Funds Transfer Pricing and the Quest for Term Funding: Working Towards New Solutions

Funds Transfer Pricing (FTP) is emerging as not just a nice to have, helpful tool in managing a financial services business, but in some cases has become a regulatory necessity. FTP, also called Collateral Transfer Pricing in some firms, is the exercise of allocating the cost of liquidity between business units at the same firm. It is no longer enough to have a friendly handshake about cost allocation, especially when one desk is providing liquidity and another is a high-octane consumer.

The new requirement is that a robust model be in place that can show all internal participants as well as regulators how costs are allocated and absorbed. While FTP started with capital market activities, the next evolutionary step is in expanding the concept to include money markets, repo trading and securities lending activities. FTP is a reflection of the fact that term liquidity has become a finite and scarce resource that is not easy to manufacture for capital markets.

A Brief History of the Problem
Before the financial crisis, neither FTP nor collateral optimization played much of a role in financial institutions. The traditional model was that Treasury or an Asset/Liability Management department would match up both sides of the balance sheet. The Treasury team would link illiquid loans on the one hand and retail funding plus an equity component on the other hand, making trades to balance the difference and consider the matter closed. There was often no explicit cost of liquidity or collateral consumption to any trading desk, and certainly trading desks were not paid if they were net contributors to the overall collateral pool.

The traditional Treasury did not really understand the capital markets concept that can easily separate legal and economic liquidity mismatches, both on the asset as well as on the liability side of the balance sheet. This is in a way remarkable as exactly this mismatch is considered to be the Achilles heel of any deposit based banking system. But Treasury managers were not looking beyond banking deposits.

To illustrate the nature of the problem, we take an example of how capital markets assets were measured at the time. While the purchase of an asset causes a €100 million outflow and produces a legal mismatch of, say, five years, it does not show up with this mismatch on the liquidity radar screen of a treasury department (see Exhibit 1). The reason for this is that assets could be funded any day in the repo market, exchanged in the securities lending markets, or sold without a great loss under the assumption that there is ample liquidity and value at risk is relatively small.

Exhibit 1:
The pre-crisis view on capital market assets

Source: DekaBank

As a consequence, the outflow is 100% neutralized with a cash inflow and the mismatch disappears. The asset is now self-funded. Correspondingly, with no mismatch on the radar screen of the treasury and no long term funding impulse, there was a fair argument that a trader should only pay the repo rate as FTP or pay no more than EONIA / EURIBOR flat or equivalent based funding. This was all fine with high quality assets in very liquid markets, but might have gotten more complicated with less liquid securities. In essence the underlying assumptions were ultra-liquid assets, in ultra-liquid markets where neither market, nor funding, nor macroeconomic liquidity risk existed.

Moving closer to today, a laundry list of factors has emphasized the importance of FTP and collateral optimization and the technologies that accompany them. The factors we include are: recent regulations; balance sheet deleveraging; the increasing role of central clearing and CCPs; regulatory and central bank demands for transparency; internal auditors; and even internal trading desks when confronted with their funding costs. These have all increased pressure on Money Market, Treasury, repo, securities lending and collateral management departments to improve transparency on pricing and bring more rigour to their allocation methodologies.

Part of the new pricing paradigm are haircuts. While most people only had a limited understanding of haircut calculation before 2007 / 2008, today we find all kind of haircuts: central bank haircuts, LCR or NSFR haircuts, large exposure risk haircuts, VaR and gap risk haircuts, FSB haircuts, stressed and going concern haircuts, etc. Haircut calculations have become an art in itself and are an important driver of FTP or collateral optimization as they are used to inject longer term funding impulses into security positions, repo or securities lending and even structured or derivatives transactions.

Taking the same example from above, this trade is not only not self-funding, but it generates a strongly negative funding position (see Exhibit 2). Less liquid credit assets like NIG rated ABS, CLO’s, CDO’s or third tier equity, etc. now have a much more limited funding value. In this example they attract a 50% haircut. And what is more, this haircut gives rise to a €50 million negative liquidity mismatch, which shows up on the mismatch radar screen of the treasury and creates a long term funding impulse. With the cost of funds at 50%, a five year Asset/Liability Management curve and only 50% EONIA/market-based funding, it is obvious that the cost of liquidity has increased significantly for the holder of such a position. Accordingly, the trading position or instrument is not self-funding any longer.

Exhibit 2:
The post-crisis view on capital market assets

Source: DekaBank

Now, this would probably not be such a big issue if we had long term repo- or long term securities lending markets that would be able to manufacture term funding liquidity at reasonable cost. But currently, more than 80% of the securities lending and the repo markets are less than one month duration and offer no means to close negative funding mismatches in later time buckets.

