Building Relationships with Regulators

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Questions and Answers

What is a key principle for a firm's dealings with its regulator?

Dealing in an open and cooperative way (correct)

Maintaining secrecy about business operations

Avoiding communication unless necessary

Seeking to influence regulatory decisions

What can a firm gain from seeking guidance from its regulator?

Early strategic guidance and time savings (correct)

A reduction in compliance costs

A guarantee of regulatory approval

A competitive advantage over other firms

What is a benefit of responding to consultation papers issued by a regulator?

The opportunity to influence regulatory decisions

The requirement to implement new regulations immediately

The chance to express opinion on forthcoming regulations (correct)

The ability to delay regulatory implementation

Why might a regulator conduct cost-benefit analysis?

To ensure proportionate regulations Signup and view all the answers

What is a potential advantage of responding to consultations through a trade association?

The ability to anonymously express opinions Signup and view all the answers

What is a key aspect of an effective relationship between a firm and its regulator?

Open and constructive discussion Signup and view all the answers

What might a regulator seek from firms regarding regulatory issues?

Opinions on formal or informal basis Signup and view all the answers

What is a potential benefit of a constructive relationship with a regulator?

Increased opportunity for strategic dialogue Signup and view all the answers

What is the primary focus of compliance in reviewing new product initiatives?

Regulatory aspects of the new service and its impact on permissions or capital requirements Signup and view all the answers

What is the purpose of a wider risk assessment in introducing new products or services?

To identify operational risks and potential reputational damage Signup and view all the answers

What is the role of regulators in managing their relationship with authorised firms?

To supervise firms according to the risks they present to the regulator's objectives Signup and view all the answers

What is an example of an effective regulatory relationship?

All of the above Signup and view all the answers

What is the purpose of verifying marketing communications and regulatory submissions during new product initiatives?

To ensure compliance with regulatory requirements Signup and view all the answers

What is an important aspect of an effective regulatory relationship?

Involvement in consultation on regulatory matters Signup and view all the answers

What is the purpose of reviewing operational readiness and system test output during new product initiatives?

To verify that the firm's systems and processes are ready for the new product Signup and view all the answers

What is an example of a strategic importance of an effective regulatory relationship to a firm?

Influencing regulatory policy through involvement in consultation Signup and view all the answers

What is the primary purpose of a planned ongoing schedule of visits to high-impact firms?

To assess the biggest risks on the prudential and conduct side of the business Signup and view all the answers

How does the regulator monitor low-impact firms?

By combining baseline monitoring of financial returns with thematic exercises Signup and view all the answers

Why does the regulator collect information from small firms?

To identify collective risks and change the behaviour of small firms Signup and view all the answers

What is the purpose of thematic exercises in low-impact firm monitoring?

To monitor compliance standards in a sector Signup and view all the answers

How does the regulator respond to risks identified in low-impact firms?

By taking action in response to risks identified by baseline monitoring Signup and view all the answers

What is the outcome of the regulator's information collection from small firms?

A change in the behaviour of small firms to improve standards across the industry Signup and view all the answers

Why do small firms not have individual relationship managers?

Because they are low-impact and do not pose a significant risk to the regulator's objectives Signup and view all the answers

What is the purpose of the regulator's communication of research results to the industry?

To change the behaviour of small firms in a way that improves standards across the industry Signup and view all the answers

When responding to a consultation paper, what is the typical structure of the response?

Provide firm details, industry position, and interest in the consultation before addressing specific points Signup and view all the answers

What is typically required when making a formal application for authorisation to the regulator?

A range of information, including staff organisational chart, business plan, and financial statements Signup and view all the answers

What is the purpose of a regulatory visit to a firm?

To undertake risk assessments and thematic research investigations Signup and view all the answers

What is the typical process after a regulator refuses an application or initiates enforcement action?

The firm can appeal the decision through an independent appeals process Signup and view all the answers

What type of visit can a medium-sized business expect from its regulator?

Scheduled visits for risk assessments and thematic research investigations Signup and view all the answers

What is the purpose of a forecast closing balance sheet in an application for authorisation?

