KYC: The Foundation Of Effective AML Compliance

Posted June 30, 2022, By The Parallel Team

Nowadays, financial firms must maintain detailed records of their customer’s past and current financial profiles for legal compliance.

While such extensive record-keeping helps protect both the customers and the financial institutions from potential fraud, it can also mean firms have to spend time and money over and above their operation cost.

Thankfully, today financial institutions and platforms have automated options to help solve their KYC and AML problems.

In this article, we’ll first understand what AML compliance is and how KYC makes an essential component of it. We’ll then go over some practical hurdles in the way of effective KYC and AML procedures and recommend a robust tech solution for financial institutions to complete all legal requirements for AML.

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What is AML?

Anti money laundering, or AML, refers to a framework of laws and regulations that financial institutions must follow to prevent criminals from disguising illegally obtained funds as legitimate income.

The Bank Secrecy Act(“BSA”) is the United States’ primary set of rules governing AML. The U.S. financial services regulators have implemented rules and regulations to ensure compliance with the BSA, including the Financial Crimes Enforcement Network (FinCEN) — the enforcement arm of the U.S. Department of Treasury — SEC, CFTC, and Financial Industry Regulatory Authority (FINRA). In particular, FINRA Rule 3310 requires broker-dealers to implement effective AML Compliance programs that are specifically designed for risk management.

Under this regulatory framework, an effective AML compliance program must incorporate the following key components:

  • Robust Know Your Customer (KYC) protocols:
    • verification of the customer’s identity, including checks of name, address, date of birth, and tax ID number
    • identification of beneficial owners and control persons of corporate entities
    • sanctions and Politically Exposed Persons (PEPs) checks
    • ongoing sanctions, PEPs, and adverse media monitoring and
    • periodic refreshes of identity data
  • Suspicious Activity Monitoring:
    • ongoing monitoring for (and alerting of) any transaction and/or money movement that suggests illicit activity
    • consideration of false document or identification information provided during the onboarding process and/or reluctance to provide beneficial ownership information
  • Documented Process for Decision Making:
    • establishment of a set protocol for evaluating red flags and making onboarding decisions based on defined risk criteria
    • consistent documentation of assessments and decisions as well as of underlying documentation reviewed
  • Employee Training:
    • periodic and documented training of relevant employees regarding the AML regulatory framework and financial institution’s procedures to comply with each regulatory requirement
  • Appointment of a Chief AML Officer:
    • responsible for ensuring that established AML procedures are current, implemented, and effective

Effective KYC is the Foundation of a Strong AML Program

The entire AML process relies on effective KYC, i.e., customer’s identity verification and reasoned assessment of their risk.

Without verifiable documentation to confirm a customer’s basic information, a firm cannot open an account for that customer. The primary objective of KYC is to manage fraud risks at the source. KYC ensures that customers with potentially criminal intent never enter the system, drastically reducing the costs of extensive transaction monitoring.

An effective KYC process must verify a customer’s identity at the outset and periodically refresh that identity data to keep it current. KYC is not a one-time process performed before onboarding a customer; in fact, the most effective KYC programs perpetually monitor sanctions lists and adverse media. Effective KYC must also perform due diligence on corporate entity customers to determine the identity of the entity’s beneficial owners and control persons.  

A financial institution’s ability to meaningfully monitor suspicious activity hinges on the depth and breadth of its KYC process. A compliance team that knows their customer and that customer’s expected transactional activity will conduct risk assessment more easily and accurately. The team can apply enhanced scrutiny of activity to customers who they have identified as having a higher AML risk through KYC. Moreover, KYC ensures that at any moment, a compliance team can easily trace a suspicious transaction back to a customer’s updated legal identity records.

Suspicious Activity Monitoring Requirements

Financial institutions and adverse media. Effective KYC must also perform due diligence on corporate entity customers to determine the identity of the entity’s beneficial owner illegally acquired money

  • Money Laundering: Actions to hide the origins of illegally acquired money
  • Terrorist financing: Financial support to terrorist individuals
  • Fraud: Intentional financial deceit
  • Bribery: Unfair financial influence over a decision-making process
  • Trafficking: Transferring money for illicit goods
  • Identity theft: False transactions in someone else’s name

To detect a suspicious activity scenario, AML compliance programs conduct ongoing monitoring of each customer transaction, such as:

  • Transfers
  • Deposits
  • Withdrawals

If a firm detects any financial transaction deemed suspicious during its AML monitoring, the BSA requires that it file a Suspicious Activity Report (SAR).

A firm must define its criteria for suspicious activity based on legal reporting requirements. In other words, it must develop “transaction profiles” — to do so, a firm must first perform effective KYC.

For example, the following transactions can be singled out for checks if a financial institution has a strong knowledge of its customers:

  • Unusual (very high or low) transaction frequency
  • Transactions above a certain threshold
  • Currency exchange transactions
  • International transactions
  • Transactions with individuals or organizations in sanctioned countries
  • Transactions by high-risk individuals.
  • Transactions with politically exposed or other high-risk individuals.

An automated transaction monitoring system can detect all ongoing transactions in real-time, flag suspicious transactions, and even automatically file a Currency Transaction Report (CTR). Once the system alerts the team of suspicious activity, it warrants further analysis to detect behavior patterns. Employees can conduct historical transaction monitoring to build a detailed case for a SAR.  