As a consequence, haircuts have partially eroded the market and asset based funding system. Capital markets activities are now a term funding drag for the bank and are in competition for term liquidity with both, internal and external actors. Investment bankers are back to the negotiation table with the treasury department. In order to keep these negotiations from getting too unwieldy, a fair and transparent FTP methodology has to be implemented.

The Practice of Funds Transfer Pricing
FTP is the practice of allocating funding costs fairly across all parties. It is at heart a governance matter, ensuring that liquidity givers and takers are each compensated for their actions. As a governance process, FTP has four parts:

Liquidity Management
o Transparent liquidity reporting
o Make mismatches transparent
o Improve liquidity planning
o Ensure compliance with regulatory liquidity ratios
o Allocate cost of liquidity
buffers
P&L Management
o Determine P&L after Funding Cost
o Manage Funding Cost at Desk / Unit Level
o Determine Fair price for firm Liquidity
Balance Sheet Management
o Ensure efficient balance sheet utilization
o Help determine cost of balance sheet utilization
Pricing
o Determine fair transfer pricing between liquidity providers and liquidity users
o Determine correct LVAs for derivatives
o Ensure transparent liquidity prices

The hardest piece of FTP is actually figuring out how the pricing methodology occurs. Some firms have turned to market-based funding rates (repo and securities lending) while others use a haircut methodology. Some firms use a combination including taking haircuts from multiple internal and external sources. A 2014 white paper by SunGard, Finadium and InteDelta described a methodology for finding the fair value of an asset for FTP. With this collection of methodologies, it would come as no surprise that the FTP values across security types are a complex function of haircuts, funding and market liquidity and regulatory requirements (see Exhibit 3).

Exhibit 3:
A practical outcome of FTP for securities

Source: DekaBank

The exhibit shows an example for a level 2B security and a non-HQLA security. FTP decomposes any security position into different buckets of varying liquidity. The ultra-liquid parts may still be self-funded and attract a short term repo rate. The less liquid parts of a security position attract a higher portion of term money and thus higher costs of funding. In the below example, the Level 2B security attracts 50% funding at the one month bucket. The LCR haircut attracts funding at the three-month (internal or benchmark) rate, reflecting the fact that in order to neutralize the LCR impact you need longer term funding than just one-month. Eventually, there is also a longer term component (in this example illustrated by the ECB haircut), which attracts a one year funding impulse.

As can be seen in the exhibit, the non-HQLA asset attracts even 90% 3- months funding. The respective funding rates for the one, three or 12 months buckets may depend on the mix of funding instruments and access to funding markets for a certain institution (e.g. money market / deposit based funding, access to repo, CP, securities lending markets and other factors). It may be based on benchmarks like EONIA, EURIBOR or a mix of all the above. The methodology as outlined is relatively robust. As regulators inject even more long term funding impulses, e.g. through the NSFR, the methodology can be easily adopted.

Once you have proper funds transfer pricing for different collaterals as outlined, it is easy to construct FTP for repos by just adding or subtracting the term cash legs to the collateral leg. FTP for securities lending can be derived by adding / subtracting the FTP for the two collateral legs, or if that is easier and more direct by adding a repo and a reverse repo. As a consequence, you will have covered short term products in a straightforward, simple and transparent methodology that is both robust and flexible with regard to new requirements.

Regulators have made term liquidity both an essential as well as a finite resource of capital markets activities, despite the cash overhang created by QE in different parts of the world. This happened through simple measures like the de facto introduction of haircuts through of the LCR, NSFR, or by making it more difficult for beneficial owners to lend on term. As a consequence, costs of funds went up and financial institutions had to deleverage their balance sheet.

The Quest for Term Funding
The question is whether capital markets can create new sources of term funding to mitigate these effects. Repo CCPs may be a good starting point, however, with the exception of ultra-liquid government securities, which are self-funded anyway, term markets have not really developed there. Also, establishing term markets on a CCP is not a straightforward task. CCPs can change the collateral composition and counterparty risk requirements pretty much overnight, thereby invalidating the term nature of any transactions immediately. We are now discussing LCR baskets, but this is just an exchange of HQLA vs cash and will not do anything to generate term liquidity. Hence, what is good for systemic risk may be counterproductive for the development of secured term repo / securities lending markets. Bi-lateral transactions do work of course, but are not as balance sheet or capital effective as CCP transactions. That said, there have been some new ideas with regard to constant maturity type transactions recently. Eventually, term funding may be forthcoming from the shadow banking sector, but would this be in the interest of regulators and central banks?