To forecast the firm's financial position after 12 months of trading Signup and view all the answers

Who typically hears representations from a firm in response to a regulator's decision?

Independent persons appointed by the regulator Signup and view all the answers

What is the purpose of a professional indemnity insurance quotation in an application for authorisation?

To satisfy the regulator's requirement for professional indemnity insurance Signup and view all the answers

What is the primary concern of the regulator when taking action against a firm that has failed to operate at the required standards?

Maintaining overall confidence in the financial sector Signup and view all the answers

What is the purpose of a cooperative working relationship between the compliance function and business units?

To identify and manage compliance risks at an early stage Signup and view all the answers

What is the consequence of the regulator revoking a firm's authorisation?

The firm is prevented from continuing in business Signup and view all the answers

What is the role of senior management in relation to the regulator?

They are personally responsible to the regulator for ensuring the business is well run Signup and view all the answers

What is the implication of a firm incurring substantial additional expense in managing a period of regulatory investigation?

It has implications for the firm's profitability Signup and view all the answers

What is the purpose of Principle 5 of the BCBS' principles for compliance and the compliance function in banks?

To ensure the compliance function is independent Signup and view all the answers

What is the relationship between the compliance function and other departments in a firm?

The compliance function works closely with other departments Signup and view all the answers

What is the 'three lines of defence' concept related to in the context of compliance?

The relationship between compliance and other departments, including the 'three lines of defence' Signup and view all the answers

State two objectives of regulation.

To protect investors and maintain confidence in the financial system. To reduce financial crime and ensure that markets are fair, efficient, and transparent. Signup and view all the answers

State the main differences between rules-based and principles-based approaches to regulation.

Rules-based regulation relies on detailed rules and regulations that prescribe specific behaviors and outcomes. Principles-based regulation relies on broader principles that set out high-level standards. Signup and view all the answers

What is the mission of the Islamic Financial Services Board (IFSB)?

The mission of the IFSB is to promote and enhance the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles. Signup and view all the answers

What are the penalties for breach of the General Data Protection Regulation (GDPR)?

Penalties can be severe, with fines of up to 4% of annual global turnover or €20 million for serious infringements. Lesser infringements can attract fines of up to 2% of annual global turnover or €10 million. Signup and view all the answers

List the data subject rights.

The right to be informed, access, rectify, erase, restrict processing, data portability, object to processing, rights in relation to automated decision-making and profiling. Signup and view all the answers

State the objective of the Dodd-Frank Act.

The Dodd-Frank Act aims to promote the financial stability of the United States by enhancing accountability and transparency in the financial system. Signup and view all the answers

Name three investment services that can be subject to passporting under the Markets in Financial Instruments Directive (MiFID).

Receipt and transmission of orders, execution of orders on behalf of clients, portfolio management. Signup and view all the answers

What does Section 404 of the Sarbanes-Oxley (SOX) Act require publicly registered US companies to do?

Section 404 requires management to assess and report on the effectiveness of internal control over financial reporting. Signup and view all the answers

What is the definition of payment services?

Payment services enable cash operations on payment accounts and the execution of payment transactions. Signup and view all the answers

How often should a company produce an 'internal controls report' as required in SOX?

Annually. Signup and view all the answers

Why does regulation require that firms have adequate capital standards?

To ensure they have sufficient financial resources to absorb losses, promote financial stability, protect consumers, and reduce the risk of firm failure with systemic consequences for the financial system. Signup and view all the answers

Explain the difference between home and host state regulations.

Home state regulations refer to the regulatory framework and requirements where a financial institution is headquartered, while host state regulations refer to the regulatory framework and requirements in the country where the institution operates but is not headquartered. These regulations ensure compliance with local laws and standards when operating across jurisdictions. Signup and view all the answers

State the two responsibilities of an effective compliance function, irrespective of the organizational structure.

<ol> <li>Assisting senior management in managing the firm's compliance risk. 2. Supporting business areas to comply with applicable rules and regulations.</li> </ol> Signup and view all the answers

Who is responsible for establishing a written compliance policy containing the basic principles followed by management and staff?

The board of directors. Signup and view all the answers

What does the Bank for International Settlements (BIS) Principle 6 require of a firm's compliance function?

