3 min read
Managing the due diligence challenges posed by HNWIs
AML RightSource : August 20, 2020
High net worth individuals (HNWIs) are an important target for asset and wealth managers (AWMs) in markets all around the world. But while HNWIs are an attractive and growing market, increasing 9% by number globally over the past year alone, they bring with them additional due diligence risks.
As pressure mounts to crack down on financial crime, corruption and even the funding of terrorism mounts, HNWIs are front of mind for policymakers and regulators all around the world. They worry about HNWIs who are engaged in illegal business activities, or those who are corruptly attempting to exploit connections and relationships. They are concerned about attempts to suborn politically exposed persons. And they are aware that HNWIs have access to offshore bank accounts and financial structures that can help them evade their tax responsibilities.
The costs to financial institutions that do not confront these risks can be high – both in terms of legal sanction and reputational damage. Regulators are taking an increasingly tough line with institutions that fall foul of the rules. In June, for example, the UK’s Financial Conduct Authority fined Germany’s Commerzbank almost £38m for anti-money laundering (AML) failures in its private banking operation. Just days later, the Swedish Financial Regulator fined SEB Bank 1 billion Swedish krona (£88m) for similar shortcomings.
Asset and wealth managers under pressure
There have been fewer such high-profile cases outside of the banking sector, but AWMs have been labouring under particularly demanding requirements since the Markets in Financial Instruments Directive (MiFID) II regulation introduced three years ago. Its provisions on know-your-customer (KYC) processes require managers to collect far more client data and documentation than in the past, during both onboarding and on an ongoing basis. This has added significant due diligence costs in the AWM sector.
Many of these costs accrue from the requirement for AWMs to make source of wealth (SoW) and source of funds (SoF) checks on their customers. These checks are crucial, enabling managers to assess how customers accumulated their wealth and how accounts will be funded – and therefore to identify risks, inconsistencies and potential problems.
This kind of due diligence can be complex and time-consuming, as well as prone to human error, particularly where processes are largely manual. AWMs are also anxious to deliver high levels of client service, including rapid and friction-free onboarding, and anxious to avoid jeopardising hard-won client relationships.
For example, SoW data might include details of the HNWI’s family wealth, their business activities and their investment activities, all of which may be extensive and wide-ranging. Collecting sufficient data to establish a coherent picture of the customer will inevitably be challenging. The need to corroborate the data – with third parties and public sources of information, for example, adds to the task. In some countries, accessing such data may be particularly difficult.
Collecting SoF data can also be hard work. AWMs will need to understand the precise nature of the assets funding the account, including the activities that generate the funding, as well as how monies are transferred and from which remitting parties and financial institutions. HNWIs’ may have perfectly legitimate financial planning arrangements that undermine transparency – the use of corporate entities, trusts and other complex holding structures, for example – adding to the challenge. They may also receive funding from third parties and such arrangements will need to be checked carefully – particularly where there is no obvious relationship with the remitter. Moreover, as with SoW data, information submitted by the client will need to be verified and corroborated.
Importantly, much of this work is more than just a one-off exercise. While AWMs are certainly expected to carry out extensive KYC and AML checks at the onboarding stage, they are also required to revisit this due diligence on an ongoing basis. SoF, in particular, will require near-continuous monitoring. Material changes or new risk indicators will need to be followed up assiduously.
It may be possible to mitigate some of this workload through risk assessment: in most jurisdictions, regulators require due diligence work that is proportionate to the potential risk posed by individual customers. For example, clients with higher net worth, more complex arrangements, links to politically exposed persons, or ties to high-risk jurisdictions will naturally pose increased risk; at the other end of the spectrum, due diligence for less risky customers may be less onerous. Still, the risk assessment process itself will require significant resources – and may also need to be revisited.
Technology provides the answers
Given all these pressures – and the likelihood they will continue to increase – AWMs now need new solutions to their compliance challenges. In particular, manual processes look increasingly impractical; instead, compliance tools powered by emerging technologies such as automation, machine learning and data analytics will increasingly be essential.
The key will be to embrace solutions that deliver compliance with relative simplicity and consistency. Working through a single technology platform that provides standardisation across the business, AWMs will have more chance of meeting their due diligence responsibilities while also delivering efficiency and effectiveness – and maintaining high levels of customer service.
Importantly, these platforms also offer a means through which to document due diligence work and to report to regulators where necessary.
This is not to suggest there is a one-size-fits-all solution suitable for every AWM. The tools each manager requires will vary according to the nature of their business, the realities of their client base and the requirements of the jurisdictions in which they operate. However, automation and analytics tools represent the industry’s best chance of embracing its legal and regulatory responsibilities without being overcome by cost and complexity.