Final Thoughts
Regulators as well as central bankers need to understand that by manipulating funding relevant haircuts (for instance by introduction of regulatory ratios like the LCR and NSFR), they can increase or decrease capital markets activity, respectively funding and market liquidity. Haircuts and market based funding levels are different sides of the same coin determining the internal and external cost of funds. Haircuts that are too high will exert funding pressures despite QE and prohibit market liquidity. Haircuts that are too low may lead institutions to leverage up their activities too much and add to too much credit sensitive assets to their trading books and balance sheets. Here, regulators and central bankers have some fine tuning to do.

Against this backdrop, FTP has become a requirement for any bank and capital markets division today. It is vital to have a fair and transparent methodology that allocates costs amongst liquidity givers and takers, thereby allowing institutions to price transactions according to their internal and external costs of funds. And here, banks have some optimization to do in steering and managing the supply of term liquidity that central bankers and regulators have allowed into the markets.

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Michael Cyrus
Head Short Term Products, Equity Finance & FX
Deka Investment – Germany

who will deliver a Presentation at our 5th Annual Collateral Management Forum. If you would like to receive more information please Request the Conference Agenda.

Panama papers: again, another reminder

The Panama Papers bring out several issues related to vulnerabilities of controls from countries and companies. We have heard about them…tax havens… offshore companies, banking secrecy, money laundering, political exposed persons… but what are they? How are they related to each other?

To start explaining, it is important to add another role as important as it is Internal Audit within the companies: the Compliance Officer. Where does it come from? What are their responsibilities?

After the most important financial scandals that took place in 2002 such as Enron and WorldCom the authority decided to tighten the nuts and the regulation changed. New rules were placed for public companies such as the prohibition of not being an auditor and consultant for the same company, disclosures if a company is dealing with a fraud, rotation of audit partners (5 years top), creation of the Audit Committee and how to protect whistleblowers among other things. And a new role emerges from this: the Compliance area.

Compliance as its name says it has the duty to comply with the law (externally) and with the policies and procedures (internally). Its difference with Internal Audit is to prevent rather than detect. As we all know either an external or internal Auditor determines a scope based on the nature of its revision in order to analyze what is being doing vs. what it should be. (For more information refer to the article, Value: Internal Audit) The bottom line: an auditor analyzes something that already has happened (after). Meanwhile compliance should be involved before taking a decision. (I.e. a contract, hire key staff, new provider, etc.)

Compliance should be in charge of manage the money laundering risk, which is defined as to give legality to money that comes from illicit activities. Those illicit activities are several among: traffic of drugs, human organs and humans. Prostitution, forgery, pornography, bribes, etc. The term “illicit” depends upon the legal framework of each country. The criminal will look for “paradises to launder money”…those countries or companies which can help him to launder lots of money at a low cost in a very quick time.

A tax haven is defined as a territory where taxes are levied at a low rate or has a system of banking secrecy. This means that banks are not allowed to give to the authorities the information of their clients… the real owner… is a “top secret” and it has to be kept as that, unless there is a criminal complaint. Offshore companies (legal entity), refer to be incorporated or register on tax havens.

Therefore, for its characteristics tax havens are used by some people for purposes of confidentiality…others for launder money and others to pay less tax or hide money from the IRS. The latest two mean a crime: tax evasion.

But tax evasion differs from money laundering. Although both are crimes they have specific characteristics. Therefore, depending on the circumstances, someone can be accused of both or just one.

Then there is another key concept: political exposed person…“PEP”. It is defined as someone who is or has been entrusted with a prominent function. Historically PEPs have shown us that tend to be corrupt. Taking bribes is illicit money; dirty money. It has to be laundered. Someone who is corrupt does not want to be known as such, so the money has to be seen as “clean”… as legal.

One of the key elements to deter and prevent money laundering is to know your customer (“KYC”) and apply customer due diligence. (“CDD”) Countries, authorities and companies need to know who the real owner is, as well as who controls. Criminals use among many methods:  shell companies, front man or identity theft to disguise its identity; therefore verify who really is the owner, it is an extremely important control.

Although there is still an investigation carried out in Panama, it reminds us (again) the importance of internal control that companies should have and countries should promote. How many factors have in common with the Enron case?

-Worldwide there are flaws in the laws that generate legal technicalities that help criminals or there are still issues to be regulated. In Enron case energy wasn't regulated. Today it is the offshore industry.

-In both cases there were rumors of corruption.

-Lack of transparency: Enron didn’t present a Balance Sheet meanwhile in Panama due to bank secrecy information is not provided.

-Enron used “mark to market” for accounting valuation and afterwards a “hypothetical future value” among the creation of several companies to disguise the fraud and real owner. (It included a trust). Today in Panama it is reported a number of companies created by complex structures, also.

-Statements from both executives of companies were: “we didn't do anything wrong”. The rationalization is the same.