KYC is crucial to effective transaction monitoring and the bedrock of a successful AML compliance program. Unsurprisingly, neglecting KYC guidelines can carry a hefty price. In 2021 alone, globally, regulatory bodies collected a mind-boggling $2.7 billion in AML-related fines from over 80 organizations.

Clearly, financial institutions must focus on being KYC- and AML- compliant at all times, not only to avoid such severe penalties but also to safeguard their reputation, future, and customer safety. Firms must be prepared to overcome any hurdle in the KYC monitoring process.

4 Key Challenges of KYC and AML Compliance

It’s becoming increasingly difficult to fulfill AML obligations without automated software.

However, as fintech companies evolve to catch criminal activity quickly, so too does the nature of financial crime. Financial regulators and institutions must keep abreast of new money laundering techniques and train their AML monitoring software to discern those customers and transactions. However, the interplay between humans and software always carries some challenges.

Here are some common pitfalls:

1. False positives and manual intervention

AML monitoring software may flag a customer because their name closely matches a name on international sanctions or block list. Customer names may also falsely match due to typos or incomplete details. Additionally, overly stringent criteria or non-customizable software is more likely to flag customers as suspicious.

Each of these incidents will require human intervention to verify identity, detect patterns, and judge legality. Over time, clearing false positives can overwhelm employee workloads and distract from identifying truly suspicious transactions.

Though some manual intervention is unavoidable, a robust and tailored system can minimize false-positive incidents.  

2. False negatives and improper screening

A weak KYC system may fail to flag suspicious individuals for enhanced due diligence and allow them to pass through as a customer or counterparty.

Improper screening can stem from a less-than-thorough sanctions list database — resulting in inadequate background checks. More commonly, a system’s inability to detect incomplete or inconsistent data can cause a poor quality of KYC records.  

Inadequate initial screening or ongoing monitoring increases the risk of harboring criminal activity — and facing the resulting regulatory consequences.

3. Customer fatigue with the KYC process and the tedium of the “chase”

The pervasive nature of KYC compliance means that customers must submit similar details and documents each time they apply to open a new account. The process is often particularly onerous for high-net-worth or frequent investors. Being submitted to ineffective and unnecessary processes can be extremely frustrating for all customers.  

What’s more, financial institution employees waste precious time sending emails over and over again seeking documentation from potential customers. In many instances, those customers have already provided the same information to other financial institutions — or even a separate arm of the same firm.

Customers can face long delays before onboarding and may even abandon their effort to open an account.  

4. Security Risk to Identification Documentation

In the course of verifying their identity, customers submit sensitive personal identification information (“PII”) — frequently over unsecured email platforms with improper security.

Customers may be unfamiliar with encryption processes and may incorrectly assume their emails are secure. Performing KYC over email is not only inefficient but also subjects customers to a significant risk of identity theft.

Given these challenges, how can financial service companies guarantee a smooth KYC- and AML-compliant screening for their customers while protecting their privacy and data?

Parallel Markets: The Most Comprehensive KYC/AML Compliance Solution

Parallel Markets is an automated KYC and onboarding software solution built for financial institutions of all sizes. Parallel’s proprietary software performs immediate checks to verify a customer’s identity, detect indicators of fraud and fulfill safety checks such as sanctions review, PEP identification, and adverse media hits.  

Parallel issues customers the portable, reusable Parallel Passport— enabling investors to provide verified credentials everywhere without repeating the same KYC process. Parallel also offers the Parallel Identity Token, which provides KYC screening for participants in Web3 transactions while preserving each individual participant’s privacy and control of their personal identifying information (PII). Parallel continuously performs sanctions checks for all products by actively monitoring hundreds of sanctions lists such as OFAC, Department of Homeland Security, the Department of State, U.K. Sanctions lists, and consolidated E.U. sanctions lists. Parallel also continuously performs PEP checks and adverse media monitoring of all Passport holders. Finally, Parallel can assist financial institutions in fulfilling their periodic KYC refresh obligations by keeping Passport data current and accurate.

Parallel’s no-code set platform helps firms and their investors coast through onboarding processes, including customer identification and verification, Accredited investor verification, and CDD rule requirements for verifying beneficial owners of corporate entity customers.

Parallel’s platform enables identification data collection and verification without leaving the single, unified dashboard that maps firm customers’ KYC progress and protects customer PII. Moreover, firms can integrate these verification processes into their existing onboarding workflow with Parallel Market’s API — which helps fulfill regulatory books and records requirements.

The overall ease and speed of the onboarding process with Parallel Markets lead to:

  • A nearly 90% decrease in overall onboarding time
  • Reduced number of investor drop-offs
  • A reduced human error margin
  • An extremely robust and regulatory compliant KYC process
  • Streamlined compliance with employee workflow
  • Secure and reliable data collection and storage
  • A strong foundation from which to conduct suspicious transaction monitoring

You can trust Parallel Market’s bank-level security and 24/7 fraud protection to take over all your KYC needs.

Disclaimer: The information contained in this article is provided for informational purposes only and should not be construed as legal advice on any subject matter. You should not act or refrain from acting on the basis of any content included in this article without seeking legal or other professional advice.