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Anti-Money Laundering: Challenges and Solutions

Neil Katkov Group Manager Asia Research Celent

Finsight Risk and Compliance Summit 2007 Mumbai, India 9 March 2007
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About Celent
Independent IT Strategy Research for Financial Services Firms
Banking Securities & Investments Insurance

Syndicated Research
Overviews/Market Trends/Surveys Case Studies Vendor Comparisons

Ongoing Advisory Services Custom Research & Strategy Consulting

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A tidal wave of regulations

Consumer Privacy Capital Adequacy / Basel II Corporate Governance Accounting Standards / IAS

Anti-Money Laundering

Information Security

Financial Reporting / SOX

Record Retention

Business Continuity Planning

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These forces have been building over the past three years
Pre-2001 Sarbanes Oxley Basel II Mandatory Basel II others Reg NMS (US) MiFID IAS / IFRS AML / US Patriot Act AML / EU Directives
1st EU Directive (1991) 2nd EU Directive 3rd EU Directive ? ?

2001

2002

2003

2004

2005

2006
Size <$75m

2007

2008

2009

Basic & Foundation

Advanced ? ?

Source: Regulatory Authorities, Celent Proposal Deadline (effective date)

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Regulation has resulted in compliance fatigue amongst institutions

Long-term

MARKET INTEGRITY/ FAILURE PROTECTION

Basel II

EFFICIENT MARKETS
Reg NMS (US) MiFID (Europe)

Competitive Implications

Solvency II

But regulations that drive inherent structural changes in the industry need to be heeded more closely

AML/Patriot SOX Privacy

International Accounting Standards (IAS)

SEPA initiatives (Single European Payments Area)

Short-term

REGULATION HARMONIZATION
Market Stability

FRICTION REMOVAL
Structural Efficiency 5

Market Objectives

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Compliance is now a board level mandate

Overall Risk Management Responsibility 2% 3% 5% 11% 1% 1% 2% Board of Directors Board Level Risk Committee

Board of Directors
38%

Chief Risk Officer (CRO) Management Level Risk Committee CEO Head of Business Units

16%

Chief Financial Officer (CFO) Internal Auditor Independent Risk Oversight or Middle Office 21%

Chief Risk Officer Board Level Risk Committee

Source: Deloitte, 2005

Others

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For financial institutions, the scope of financial crime is expanding

Retail Finance
Retail banking

Wholesale Finance
Corporate banking

Online brokerage
Private banking

Institutional securities
Execution-only brokerage

Cards
Personal insurance

Commercial insurance

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Money laundering, then and now: continuity and evolution

1997
Wire transfers Internet-based and e-money systems Remittance services and money exchange services Assistance from lawyers Hawala, hundi or other underground banking systems Bank-centered techniques: collection accounts, loan back arrangements bank drafts, money orders and cashiers cheques smurfing Cash smuggling Accounts in relatives names, shell companies

2004
Wire transfers New electronic payment systems Remittance services and money exchange services Assistance from Gatekeepers Hawala, hundi or other underground banking systems Terrorist financing through nonprofit organizations Insurance industry, particularly through independent insurance agents Politically Exposed Persons (PEPs)

(from FATF Reports on Money Laundering Typologies)

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Tighter AML regulation in the US and Europe is pushing money laundering activity into Asia Pacific
Totally Funds Laundered Worldwide $1,200 $1,100
US$ billions

Money Laundering by Region (Total = $950 billion in 2006)

Europe 26%

$1,000 $900 $800 2004

Source: Celent

Middle East Africa 5%

AsiaPacific 31%

Americas 38%

2005

2006

2007

2008

2009

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The perpetrators: money laundering by criminal sector

Money Laundering by Activity Terrorist groups 1%

Other Organized Crime 23%

Drugs 26%

Smuggling 29%

Embezzlement/ White Collar Crime 21%

The usual suspectsdrugs, smuggling, organized crimeaccount for over of all money laundering Terrorist financing is a drop in the bucket in real terms. Nevertheless it is driving todays AML and KYC regulations White collar crime, including embezzlement and internal fraud, is a significant (and growing) problem.
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The victims: money laundering by industry sector

Money Laundering by Industry Sector

The largest portion of laundered funds are processed through banks. This is largely due to the fact that banks are often the first stop in a multi-tiered laundering scheme. Investment firmsincluding brokerages, mutual fund companies, hedge fundsalso see a significant amount of activity, attracting more than 1/4 of money laundering.

Insurance Firms 9% Credit Cards 5% Money Services 4%

Banks 55%

Brokerage & Investment Firms 27%

Schemes targeting insurance companies are a growth sector, now accounting for close to 10% of activity.
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Regulatory intensification: the USA PATRIOT Act

Within the US: expanded AML requirements beyond banking sector (regulated since 1970) to brokerages, insurance firms, money services, etc. etc.
Globally: intensified AML policies of the US have produced a ripple effect on the international regulatory scene Many Asian countries have introduced or updated AML laws and regulations in PATRIOTs wake:
China, India, Japan, Philippines, Malaysia, Singapore, Vietnam

Unlikely suspects such as FATF blacklist countries are also strengthening their AML efforts
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Internal threats: insider fraud

Types of Insider Fraud
White collar crime Misappropriation of funds Forgery Check Theft Market abuse/broker fraud Money laundering Personal information leaks ID Theft

Fighting Insider Fraud: Security:

Firewalls Authorization and access control and monitoring

Behavior detection technology

Employee screening

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The tools: anti-money laundering programs

