Securing Securities: Money Laundering in Capital Markets

In the UK national risk assessment of money laundering and terrorist financing (NRA) published in October 2017, the Home Office and HM Treasury took the view that money laundering in capital markets – namely those markets on which equity and debt is raised and traded, along with derivatives, currencies and commodities – was a significant emerging risk. The Financial Conduct Authority (FCA), as regulator of the UK’s capital markets, tends to agree. It is a view informed by the high-profile case of Deutsche Bank, which in January 2017 was given the largest fine ever imposed in the UK for anti-money laundering (AML) control failings. In its final notice, the FCA describes how the bank allowed a Moscow-based customer to convert at least $6 billion-worth of roubles into US dollars using ‘mirror trades’. These funds were then transferred into offshore accounts in countries such as Cyprus, Estonia and Latvia.

Such cases are naturally of concern to the UK. London is a global securities hub. Money laundering on this scale exposes yet another multi-billion-dollar-sized hole in the UK’s AML defences, compromising the integrity and effectiveness of both the domestic and international financial systems. During 2018/19, the FCA has focused, therefore, on this issue.

It is tempting to see this as part and parcel of the UK government’s desire to address the security implications of the City’s complicity in grand corruption. AML measures and financial sanctions, of the kind that have restricted access by Russian state-owned institutions to the EU’s capital markets, appeared side-by-side in a December 2017 FCA speech on systems and controls. In a report published in May 2018, the House of Commons Foreign Affairs Committee advocated for the exclusion of Kremlin kleptocrats from the UK’s capital markets as part of a coordinated response to Russian state aggression.

However, it is a difficult problem to tackle. Reports on the subject from the International Organization of Securities Commissions and the Financial Action Task Force (FATF), among others, acknowledge the advantages of capital markets when it comes to layering and integrating the proceeds of serious fraud and corruption (in other words, obscuring their source and co-mingling them with legitimate assets). They also note that, in addition to money laundering opportunities, capital markets provide the means (via market abuse, insider dealing and securities fraud) to generate further illicit funds. Yet, despite the work done by these organisations, and anecdotal evidence of money laundering on the London Stock Exchange going as far back as the late 1990s, capital markets did not even merit a mention in the first NRA, published in 2015.

Regulators, investigators and researchers struggle to get to grips with the crime. The classic money-laundering paradigm – of cash revenues derived from illegal activities (such as drug dealing) deposited into a bank and moved around the financial system before being withdrawn and invested in luxury goods – does not apply to capital markets. Most brokers do not accept cash, and so are not involved in the introduction of illicit funds into the legal financial system. At the other end of the process, the outcome of money laundering in capital markets looks very different from, for example, a mansion in Knightsbridge. Assets as intangible as a tax-haven-domiciled exotic derivative are difficult for law enforcement to identify or confiscate.

In fact, funds that disappear into capital markets can become almost impossible to trace without the help of an industry expert. Product and service offerings within capital markets are diverse, numerous and often highly complex. They are also constantly reinvented, in response to investor demand, market conditions and technological advances. Capital markets offer criminals further anonymity with cross-border transactions carried out at speed, electronically and/or in huge volumes.

Compounding matters, according to the 2017 NRA, is that capital markets have relatively weak compliance controls and low levels of suspicious transactions reporting. One reason for this is what the FATF describes as a lack of AML awareness among capital market professionals, combined with only a limited number of ‘securities-specific indicators and case studies’. Those examples that do circulate are commonly incidental to other forms of financial crime and accordingly short on detail. They may also be a money laundering typology unlikely to be encountered by the relevant firm (for example, the misuse of unregistered securities in the UK, where bearer shares are no longer legal).

The ‘intelligence gap’ around the scale and nature of money laundering in capital markets does not help matters. The FCA hopes to plug this gap: for example, it is no coincidence that understanding money laundering in capital markets has been added to the operational priorities of the UK’s Joint Money Laundering Intelligence Taskforce. But certain features of capital markets also make it hard to impose the sort of AML procedures typically found in banks, which are mainly relevant at placement - the point at which criminals are most vulnerable to detection. For the most part, securities accounts are credited with funds from other financial institutions. As such, they tend to depend on that institution’s customer due diligence.

It is also unusual for capital markets’ participants to have the overview of a securities transaction necessary to spot the warning signs of layering and integration. Such transactions commonly involve several intermediaries, playing various roles, in a sector populated by a vast array of firms, products, services, investor types, trading platforms and payment methods. More generally, notwithstanding the international nature of the industry, there are no common definitions, let alone regulatory standards, relating to securities or capital markets, inevitably complicating cross-border cooperation between regulators and agencies.

Given these issues, it is hardly surprising that the FCA is keen to appear supportive of UK capital market firms, which must now worry about money laundering on top of the other financial crimes prevalent in capital markets. The FCA expects to publish the outcome of its diagnostic investigations into money laundering in capital markets in June 2019. In the meantime, it is treading softly: pointing capital markets’ firms towards the updated FCA financial crime guide, recommending technology as a way to streamline their AML activity, and offering reassurances regarding the commencement of investigations into potential criminal misconduct under the new Money Laundering Regulations. Longer-term, it remains to be seen how it proposes to address the issue of money laundering in the UK’s capital markets. Having acknowledged money laundering to be a sizable vulnerability, the UK can ill-afford to leave the problem unattended. At the same time, the existing demands on those authorities responsible for UK AML investigations and enforcement may leave them struggling to respond.

Crisa Cox
Crisa has recently completed a Master's in Intelligence and International Security from King's College London. Prior to this, she spent over a decade working as a corporate lawyer in the City of London.

The views expressed in this Commentary are the author’s, and do not reflect the views of RUSI or any other institution.