The cost of monitoring transactions in the wrong way is a heavy one. So too, however, is the cost of evolving an effective process. Why is this the case?

Several cases have surfaced recently that point to the fact that regulatory authorities are sharpening their focus on the transaction monitoring processes that financial institutions use in their struggle against money laundering and terrorist finance. Recent fines issued against Standard Chartered and UniCredit highlight clear failures in this regard.

This article sets out the constituent elements of a transaction monitoring process, as well as the things that firms must consider in order to get it right. Thereafter, it will look at the way in which various factors in this field are causing firms' total costs to increase - a common phenomenon today.

Legislative obligations

Transaction monitoring is a regulatory requirement in the UK and, according to the Money Laundering Regulations 2017, firms must identify and scrunitise transactions that the authorities might consider to be unusual or have no economic purpose. This is not the same as being objectively suspicious, so the job of a transaction monitoring system is to point out these unusual transactions and subject them to further scrutiny. At the end of the process, the system must either discount the transaction in question as a 'false positive' or refer it upwards towards the compliance department or senior managers.

Transaction monitoring types

There are a multitude of processes that a firm may employ to monitor the transactions of its customers. For example, a transaction monitoring method can be either manual or automatic. A process of 'manual screening' ensures that the firm scrutinises all transactions, but it is expensive. It is not uncommon for large firms to devote large resources to manual monitoring processes.
 
Automatic processes, on the other hand, are speedy, consistent in performance and can deal with surges in activity more readily. A firm that automates its efforts may use an alert-based system, which is speedy and responsive to its demands and generates alerts as soon as the transactions are available for scrutiny.
 
Alternatively, the firm might use a case-based system which provides an aggregate risk score (which it bases on a number of factors) before generating an alert. Regulators might view a case-based alert system as a more thoughtful way of doing things than others, because it collates information about the customer intelligently in an effort to decide whether or not a transaction requires further investigation.

Transaction thresholds – the path to an optimised system

A transaction monitoring process must have thresholds in place to help it spot those transactions that require further investigation. The thresholds themselves can be either simple or complex. Complex thresholds encapsulate more information for consideration, but if those thresholds are not properly aligned to the company’s assessment of the risks that the customer poses, the company might experience an influx of alerts. It will then have to spend significant resources on either people or software with the aim of discounting or 'escalating' these alerts upwards.

Conversely, a complex threshold may fail to assess the spectrum of payments executed by customers adequately and so could fail to generate enough hits.

To choose the best process, a firm must ensure that the quality and quantity of alerts that it generates are in keeping with the wider resources at its disposal; this involves designing thresholds that are in line with the firm’s customer base.

Furthermore, once it has chosen and implemented a transaction monitoring process, it must maintain it adequately. As part of this, it has to review it continually, watch it continually and conduct 'assurance,' a word that businessdictionary.com defines as part of corporate governance in which managers provide accurate and current information to concerned parties about the efficiency and effectiveness of its policies and operations, and the status of its compliance with its statutory obligations.

This will ensure that the feedback that the firm generates about the operation of the transaction monitoring system is subject to regular review. It will also ensure that, in terms of internal control, the process does not remain static. The use of information to generate feedback allows the firm to keep refining the process.

Today's climate – where does the cost originate?

Why are the costs associated with implementing and maintaining an effective transaction monitoring system rocketing? Two key factors are at play here.
 
Firstly, never-ending technological development has enabled firms to execute ever-greater volumes of payments. Effective transaction monitoring systems therefore require more and more capacity to process, monitor and detect unusual activity. The knock-on effect here is that the average private bank has to deploy more and more resources outside its own transaction monitoring system in order to support it.

Secondly, the regulatory environment has changed and will continue to change. With the transposition of the European Union's fifth Money Laundering Directive into all national laws schedule for 2020, more types of product and customer will require "ongoing monitoring" (the scrutiny of his transactions to see if they are consistent with his business and risk profile). An effective transaction monitoring system therefore not only has to scrutinise increasing volumes of transactions; it also has to be agile enough to scrutinise complex transactions correctly.

This, then, is why costs are sky-rocketing. Gone are the days of simple screening solutions that detected adverse information relating to payers and payees, as well as rudimentary thresholds relating to expected volume and activity.

Temporising with rising costs

An effective transaction monitoring system (and its supporting process) requires investment, both in terms of capital and personnel, and the cost of implementing an effective process will inevitability continue to rise. However, as we have seen, firms can temporise with rising costs.

* Philip Creed can be reached on +44(0)28 9042 5451 or at info@fscom.co.uk