Counting the cost

Opinion | 30 November 2016

It is universally accepted that we have a global trade finance gap on our hands, so instead of stemming this problem, why is compliance exacerbating it, asks Richard Jones

Senior managers in banks and insurance companies could be forgiven for feeling a little over-burdened of late. As well as the usual concerns of running major institutions responsible for the financial plumbing of the global economy, two newer issues are causing concern.

First are the laws and regulations aiming to combat financial crime, which are becoming ever more numerous, complex and stringent. Of course, this is no surprise. The effective detection and widest possible prevention of financial crime, including fraud, money laundering and the financing of terrorism, is essential to preserve trust in our banking and financial system, as well as to ensure the smooth conduct of trade and commerce.

And the second reason is that under British law, these senior people have become personally accountable, even potentially criminally liable, for the actions of their companies. The Senior Managers' Regime (SMR) (introduced in March 2016, initially in banking and insurance) supports what can now be perceived as a sea-change in the culture of the financial services sector. It replaced the old 'Approved Persons' regime and puts the onus of responsibility firmly on individual senior managers to ensure their organisations discharge their duties.

Senior role sea-change

Among senior managers affected are of course banks' money laundering reporting officers (MLROs); those responsible for making sure any client or activity arousing a suspicion of money laundering or of terrorist financing is identified, recorded, investigated and, where necessary, reported to the relevant authorities. In practice, however, the changes mean that all senior managers, not just MLROs, will understandably become more risk-averse.

Every decision taken in the course of combating financial crime must be recorded, with the rationales provided. Given this, senior managers must take even more care than before to ensure their organisations have appropriate anti-financial crime and anti-money laundering policies and procedures in place, and that they follow a risk based approach, assessing the risk associated with every client, product and service. They will also do their utmost to ensure their staff know and carry out their duties, because they may face criminal penalties themselves if they fail to do so.

What is more, increased compliance costs mean that banks seeking to service these markets have to make a long-term commitment to building up the right people, processes and systems in order to effectively manage the increased legal requirements expected of them.

A Thomson Reuters survey1 in May 2016 revealed some banks spend up to £300m annually on know your customer (KYC) compliance, and customer due diligence (CDD), with the average bank spending £40m a year on KYC compliance alone - partly due to the number of employees required to ensure standards stay high. And it makes the process for on-boarding clients lengthier, with 30% of the 722 corporate respondents to the survey suggesting that the process of being on-boarded took more than two months.

The price paid by correspondent banking and trade finance

Of course, the unintended consequences of such regulation are now surfacing (see page 60). The additional pressures of increasingly complex anti-financial crime regulation are causing many large multinational banks to de-risk; they've launched a major scale back of their trade finance and correspondent banking services for lower-volume business, and especially for countries perceived to have a lower retention of risk.

Yet compliance pressures are not the only inadvertent effects of regulation. The capital adequacy requirements imposed on financial institutions (for example under the Basel III framework, these are designed to boost resilience to shocks) have reduced the profitability of certain types of products and services for banks. As a result, many have been questioning the viability of activities in those emerging markets characterised by lower volumes of business.

Hard figures are already recording the impact. The International Chamber of Commerce's (ICC's) 2016 Global Survey on Trade Finance2, found that nearly 40% of the 357 respondents it surveyed across 109 countries reported terminating correspondent relationships due to the cost or complexity of compliance. Furthermore, the percentage of respondents citing compliance requirements as a significant impediment to trade finance increased from 81% in the previous year, to 90%, with 83% of respondents stating that they expect compliance costs to increase in 2016.

SWIFT's report on de-risking3 shows that South Africa lost more than 10% of its foreign counterparties between 2013 and 2015. Mauritius observed a decline of 18% and Angola lost 37% of its foreign counterparties. Perhaps most concerning is the fact that this comes at a time when global demand for trade finance is growing, resulting in a major trade finance gap. The African Development Bank reports this stands at between US$110bn and US$120bn across Africa alone. The Asian Development Bank, meanwhile, reports a US$692bn gap for developing Asia (including India and the People's Republic of China), with the global trade finance gap standing at an estimated US$1.6trn.

And despite this, the regulatory bar keeps on rising, resulting in increasing numbers of larger banks reducing their correspondent relationships, especially in emerging regions such as Africa, Southeast Asia and Latin America and the Caribbean. Particularly smaller or less-developed countries in these regions are now considered too complex and therefore too onerous for compliance departments to deal with. As a result, the withdrawal of services from these countries becomes a seemingly sensible and even obvious solution.

Much to the detriment of global trade, and certainly against the intended consequences of the regulations themselves, this is hitting small and medium sized enterprises (SMEs) the hardest, which are the lifeblood of economic growth in emerging markets. In fact, ICC's 2015 Global Survey states that SMEs account for around 53% of all rejected trade finance transactions (by contrast, 79% of the trade finance transactions for large corporates are accepted). Many of these, and their banks, rely on trade finance and the availability of correspondent banking relationships with the major money centres to start or to stay in business - help that is now increasingly scarce, if not entirely withdrawn.

Alternative providers

Thankfully, that is not the end of the story. More and more countries see trade as an economic route to growth and are both removing trade barriers and encouraging their enterprises to export. They are determined, therefore, to find alternative sources of finance to the withdrawing multinational banks. Specialist providers are already helping bridge the gap, some with a regional outlook while others specialise in certain industries (such as commodities or energy). Others are looking to multilateral development lenders or export credit agencies, many having rolled-out trade finance facilities to support shorter-term financings backing trade. And then there are the all-important players that are not retreating because trade finance and correspondent banking is their raison d'être.

Certainly, commitment is key. The trade finance gap is growing larger year on year, and it is emerging markets (the markets that are at the centre of global trade and full of companies hungry for growth) where the gap is the most significant. As others scale back operations, it is important that those who have committed to even the smallest lesser-developed economies remain so. And where banks can't commit, they should collaborate - partnering with new and alternative providers, as long as they are willing to make the necessary investments in regulatory and compliance best practice. Given the extraordinary track record of trade finance as a technique (with default rates consistently well below 1% according to ICC's annual Trade Register) such an investment is clearly worth the effort.

Richard Jones is CEO of Crown Agents Bank




  1. See Thomson Reuters 2016 Know Your customer Surveys Reveal Escalating Costs and Complexity:

  2. ICC Global Survey on Trade Finance 2016:

  3. See Addressing the unintended consequences of de-risking - Focus on Africa:

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