Regardless of the mentioned above and the importance of controls and managing risks there is something more transcendent: values. Why do people even knowing that something is wrong, they do it?

And the history…again is repeated…with so much similarities…

By Mónica Ramírez Chimal, México

Partner of her own consultancy Firm, Asserto RSC:  www.TheAssertoRSC.com

Author of the books, “Don´t let them wash, Nor dry!” and “Make life yours!” published in Spanish and English. She has written several articles about risks, data protection, virtual currencies, money laundering. Monica is international lecturer and instructor and has been Internal Audit and Compliance Director for an international company.

Processors Looking To Fill Vantiv Void Warned Over DFS Volatility

Payment processors aiming to take Vantiv’s place serving the billion dollar daily fantasy sports (DFS) market have been warned they face a “high risk, volatile and uncertain” legal environment.

Vantiv will stop processing payments for DraftKings and FanDuel, the two most popular operators in the sector, on February 29.

A series of state and federal investigations into the legality of DFS in the U.S. in relation to gambling has dragged the company, and card networks MasterCard, Visa and American Express, into a thickening mire.

Vantiv has decided the risk is too great as the number of states declaring the games illegal increases.

DFS is a hyper-charged version of the popular online games which allow individuals to create teams and compete against each other by earning points from professional sports.

In its fourth-quarter 2015 earnings call, Vantiv chief executive Charles Drucker said: “We have decided that it is prudent to suspend processing for transactions involving daily fantasy sports due to the increasingly uncertain regulatory and judicial environment around these operations.

“We may re-enter the space in the future should conditions change.

“In the meantime, we remain firmly committed to processing for online and land-based gaming operators, including state lotteries and other regulated gaming activity where the regulatory and judicial framework are more clearly established.”

PayPal said it would continue to process payments for DFS sites.

A Gamble Worth Taking?
Industry watchers believe any company hoping to step into Vantiv’s shoes is likely to be offered a weaker deal and may take on a greater burden of risk.

Gaming law expert Daniel Wallach of Becker & Poliakoff told PaymentsCompliance: “The level of risk is too high right now for payment processors like Vantiv.

“They are getting out until there is more clarity, and the big question is will there be other payment processors to fill the void and process these types of transactions.

This article first appeared on PaymentsCompliance, click to find out more.

“Vantiv is certainly one of the most prominent processors in the space and it remains to be seen of another legitimate processor will step in to fill the void, as without payment processors, there is no DFS.”

A great jeopardy for payment processors is what several state attorneys general opinions could potentially lead to once decisions are made.

According to our sister publication GamblingCompliance, 23 states are currently considering DFS legislation.

Federal investigations could mean criminal indictments under laws such as the Unlawful Internet Gambling Enforcement Act, the Illegal Gambling Business Act and the Wire Act.

“The legal environment for DFS is in a state of high volatility at the moment; while state legislators are moving quickly to provide an unobstructed legal path for DFS, they are not the only participants or lawmakers whose voices matter,” Wallach said.

He said state attorneys generals are increasingly weighing in to declare DFS constitutes illegal gambling.

“Those opinions are creating an environment of great risk for payment processors and others in the spectrum,” he said.

“The spectrum of federal criminal prosecution looms over the entire industry, while at the same time state lawmakers are rushing to provide a legal protection and clarity for the industry, but the potential involvement of the feds is a big unknown at this point.

“The one thing payment processors and banks cannot tolerate is the risk and the unknown, that is not a safe environment for companies that process billions of dollars in transactions.”

Big Risk, Big Reward?
The DFS industry is considered a small portion of the overall portfolio of many of the processors; however, Vantiv has not declared how much it makes from the sector.

A study by GamblingCompliance priced a fully regulated sports-betting market as worth $12.5bn, with online gambling worth about $4.4bn annually.

Payments expert Matthew L. Cantor, a partner in the New York office of Constantine Cannon LLP, said the Empire State had been aggressively leading the charge to criminalize DFS.

“There is a certain degree of risk involved and a real likelihood the sites will close, and a key pressure point of that is what is happening in New York,” he told PaymentsCompliance.

“That creates increasing risks for processors and others involved in the chain, anyone else invested in DFS.

“It would be difficult to imagine a company striking the same kind of deal that Vantiv had with the sites, should someone attempt to step up to replace them.

“Vantiv had that position previously and I think now we would see the advantage switched to the sites.”

DraftKings and FanDuel enjoy marketing deals with major sports franchises and draw direct investment from the MLB, NBA, NHL and MLS.

Although this may seem enticing, a newcomer is unlikely to enjoy the same advantages of Vantiv which had a long-standing relationship with the pair through their rise to prominence.

