposed Persons), sanctions, or watchlist screening. While these are an important starting point, they provide only a part of the picture. Delving deeper into a client’s background, the reasons why they are on a watchlist, and their motivations for seeking legal services is crucial. This approach helps identify specific risks that might not be immediately apparent.

Source of wealth vs source of funds

One overlooked example is source of wealth and source of funds. Though interconnected, both reveal different aspects of a client’s financial background. This subject was extensively addressed at the Law Society’s 2023 Risk and Compliance conference.

Source of funds is a snapshot, showing the immediate origin of the money in an individual’s bank account – essentially confirming that they have the financial means for a particular transaction and identifying the account it originates from. 

In contrast, the source of wealth traces back to how an individual has built up their wealth over time. Exploring this in detail can uncover key insights into a client’s financial background, including potential risks and ethical considerations. In short, it’s a piece of the story behind their wealth accumulation.

Look beyond the client’s profile

Customer Due Diligence (CDD) should encompass more than just the client. It’s important to know their border network of associations and past relationships to fully assess risks.

A thorough CDD process includes investigating a client’s past business connections. Relationships that have ceased can still hold crucial insights into the client’s risk profile. Unearthing these historical ties can reveal hidden risks and conflicts of interest.

Scrutinising a client’s links to proxy companies is equally important. While these entities can be used for legitimate purposes, they can also be used for unlawful activities such as money laundering. A detailed examination of these connections helps to determine whether these companies are being misused for illicit purposes.

Where traditional compliance can fall short

We’ve talked about why knowing a client’s story is crucial to boosting due diligence efforts and strengthening risk management. But how have we traditionally done it, and why hasn’t it been enough?

1. When dealing with a high volume of clients or transactions, manual processes can be overwhelmed, leading to missed or overlooked information.
   
2. Clients with complicated international networks make manual research ineffective when tracking cross-border connections and financial flows.
   
3. Keeping up-to-date with rapidly evolving global AML and KYC regulations manually is challenging and increases the risk of non-compliance.
   
4. Advanced laundering operations often use complex structures to conceal illicit funds. Manual processes might not effectively uncover these sophisticated schemes.
   
5. In situations requiring urgent compliance decisions, manual processes may be too slow, leading to missed opportunities or increased risk.

The role of AI in compliance

AI tools like Xapien offer a new way to conduct due diligence. It automates data gathering and analysis in minutes, so compliance teams can dig deeper into the client’s background and strategise their next steps.

Xapien’s AI system automatically gathers data from a diverse range of sources by searching the entire indexed internet, substantially reducing the time and effort required for manual research. It translates the data from over 133 languages and then analyses it to provide an in-depth background of clients, their networks and motivations.

This includes examining both positive and negative media, corporate affiliations, descriptions, quotes, close associates, and business partners. The findings are presented in a fully sourced, human-style report. With the bulk of data collection and initial analysis managed by AI, you can concentrate on more strategic aspects of compliance and risk assessment.

Learning the ‘story’ of clients will become a vital part of regulatory compliance in the legal sector. Not only to ensure adherence to evolving regulatory standards but also to safeguard the reputation of law firms by enabling more informed and ethical decision-making. AI tools like Xapien help you do this by enhancing the efficiency and thoroughness of due diligence processes. Curious to see how Xapien works? Get in touch to learn more.