The growing case for investing in financial crime frameworks in asset management


The market for asset and wealth managers is tough and as with many industries, COVID-19 provoked a rise in new threats. This also highlighted the need for asset and wealth businesses to have resilient end-to-end digital services driven by data, and with customer experiences as their North Star. The pandemic created a sense of urgency to spur transformation at a pace the industry has never seen before.

The sector has also seen an enormous amount of M&A activity in recent years – some involving the biggest players in the market. These deals mean firms can better leverage economies of scale, introduce more digitisation and manage risks more efficiently, particularly fraud, the most prominent COVID-19 trend in the financial crime landscape. There is strong evidence that for instance, cyber attacks over asset managers are on the rise. Recent studies indicate that asset managers are less confident that they can detect financial crime with surging exposure to the criminal use of third parties.

However, with the regulatory landscape continually expanding and driving operational costs up, most asset managers have not been able to focus as closely as they would like on financial crime compliance. This has been exacerbated by the perception that asset management is relatively low risk. While it’s true that products such as pensions, savings accounts and diverse growth portfolios often pose lower levels of financial crime and money laundering risk because of their barriers to entry and relatively illiquid investment structures, there’s still enough risk to warrant attention.

In fact, because there’s increased regulatory scrutiny directed at large banking institutions, criminals see asset management as a better, less scrutinised option. On top of which, while the value of announced M&A deals involving asset and wealth managers fell by half to $13.5bn in 2019, smaller deals accounting for the bulk of consolidation activity appear to be on the rise. Those more boutique asset managers want to benefit from cost savings and technology to the same extent as large players. However, the financial crime frameworks, often end up being disjointed as a result of lengthy mergers.

So, how can wealth and asset managers build better financial crime frameworks? We believe they need to focus on four core areas:

Shift the focus within customer and third-party relationships

The asset and wealth management business model makes it difficult to improve financial crime frameworks. For example, managers rely on building close relationships with both customers and third parties, such as referring agents, advisers, administrators and distributors. It’s a crucial part of the culture. While there’s a regulatory requirement to ensure robust monitoring of these relationships, firms continue to struggle with implementation. Ultimately, asset managers are reluctant to create any friction in those relationships, which many see due diligence as.

Firms need to pay more attention to independent advisers that run Know Your Customer and Customer Due Diligence (CDD) activities. It’s key to have a clearly documented control framework to be able to show how they manage third parties. The financial regulatory body, Financial Conduct Authority (FCA) recognises the issue and has therefore made operational resilience, including outsourcing provided by third parties, a cross-sector priority in its Business Plans of 2019-20 and 2020-21.

Refocus on the Three Lines of Defence model

The need to get close to customers and third parties also makes it challenging for asset managers to incorporate the Three Lines of Defence model, where the first line is operational management, the second is risk management and compliance functions, and the third is internal audit. The model, initially introduced by the regulators as a direct response to the financial crisis, have proven challenging to implement. Most financial institutions realised that the change of the operating model needs to be coupled with a cultural change. Within asset management in particular, the first line tends to be reluctant to incorporate controls into their processes as they fear damaging relationships.

There must be a cultural change to fully implement the Three Lines of Defence model. A strong tone set by the leadership through persistent communication is integral to enabling this. The leadership can embark on a cultural campaign to strengthen second line’s power to introduce change within the first line. Unless the first line understands its role and consciously acts as a risk owner, the second line can’t effectively fulfil its role of a control function. An oversight framework as a basis for the Three Lines of Defence model, helps asset managers to spot their financial crime vulnerabilities more holistically as opposed to the fragmented approach in a disjointed environment emerging from M&A activity.

Explore digital opportunities to replace manual process

Amid the array of priorities, firms often overlook the systems and processes for financial crime frameworks. In a merger situation particularly, this can leave the new organisation fragmented, which prevents it from exploring and integrating the latest regulatory technology that can support financial crime compliance.

This fragmentation means investors with multiple funds in different jurisdictions often need to provide the same documentation multiple times. Sometimes, the same investor might even need to meet different requirements and standards. It’s an inefficient process, with customer experience suffering.

Firms must fully integrate and harmonise their systems across functions to reduce manual activities. Merging customers’ commercial information and suitability with their CDD data and financial crime risk assessment is a first step towards a centralised approach upon which firms can build more effective governance frameworks.

Improve skills and resources

As regulators haven’t scrutinised asset and wealth management as closely as the banking industry, firms haven’t focused on growing their financial crime capability. As a result, they don’t have the robust resources and skills to build effective financial crime control frameworks.

With the Three Lines of Defence model formalised, firms can then identify skills gaps and use clear role descriptions to drive recruitment. These will be essential as compliance staff in the second line need different skills compared to customer operations staff in the first line. Where it proves challenging to source the right skills, firms should look to train their people and promote financial crime awareness across all functions.

Asset and wealth managers can improve financial crime frameworks

There are plenty of challenges facing asset managers when it comes to creating robust financial crime frameworks. But without investment in clear frameworks, firms risk their reputation as well as their money. By shifting the focus of relationships, refocusing on the Three Lines of Defence, bringing in the latest regulatory technology and improving skills, asset and wealth managers can build their defences against financial crime.

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