“Vantiv is known and reputable, so you might have to step down in class from a Vantiv to a processor that is more risk tolerant,” Wallach said.

“But credit card companies and banks are not exactly known for their risk tolerance.”

Wallach said he felt sure there would be a company or group of companies to collectively fill the void, but it may not be immediate.

“Payment processors are averse to the kind of risk that could jeopardize their ability to do business in the United States,” he said.

“The laws will eventually change (for the betterment of fantasy sports), but right now the environment may be too risky.

“I don’t think if Vantiv disappears from the scene that DFS will disappear.

“There will always be someone else to perform that function.

“The level of risk is high, notwithstanding the optimism coming out of the industry."

In November, a Massachusetts court reportedly ruled in favor of a motion by DraftKingsrequiring payments companies Vantiv and NBX to continue processing New York transactions for them until the legal issues were decided.

In the same month, customers of DFS sites filed a class action lawsuit against Visa, MasterCard and American Express alleging the companies aided the legality of an unregulated industry.




Written by:
Mark Taylor
News Editor, PaymentsCompliance
BlockchainBriefing

FATF chief talks de-risking dangers and correspondent banking

First part of my interview with the head of the world’s anti-money laundering task force on de-risking, and the fraught relationship between disruptive fintech companies and the banks which handle their accounts.

Wholesale de-risking or de-banking, which involves denying accounts to customers deemed high risk, is rapidly becoming a major sector issue and even a “crisis” in areas in vital need of cross-border transfers.

David Lewis, executive secretary of the Financial Action Task Force (FATF), said the agency would continue to rail against a practice it believes fuels black markets, following two statements issued last year.

Troubled areas served by charities, or those such as the Caribbean whose economies are heavily dependent on remittance flows, are directing anger at the US.

Lewis said an FATF report into correspondent banking relationships and the impact of cutting money remitters, payment services providers and other sectors, is nearing completion.

“It’s a concern to us, as it undermines transparency within the financial sector and law enforcements ability to follow the money,” he said.

Wholesale de-risking is considered a blanket decision by banks, without due regard to the risk of individual customers within that decision-making process.

“We see it impacting mostly on customer segments that have a risk of money laundering and terrorist financing and where the profits for the bank are relatively small,” Lewis said, adding that it was a major concern for several other international finance organisations.

“We are working with the Financial Stability Board (FSB) to look at implications of banks cutting off correspondent relationships.

“This is affecting particularly areas such as the Caribbean and Africa.”

The FSB echoed claims it would merely push honest remitters underground in an attempt to stay in business.

Lewis said there are two main drivers which affect correspondent banks, money service business, charities or a host of other sectors including fintechs.

“Banks are seeing the costs of compliance rise, largely because they have been found wanting by regulators and law enforcement agencies and are finally putting in place the necessary controls,” he said.

“Sometimes I see in the press talk of stronger or revised regulations causing this, while what we are actually seeing is just the regulators starting to enforce the rules that have always been there.

“Banks are getting caught out, they are responding by investing a lot more heavily in compliance. 

“This is squeezing their margin, and ultimately that is changing the risk-reward relationship to a point where the profits are so small that it’s not worth the potential reputational damage for the bank, let alone the profit, to engage in that relationship.”

US authorities are preparing guidance on the matter, with the Office of the Comptroller of the Currency stating banks’ fear of breaching AML laws is often misguided.

“Aggressive” enforcement of the Bank Secrecy Act is seen as the number one problem.

Recently Barclays announced it was selling its Africa banking arm, having decided the reward was too low given the risks of serving a volatile jurisdiction.

As legal experts have pointed out banks will consider several factors prior to making a decision, but it is often a perfectly legal business choice despite claims of competition malpractice.

Lewis said: “We are seeing them [banks] assess their relationships not just on the basis of AML/CFT risk, but on broader legal and regulatory risk and reputational risk and the commercial appetite along with the geographic appetite.”

“We have seen correspondent banks, money service business, charities and other sectors including fintechs particularly hit by de-risking.

“Secondly, we have to clarify regulatory expectations.

“The nub of that is the question of whether a bank is required to know their customer’s customer (KYCC).”

Despite the FATF insisting this is only the case “in exceptional circumstances”, many are taking no chances.

“There is a growing perception within the banking sector that they are,” Lewis said.

“However, whether they are required to know it or not, it increasingly seems that they are not comfortable maintaining the relationship if they do know it.

“There is such a fear of regulatory action that if they don’t have confidence in their customer’s customer they are pulling back.

He described it as a “big issue”.

“If they have any doubt at all on circumstances where they are required to KYCC or in situations where customers don’t offer a great profit, they are cutting them off,” Lewis said.

“We are concerned about that as it reduces transparency in financial transactions.

