Markets money laundering is a rapidly emerging risk for financial institutions. It refers to money laundering that ‘cleans’ dirty money by trading securities in capital markets. As the G7-mandated Financial Action Task Force explains, “some of the characteristics of securities sectors, such as a high level of interaction, high volumes, speed and anonymity may create opportunities for criminals to launder the proceeds of crime”.
Regulators are turning their attention to markets money laundering
That regulators are willing to impose significant fines on firms whose AML controls are deficient is clear. The combined AML fines in 2020 and 2021 – exceeding $12 billion – are greater than the fines for every previous year combined. In addition, these fines no longer come exclusively from American regulators but globally, suggesting that the importance of anti-money laundering has global recognition.
Within this paradigm shift, regulators are also beginning to recognise markets money laundering as a distinct risk. The watershed appears to have been the $630 million fine imposed by UK and US regulators on Deutsche Bank in 2017, for facilitating the flight of $10 billion worth of roubles from Russia via the use of ‘mirror’ trades. Following the fine, regulatory and industry bodies have published several detailed reports about the specific risks of money laundering via capital markets, including the FATF’s 2018 Guidance for a Risk-Based Approach for the Securities Sector, the FCA’s 2019 Thematic Review, and AFME’s 2021 Anti Money Laundering Transaction Monitoring in the Markets Sector.
Existing AML transaction monitoring systems are ineffective in the markets sector
The risk is significant in part because of how poorly conventional AML transaction monitoring (TM) solutions fare when faced with the speed and size of capital markets activity. The UK’s 2017 National Risk Assessment of Money Laundering and Terrorist Financing remarks that “capital markets have relatively weak compliance controls & low levels of suspicious transactions reporting”.
The 2021 AFME report observed the same trend across Europe, remarking that 80% of firms surveyed in the past year had filed no suspicious activity reports (SARs) for their markets business from alerts generated by AML TM systems. Instead, 95% of SAR filings in this sector came from other divisions, mostly the market abuse and front office functions. They also note that the traditional AML TM abuse typologies are largely unproductive because they result in very high levels of false positives. They advocate the implementation of markets-specific AML TM solutions that make use of machine learning, network analytics and specialised typologies.
Consider the 2017 fine for Deutsche Bank. A small number of customers used so-called ‘mirror trades’ to transfer $10 billion from Russia, through Deutsche Bank in the UK, to overseas bank accounts in Cyprus, Estonia and Latvia. The mirror trading scheme involved two legs:
1. A Russian customer of Deutsche Bank’s Russian subsidiary would buy highly liquid Russian securities from the subsidiary, paying in Roubles.
2. At the same time, a non-Russian customer of Deutsche Bank’s UK business sold the same number of the same securities to Deutsche Bank in exchange for US Dollars.
During this time, Deutsche Bank lacked an automated AML system able to detect suspicious securities trades, including mirror trades. As a result, it could not effectively monitor the high volumes of securities transactions that it executed on behalf of its customers.
The scale of markets money laundering is unknown
Markets money laundering has only begun to command the attention of the industry in the last few years. Given the weakness of existing controls which likely means much money laundering is presently undetected, it is impossible to know the full severity of the issue. As the UK’s National Risk Assessment puts it, “while our understanding of the risks of money laundering through markets has developed significantly since 2015, the scale and extent of this risk remain an intelligence gap”.
However, given that the high value and cross-border nature of trading is highly attractive to money launderers, it is likely significant. Recent cases such as the 2017 Deutsche Bank ‘mirror’ trades may only be the tip of the iceberg. To mitigate this risk, financial institutions should review their existing AML controls for capital markets activities and ensure they are effective.