Securities under the microscope
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Securities under the microscope

Limited transparency in securities flows has been a concern for some time. The challenge facing regulators is to address issues around ownership without affecting legitimate transactions.

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In the context of combatting money laundering and the financing of terrorism, while ensuring enforcement of economic sanctions, regulators recognise the need for transparency in securities flows and visibility of beneficial ownership of these securities.

Regulators in Europe and the US are also continuing their efforts to gain transparency into the shadow banking market with a focus on transparency into secured financing transactions – repo and securities lending, says Michael Barrett, vice-president at Genpact Headstrong. “During the onset of the financial crisis and the Lehman bankruptcy, regulators felt that their limited view into the characteristics of the funding used in the repo market, the quality of the collateral and risk practices in securities lending hampered their ability to manage financial stability and control the risks associated with leverage and liquidity.”

The result is the reporting of secured financing transactions into trade repositories in Europe, a move to central clearing of securities financing transactions and proposed minimum haircuts for non-centrally cleared transactions.

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Regulators are having to balance multiple agendas – on one hand, complying with the enhanced anti-money laundering and counter terrorism financing [AML/CTF] requirements around beneficial ownership promulgated by the Financial Action Task Force (FATF) 2012 revisions and on the other, the need to create a suitable regulatory environment in which markets can operate effectively.

According to Neil Jeans, head of policy and standards at Thomson Reuters Org ID, the increased requirement to understand beneficial ownership in some markets is creating inertia and adversely impacting the ability to trade and settle transactions, which is affecting trading volumes.

“The importance of knowing your customer, as well as who is behind your customer, is widely understood and accepted. However, AML/CTF legislation and regulation still has its basis predominately in retail financial services, which has resulted in interpretations and adaptations by practitioners operating in the securities and other wholesale markets that are contrary to market practices in order to achieve a level of compliance.”

Jeans refers to increasing acknowledgement by regulators that the pursuit of one aspect of the regulatory agenda can have unintended consequences in other areas of the financial services industry. “More enlightened regulators address this with increased clarity and guidance as to what constitutes compliance across multiple industry sectors.”

When asked how the fourth AML Directive will impact due diligence requirements for securities transactions, Barrett observes that it builds on the risk-based assessment requirements of its predecessor by adding requirements that the European supervisory authorities assess money laundering and terrorist financing risks faced by the EU as an entity itself, and that each member state conducts a risk assessment on a national level considering the assessment done by the European supervisory authorities.

“The purpose of these requirements is to try to harmonise and make more consistent the KYC/AML due diligence rules across Europe. The results of these assessments will have to be incorporated into the internal risk assessments of the firms themselves.”


 To understand the contagion risk in the market, regulators need to be able to understand the interrelatedness of the transactions occurring within it

David Lewis,

The new Directive also attempts to provide greater clarity on how firms determine which customers qualify for simplified due diligence or need enhanced due diligence by specifying the risk factors to be used in their determinations, Barrett continues. “As this is a new Directive, it is difficult to predict how big an impact it will have on the firms as there are dependencies on what the European supervisory authorities do and what the member states do to comply with it.”

The Directive translates potentially into more work for financial institutions, increased time to open accounts and a requirement for more information from customers before they can trade, in what can be fast moving and dynamic markets, says Jeans.

“However, it also creates an opportunity to address some of the issues faced by industry sectors, including the securities markets, in achieving compliance with AML/CTF obligations. While the Directive has the potential to create market inertia if not adopted in a pragmatic way for the securities industry, it also presents an opportunity whereby countries can create a regulatory environment in which financial institutions are able to leverage technological advances to mitigate the impacts of the increased requirements and enhance the management of risk.”

David Lewis, senior vice-president at SunGard’s capital markets business, says the primary concern for regulators is the levels of exposure between organizations that are making collateralized loans between themselves.

“Whilst this market is significantly smaller than it was pre-Lehman, it still amounts to multiple trillions of dollars of short-term funding liabilities each day. In order to understand the contagion risk in the market, regulators need to be able to understand the interrelatedness of the transactions occurring within it. They have now come to realise that in order to manage it, they must be able to measure it and that is where trade repositories may be brought in,” Lewis concludes.

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