“It increases the ML/TF risks we are trying to address.”

In the forthcoming report, Lewis said the guidance on correspondent banking clarifies what FATF thinks regulators should be doing.

Everyone in the industry is advised to pay attention to the paper, and Lewis admits the outcome is not always easy.

“It’s a different question then about whether regulators go away and do that,” he added.

“Implementation is the big challenge here.”

Lewis echoes the fears of those who have witnessed the problems that can come with de-risking, and why cutting off a payment processor will not stop a crime from occurring.

“We recognize sometimes banks have to profile customers and look at risk from a number of different angles, we want to promote a common sense risk-based approach that doesn’t exclude a large number of customers and essentially increase risk.

“The nub of this issue for us is how to get banks to properly assess the risks and take a proper risk-based approach rather than make these blanket decisions,” he said.

“Of course if you are like a HSBC and have 55m customers, you have to be realistic about what is possible.

“What happens is if you are a big bank you get rid of the customer but not the risk, is that they move to become a customer of one of your customers.

“Ultimately, if you are a big bank you’re a clearing bank, and the customer you’ve exited will become a customer of another bank and that will probably be using you as a clearing bank.

“So you’re still exposed to the risk, you’ve just less sight of it and less ability to manage it,” Lewis concluded.




Written by:
Mark Taylor
News Editor, PaymentsCompliance
BlockchainBriefing

No Hollywood Ending For Compliance Officers As Liability Pressures Tighten

Waves of financial crash nostalgia are sweeping over us as fears of a repeat of the 2008 crisis send shockwaves through markets.

Oscar hopeful "The Big Short" has hit cinemas, gently reminding us that some actually profited from the bubble which threatened to collapse major institutions until governments bailed them out.

Inside an altogether different bubble, those tasked with helping stave off disaster met at the Davos 2016 World Economic Forum recently to discuss what could be done to prevent a reoccurrence.

Rubbing shoulders with celebrities, the world’s great and good decided that blockchains, ledger technology, can help us take that next financial evolutionary step as nervous glances were cast at oil process and share index value.

Much hot air has been expended arguing over the "whys" and "what ifs", but despite the festering public resentment over the fact, there has been little talk of punishment for wrongdoing.

There were famously no US or European prosecutions in the wake of the 2008 meltdown, no accountability, and a bemusement that despite a spectacular and unprecedented mishandling, it turned out no one was to blame.

One man who may have a view on where the buck stops, but whom we are unlikely to hear from for some time, is the former chief compliance officer for global money remitted MoneyGram, Tom Haider.

While politicians, actors, activists and economists quaffed Dom Perignon at the Swiss retreat and heralded the rise of automated technology in financial services, Haider had more immediate concerns to attend to.

He is being prosecuted by the US Treasury, and is the first person to contest Bank Secrecy Act charges.

In January, his argument to have the case thrown out was denied and it will now proceed to federal trial.

The Financial Crimes Enforcement Network (FinCEN) is seeking a $1m penalty against Haider, who is accused of overseeing significant money laundering failings during his time at the money transfer company.

He is accused of failing to maintain an adequate compliance program and file timely suspicious activity reports.

Haider, protesting innocence, believes the company itself, which agreed to a $100m penalty following admission it violated anti-money laundering laws, should be held fully to account given his attempts to flag problems.

Despite little public fanfare of it, the financial crash did create a new type of regulator in its wake; aggressive and driven by a public desire to see someone, anyone, culpable for a major financial error.

The “high risk, high reward” compliance profession saw salaries top $1m a year in some cases, but with a heavy load that they bear individual liability for company-wide failings.

In January 2013, Humberto Sanchez, the compliance officer of a money services business in Los Angeles, was handed an eight-month prison sentence after pleading guilty to failing to have an effective AML programme in place, in violation of the Bank Secrecy Act.

In 2014, the Office of the US Attorney in Manhattan charged Charlie Shrem, chief compliance officer of Bitcoin company BitInstant, with money laundering conspiracy as part of the notorious Silk Road online drug marketplace case.

In July 2013, James Green, the chief compliance officer of foreign currency trading firm FX Direct Dealer, was hit with a $75,000 penalty by the National Futures Association (NFA), the self-regulatory organization of the US futures industry.

Legal experts believe those in the payments sector are in a particularly perilous position, as enforcers such as the Consumer Financial Protection Bureau (CFPB) target companies which process fraudulent payments despite proof that the company itself has been defrauded.

Michael Zeldin, special counsel in BuckleySandler’s Washington, D.C. office and a principal in the firm’s financial crimes practice, told me he was concerned 2016 could be the year of individual liability.

“Compliance for global organizations, especially for companies that rely on agents, branches, affiliates all over the world, is a very challenging undertaking,” he said.