Independence, adequate resourcing, and access to the board of directors. Signup and view all the answers

What is the purpose of the compliance manual?

To provide guidance on compliance policies, procedures, and employee responsibilities for adherence to laws and regulations. Signup and view all the answers

What are the three key stages involved in a risk-based approach to a monitoring program?

<ol> <li>Identification of risks. 2. Assessment of the likelihood and impact of risks. 3. Implementation of controls to mitigate identified risks.</li> </ol> Signup and view all the answers

What are the most common methods used to monitor whether a business is in compliance with regulations, internal policies, and procedures?

Regular audits, risk assessments, review of business processes, and transactions. Signup and view all the answers

To which types of people might compliance staff provide individual training?

New employees, existing staff, and members of the board of directors. Signup and view all the answers

What role might compliance play in the development of new business?

Advising on regulatory requirements and ensuring compliance of new products and services with applicable laws and regulations. Signup and view all the answers

What is the role of the IMF's trust fund for AML/CFT?

To finance technical assistance projects aimed at strengthening global AML/CFT regimes. Signup and view all the answers

How do financial institutions detect money laundering activities?

Through systems and procedures that look for patterns or unusual activities within transactional data. Signup and view all the answers

What are some indicators of potential money laundering?

Large cash transactions, frequent international transfers, and complex company structures. Signup and view all the answers

What is a politically exposed person (PEP)?

An individual who holds a prominent public position, posing a higher risk for involvement in bribery and corruption. Signup and view all the answers

How does the FATF assess compliance with its recommendations?

By conducting mutual evaluations and peer reviews of member countries. Signup and view all the answers

What is the purpose of the UN Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances?

To combat the global drug problem and associated money laundering activities. Signup and view all the answers

How do international standards on customer identification help prevent money laundering?

By ensuring that financial institutions can verify the identity and assess the risk of their customers. Signup and view all the answers

What is the IMF's Financial Sector Assessment Program (FSAP)?

A program that evaluates the stability and soundness of countries' financial sectors, including AML/CFT measures. Signup and view all the answers

What is the impact of tax crimes being included as predicate offences?

It broadens the scope of AML efforts to include illegal activities related to tax evasion. Signup and view all the answers

How does the FATF promote global AML/CFT standards?

By issuing recommendations, monitoring compliance, and providing guidance and best practices. Signup and view all the answers

What is the role of due diligence in AML efforts?

To verify the identity of customers, assess their risk level, and monitor their activities for suspicious transactions. Signup and view all the answers

What are the consequences of non-compliance with FATF recommendations?

Countries may face sanctions or other countermeasures from the international community. Signup and view all the answers

How do financial institutions manage the risk of terrorist financing?

By implementing enhanced due diligence, monitoring transactions, and reporting suspicious activities. Signup and view all the answers

What is the significance of international cooperation in AML efforts?

It ensures a coordinated approach. Signup and view all the answers

Study Notes

Building the Relationship

Building a good relationship with the regulator is crucial for compliance staff, based on mutual trust and open communication.
A good relationship enables seeking opinions on issues, discussing resolutions, and obtaining guidance from the regulator.
Responding to consultation papers allows firms to express opinions on forthcoming regulations and provide information on practical implications.

Managing Regulatory Relationships

Regulators supervise firms according to the risks they present to the regulator's objectives.
High-impact firms have specific programmes of core work to assess prudential and conduct risks.
Low-impact firms are monitored through baseline monitoring, thematic exercises, and sector-wide reviews.

Applications

Obtaining authorization requires a formal application to the regulator, including information such as:
- Staff organizational chart
- Business plan information
- Compliance procedures
- Details of professional advisers
- Financial statements and forecasts

Representations

Firms can make representations to regulators in response to refusal of an application or enforcement, which may be in writing or oral.

Regulatory Visits

Scheduled visits are undertaken periodically to assess risks or as part of thematic research and investigation.
Unscheduled visits ('dawn raids') may occur, and firms should be prepared to respond to regulatory or law enforcement visits.

