Dear CEO | Release Date: 9th September 2021
To read a shorter summary of this Dear CEO letter, click here.
To access the original FCA document, click here.
Long Summary
The Financial Conduct Authority (FCA) addresses this letter to firms involved in trade finance activities. The focus is on reinforcing the expectations regarding trade finance operations, particularly emphasising robust financial crime risk management. The letter highlights concerns following the failure of several high-profile commodity and trade finance firms and identifies inherent risks associated with the complex, global nature of trade finance.
FCA and PRA Expectations
The FCA, in conjunction with the Prudential Regulation Authority (PRA), outlines the necessity for firms to exhibit a risk-sensitive control environment capable of effectively mitigating the identified risks. Expectations are detailed within the frameworks of existing regulations and guidelines, including the Joint Money Laundering Steering Group guidance, the PRA Rulebook, and the FCA’s Financial Crime Guide. Additionally, firms are urged to perform a comprehensive financial crime risk assessment, a key action required from every firm engaged in trade finance.
Key Areas of Concern
Financial Crime Risk Assessment
Firms are often found lacking in their focus on identifying and assessing risks related to financial crimes such as money laundering, sanctions evasion, terrorist financing, and fraud. The FCA notes that assessments are frequently too generic, failing to cover the diverse risk exposures inherent in trade finance client relationships. Firms are advised to undertake thorough risk assessments that consider various dimensions including client industries, operational jurisdictions, and transaction specifics.
Counterparty Analysis
Appropriate credit analysis is crucial and should encompass all entities involved in a transaction, not just the borrower. This analysis should extend to end-buyers, credit insurers, and other relevant parties. The rationale behind transactions should be scrutinised to identify any signs of fraudulent activities, collusion, or money laundering, especially when transactions involve high-risk jurisdictions or sectors.
Transaction Approval and Oversight
Before approving transactions, firms should conduct detailed analyses to identify any red flags or higher risks that necessitate enhanced due diligence. Policies and procedures should be clear on the measures required for higher-risk transactions and ensure structured assessments are in place. There should be robust oversight to ensure compliance with the firm’s policies and that controls are effectively operational.
Transaction Payments
Regarding transactions where end-buyers are the primary repayment source, it is prudent to obtain formal acknowledgments confirming payment obligations. For transactions involving credit insurance, firms should ensure they are explicitly identified as loss payees and comply with the terms set out in the insurance agreements. Effective risk management practices should include evaluating the adequacy of security, maintaining perfection of security, and planning for potential non-payment scenarios.
Supervisory Strategy and Planned Work
The FCA intends to continue its rigorous supervision of trade finance activities, focusing on areas where recent assessments have revealed significant issues. The supervisory strategy will involve regular reviews and interventions where necessary to ensure that firms adequately address the outlined risks and maintain compliance with regulatory expectations.
Conclusion and Next Steps
Firms are expected to take decisive actions to address the issues highlighted in this letter. They must ensure that all aspects of their trade finance operations—from risk assessments and counterparty analyses to transaction approvals and payments—are conducted with stringent adherence to regulatory standards and best practices.
Key Takeaways and Actions
- Risk Management Enhancement: Firms should enhance their risk management frameworks to address specific vulnerabilities associated with trade finance, particularly those related to financial crimes.
- Comprehensive Risk Assessments: Carry out detailed and holistic financial crime risk assessments and ensure these are documented and integrated into the firm-wide risk management processes.
- Robust Counterparty Analysis: Implement thorough due diligence processes for all parties involved in trade finance transactions to mitigate risks of fraud and financial crime.
- Enhanced Transaction Oversight: Establish clear procedures for transaction approval that include checks for red flags and higher-risk scenarios requiring additional scrutiny.
- Secure Transaction Structures: Ensure that payment structures and insurance arrangements are robust and provide adequate protection against non-payment and other financial risks.
Firms are urged to engage proactively with regulatory updates and prepare for compliance with ongoing and upcoming regulatory changes. The FCA anticipates ongoing engagement with firms to ensure that the trade finance market operates transparently, safely, and effectively, thereby safeguarding the interests of all market participants.