“Regulators and prosecutors need to understand just how difficult it is.

“If we find ourselves in an environment where the government believes that someone always must be left standing when the music stops, that worries me greatly.”

Given that financial compliance officers are often at the mercy of budget constraints, it may result in senior management being drawn into compliance rows if officials look further up the chain for a culprit.

The need to be seen to be aggressive is always most pressing following high-profile cases, but while the global economy teeters again, it is perhaps time to show a little more caution.

Haider’s case throws up an interesting puzzle, as in MoneyGram’s admission it includes detail that his calls to flag up a number of fraudulent transactions was overruled by internal officers.

It is unlikely that there will be a Hollywood movie made about Haider’s fate, but it is a tale everyone should be aware of as it may ultimately turn away talented individuals at a time when the fintech space needs them the most.

Compliance officers in the payments space will be hoping it does not turn into a horror story.







Written by:
Mark Taylor
News Editor, PaymentsCompliance
BlockchainBriefing

Blockchain In 2016: Keys Trends And Themes

If 2015 was  as many declared the “year of the blockchain”, the technology  will have to go some way in 2016 to top the impact  that it has had on financial services. BlockchainBriefing looks ahead.

Despite the excitement there is nothing new about ledger technology.
It has been used  with much less fanfare quietly for decades, in areas such as the military and by other government organizations.
According  to Professor Michael Mainelli, the emergence of Bitcoin and the perceived threat of the crypto-currency to traditional finance  models is behind the recent ignition.

 

Banking

The year ended with the  42nd  banking name committing to a project  to develop standards in blockchain by innovation experts R3.
Some  are long-time rivals, but the unprecedented partnership has brought the likes of Goldman Sachs, RBS, UBS, J.P.Morgan, Deutsche Bank, Nordea and Mizuho to the same table.
The collective is working  on a standard for ledger technology, a blockchain or blockchains, which will allow for transfers of data, finance  and other forms of value between the members via a network.
One strand of the group  is a regulatory and legal outreach section which will spend 2016 working  with lawmakers to understand how the technology can fit into the banking and finance  world with minimal disruption.
R3 also waved goodbye to 2015 by proclaiming it had a broader remit, and would include  clearing houses, stock exchanges and non-bank institutions in the next year.
The project may be too big to succeed, but it is certainly too big to ignore.

 

Non-Banking

Outside financial  services there are swathes of other industries now investing.
Mainelli co-founded Z/Yen, one of London’s leading commercial think tanks,  in 1994 and has been building  ledgers in one form or another for the last 20 years.
Details  of R3’s proposals are scant, but with a standard being  developed the group  has indicated it is looking  to create common ground, a single  ledger, which is anathema to Mainelli.
“I don’t think many of the people who have discovered ledger technology, have really thought it through,”  he said.
“We believe there will be hundreds of thousands, millions of these ledgers, not one true chain.
“I fundamentally disagree with the theory  there will be only one blockchain, be it the Bitcoin blockchain or something else.
“Some slower members, naming no names, have copied these coin chains  and wondered why they don’t work so well, but they are crypto-currency models, they work well, but not for everyone.
“If you come  from the ‘just discovered’ group  because it has to do with coins, and you copy that  coin model, you are not going  to get the same performance or characteristics in your distributed ledger; slow, cumbersome, not built for anything else.”
Mainelli believes in 2016 there will start to be a consolidation of many of the blockchain and ledger creators, which he breaks down  into two different types  — token and non-token.
Expect moves in the insurance and  charity sectors following discussion papers in the latter part  of 2015.
Mainelli’s view is that  should  sectors use databases to verify, and a problem arises, insurance companies are often  the first to start investigating.

 

Wider  Adoption

Nasdaq opened the new year by claiming  it had documented a successful private securities transaction via its distributed ledger platform Linq.
This proof-of-concept transaction was recorded on New Year’s Eve, and the exchange claimed this was the first real use case  of blockchain technology.
Several weeks earlier,  post-trade technologists at Kynetix conducted a  real-time exchange of ownership of a single  lot of pepper using blockchain technology.
Kynetix chief executive Paul Smyth said the transfer unlocked opportunities to streamline financing, collateral, settlement of derivatives contracts and post-trade processes.
The arguments over who did what first are a sideshow to the issue that  we are in a period where  lab
testing is now bleeding into real-time use cases.
Depending on who you ask, widespread adoption is one year away ( TABB analysts) to a decade away
(Deutsche Bank).
The Institute of International Finance  (IIF) believes there are  numerous regulatory obstacles to overcome before we can all get too excited, although it has also said “when, not if”.
Disagreements over the length of adoption aside,  a more  common consensus is that  Bitcoin use will start to fade  through 2016.
The crypto-currency has for many  outlived its usefulness and will recede back into the shadows. Much of the problem centres on the subject of regulation.
Throughout last year the European Banking Authority and the European Central  Bank did not move from their stance in 2014 that  crypto-currency should  be avoided at all costs.
Both are expected to release papers in 2016 re-affirming this, as central banks and clearing houses begin to look at using ledger technology to assist with their own back ends and their own currency  operations.