AML Spending by Region - 2006 $4,000 $3,500 $3,000

Financial institutions in Asia, Europe and the US spent a total US$3.6 billion on AML programs in 2006
US spending leads the way, spurred by the US PATRIOT Act and other regulatory scrutiny AML spending is still minimal in Asiaabout US$535 million in 2006due mainly to lack of regulatory drivers

US$millions

$2,500 $2,000 $1,500 $1,000 $500 $0 Asia Europe US

Source: Celent

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Breakdown of AML spending

People costs involved in training, reporting and other compliance-related activities make up the bulk of AML program spending
Anti-Money Laundering Spending Breakdown

Software and hardware account for only 12% of total spending on AML
Rules development, system fine-tuning and other ongoing system maintenance activities are a significant costabout onefourth% of AML spending

IT Maintenance 24%

Training, Compliance, Reporting 64%

Software/ Hardware 12%

Source: Celent

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Elements of a comprehensive AML solution

FINANCIAL INSTITUTION

Legacy Systems/Data Sources

Transaction Monitoring Alerts

Data Analysis GOVERNMENT AGENCIES Record Keeping FinCen Reporting Other

Data Warehouse

KYC/account set-up Watch list filtering Transaction monitoring Workflow/case management Reporting

Watch List Monitoring

OFAC Watch Lists

AML SYSTEMS KYC/account set-up

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Sample transaction monitoring interface

Activity profiling Transactions, with drilldown Visualization tools (graphing)

Source: NetEconomy

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Sample watchlist filtering interface

Message details Suspicious entity ID details Synonyms Match accuracy (%)

Source: FircoSoft

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Sample case management interface

Open cases Drill down Case status Workflow/analyst assignment

Source: Norkom Technologies

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AML technology adoption trends

Europe will soon catch up with the US in AML software adoption Asia still has very low adoption; most countries have only recently got serious about AML In all regions, very small institutions are still getting by with largely manual approaches to AML
Transaction Monitoring Technology Adoption, 2006 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Small FIs Asia
Source: Celent

Mid-tier FIs Europe

Large FIs US

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The state of AML in Asia

High Progress (Implementation of systems) Australia Singapore Hong Kong Philippines Japan India South Korea Malaysia China Taiwan Indonesia Low Low
Source: Celent

Thailand

Industry Awareness

High
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Spending on anti-money laundering solutions in Asia will grow faster than in Europe or North America

Global AML Software Spending 160 140 120 100 80 60 40 20 0 142.1 113.7 144.7 122.7 148.5 129.2 142.1 146.0 146.0 139.5 133.0 139.5 93.0

US$ millions

60.7 28.4 38.7

71.0

81.4

2004

2005 Asia

2006 EMEA

2007

2008

2009

Americas
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Source: Celent

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Recent AML Deals

Bank Association of the Philippines establishing shared AML system NetEconomy and LogicaCMG
Standard Chartered and HSBC: global roll-outs including Asia: Norkom Technologies Bank of China: Implementing TCS AML system together with new core banking system over next 5 years SMBC (Japan): real-time watchlist filtering using Fircosoft
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Vendor consolidation
Large tech companies, and private equity firms in a few cases, are acquiring specialist AML vendors
This does not mean the disappearance of these solutions Rather, the big firms are investing to enhance their usability, and integrate them with the new owners' extensive financial solutions offerings

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Regional distribution of incumbent AML vendors

Major incumbent vendors are concentrated in Europe and North America
This leaves Asia open to competition from a new wave of AML vendors, particularly from Indian vendors
Infrasoft TCS 3i SDG
Regional Distribution of Financial Services Clients Accuity Ace ACI Actimize ChoicePoint/Bridger Insight Experian/Americas Softw are FircoSoft Fortent/Searchspace LogicaCMG Mantas Metavante/Prime Associates NetEconomy Norkom Northland SAS Side STB Top Wolters Kluw er/PCi 0% North America 10% Europe 20% 30% 40% 50% 60% 70% 80% 90% 100%

Asia Pacific

South America

Rest of World

Source: Vendor RFIs

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A silver cloud to the compliance burden?

The overlap between compliance and business IT challenges...

IT Area Compliance Issue Private and Secure Customer Information KYC Transaction Monitoring/Analysis Reporting and Retention Sarbanes-Oxley Basel II/Risk Management Data Integrity

Record Retention & Accessibility

Operational & Financial Transparency

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Leveraging the technology investment across compliance and business uses...

Financial Crime
AML Fraud ID Theft Market Abuse

Compliance
Risk Mgmnt Financial Transparency

Marketing
Profitability Analysis

CRM

Enterprise Risk Framework

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...means, ideally, there is a virtuous cycle of compliance, IT and business value

Improving service levels Business intelligence/strategic planning Multi-channel distribution Customer profitability analytics Targeted marketing

Compliance Business Value IT Business Value

Compliance Provides support to IT business cases.

IT Can serve compliance while serving business and vice versa.

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Action Items for banks: AML

Risk-based approaches to AML
KYC and onboarding

Need to combine AML, anti-fraud and security

To deal with enlarging scope of financial crime and internal fraud

Need for multi-regional and cross-border diligence

The ability to monitor and relate activity in multiple jurisdictions

Effective AML and anti-insider fraud technologies

For smaller banks: AML Lite technology
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Thank you.
Neil Katkov nkatkov@celent.com Information infojapan@celent.com

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