 

Industry Representation

Blockchain’s rise to prominence in 2015 triggered the emergence of several trade bodies. One of the most  interesting is the Wall Street Blockchain Alliance (WSBA).
The New York financial  hub has had an uneasy relationship with Capitol Hill and Silicon Valley, particularly post-financial crash, but lies in a position where  it can take the technology being  created and apply it to financial  markets.
The WSBA and others are to produce papers in the coming  months as the slow road  to regulatory appeasement begins in earnest.





Written by:
Mark Taylor
News Editor, PaymentsCompliance
BlockchainBriefing

A bit more about PSD2

The new PSD2 main aspects are the following:

1) Use third-party providers to cut payment costs

• A payer using an online account will have the right to use payment software, devices and applications provided by an authorized third party and to have payments executed on his or her behalf by this provider.

• For example, payers who have no credit or debit card will be able to authorize new market entrants to use their bank details to make payments from their accounts.

• Payment service providers’ charges should not exceed their direct costs. Additional charges for using payment instruments, such as credit and debit cards, for which banks’ “interchange” processing fees are already regulated, will be prohibited.

2) Making payments safe:

• A bank servicing a payer’s account could deny a third party service provider access to it only for objectively justified and substantiated security reasons which have been reported to the supervisory authorities. This safeguard should preclude any possibility of banks “blocking” the market for new payment services.

• Third-party payment service suppliers, for their part, would be required to ensure safe authentication of the user and reduce the risk of fraud. They would have to ensure that a user's personal payment data transit through the safe channels and that they are shared only with the user’s consent.

• In the event of an unauthorized payment being made from his or her account, the holder should not lose more than €50 if the payment instrument was lost, stolen or misused. A service provider that fails to act to prevent such a fraud after a notification of a loss, or does not require strong customer authentication when necessary, could be deemed liable for its client’s losses and ordered to remedy the financial damage.

Next steps:
The law now needs to be officially endorsed by EU member states before it can enter into force.

Facts:
The payment services directive (PSD2) is the most recent set of EU rules on payments, which also covers online payment services.

Two previous pieces of legislation are:

• 2012 Single euro payments area (SEPA) - requiring banks to comply with SEPA rules enables their clients to use a single bank account to make euro payments to and from all SEPA countries, the 28 EU

• Member States plus Iceland, Liechtenstein, Norway, Switzerland and Monaco. This makes payments faster and cheaper with no differentiation between national and cross-border euro payments

• 2014 interchange fees are capped and surcharging prohibited for consumer cards under the Multilateral Interchange Fees (MIF) regulation for card-based payment transactions

Written by:
Jose-Carlos Cuevas
Regional Treasurer Europe
GE Power & Water

Benefits and Risks of Bitcoin from a consumer’s point of view

Bitcoin is a decentralized crypto-currency that doesn’t fall under any traditional payment regulations. It is getting more and more popular for consumers but it is less popular for banks and governments. Being based on a person-to-person structure means no affiliation to banks, governments or central authorities. They aren’t issued by central banks, they are generated digitally. The strength of bitcoin industry is growing which results in a larger user base

Why is it so popular for consumers around the world? Let’s see some main benefits of this crypto-currency.

• Bitcoin transactions provide anonymity, so it protects the user’s identity
• Mobility and real-time payments
• Cost saving as there is hardly any cost to send or receive bitcoins
• People are provided with the control of their own funds
• Transactions can be made by anyone with a cellphone or internet
• Universal currency that can be used in any country
• No need for a credit/debit card or bank accounts to make transactions

There are benefits of bitcoins but they come with risks too. Some of them are:

• Transactions are irreversible. Once it’s done, it’s done. If a transaction is accidentally made to the wrong recipient only that person can return or void the funds.
• There is a high risk of financial instability and liquidity
• Volatility of changing values - no guaranteed value
• Increasingly used by criminals and money launderers

Before starting buying or selling bitcoins it is highly advisable to take pros and cons into consideration. 

There is a debate on whether bitcoin or other digital, virtual currencies can take over physical money, coins and bills. At the moment future can’t be precisely predicted on this matter. There are constant technological changes so there is a chance that the physical money we know will eventually disappear but that doesn’t mean banks or other financial institutions will also vanish.