Independence of the Compliance Function

The compliance function should be independent, as stated in BCBS Principle 5.
Independence does not mean complete separation from management and staff, but rather a cooperative working relationship to identify and manage compliance risks early on.

International Regulatory Environment

The objectives of regulation include protecting investors and maintaining confidence in the financial system, and reducing financial crime and ensuring that markets are fair, efficient, and transparent.
There are two approaches to regulation: rules-based and principles-based. Rules-based regulation relies on detailed rules and regulations that prescribe specific behaviors and outcomes, while principles-based regulation relies on broader principles that set out high-level standards for firms to achieve.
The Islamic Financial Services Board (IFSB) promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles.

The General Data Protection Regulation (GDPR) imposes severe penalties for breach, including fines of up to 4% of annual global turnover or €20 million (whichever is greater) for serious infringements, and up to 2% of annual global turnover or €10 million (whichever is greater) for lesser infringements.
Data subjects have several rights, including the right to be informed, the right of access, the right to rectification, the right to erasure, the right to restrict processing, the right to data portability, the right to object, and rights in relation to automated decision-making and profiling.

US Regulatory Environment

The Dodd-Frank Act aims to promote the financial stability of the United States by improving accountability and transparency in the financial system, ending "too big to fail," protecting consumers from abusive financial services practices, and ending bailouts.
Section 404 of the Sarbanes-Oxley Act requires management to assess and report on the effectiveness of the company's internal control over financial reporting, and the company's external auditor to audit and report on management's assessment.

Payment Services and Counterparty Risk

Payment services are defined as services that enable cash to be placed on a payment account and all operations required for operating a payment account, including cash withdrawals and payment transactions.
Counterparty risk is the risk that the other party in a financial transaction may default on their obligations, and can lead to significant financial losses if the counterparty fails to meet their commitments.

Fintech and Artificial Intelligence

Regulators approach Fintech by promoting innovation while ensuring consumer protection, financial stability, and market integrity. They may implement regulatory sandboxes, provide guidance on compliance, and establish frameworks that support the growth of Fintech while mitigating potential risks.
Artificial intelligence (AI) has several applications in financial services, including fraud detection and prevention, risk management, customer service, algorithmic trading, and credit scoring and underwriting.

Securities Regulation

The International Organization of Securities Commissions (IOSCO) has three objectives: protecting investors, ensuring that markets are fair, efficient, and transparent, and reducing systemic risk.
The US Securities and Exchange Commission (SEC) is responsible for protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.
The SEC enforces securities laws, oversees securities exchanges and other market participants, and works to prevent fraud and abuse in the securities markets.

Compliance Function

An effective compliance function has two responsibilities: assisting senior management in managing the firm's compliance risk, and supporting the business areas to help them comply with applicable rules and regulations.
The compliance function should be independent, adequately resourced, and have access to the board of directors.
A compliance manual provides guidance on compliance policies and procedures, and outlines the responsibilities of employees in ensuring that the firm adheres to applicable laws and regulations.

Risk-Based Approach

A risk-based approach to monitoring involves identifying risks, assessing the likelihood and impact of these risks, and implementing controls to mitigate the identified risks.
Compliance staff should provide training to employees, new and existing, and members of the board of directors.
The compliance function plays a role in the development of new business by advising on regulatory requirements and ensuring that new products and services comply with applicable laws and regulations.

Money Laundering and Terrorist Financing

Money laundering involves turning money derived from criminal activities ("dirty money") into money that appears to have been legitimately acquired ("clean money").
Terrorist financing relates to the financial support of organizations or groups that perform terrorist acts and includes any financial transactions undertaken to facilitate such acts.
The Financial Action Task Force (FATF) issues recommendations to set minimum standards for action in different countries to ensure consistent international efforts against money laundering and terrorist financing.
The three stages of the money laundering process are placement, layering, and integration.
The layering stage is considered the biggest risk for financial services firms because any transaction that exchanges one asset for another or changes the registered owners of an asset could be part of layering.### Anti-Money Laundering (AML) Efforts
Enhanced due diligence measures involve more rigorous checks for high-risk customers, including politically exposed persons (PEPs).
The cross-border nature of money laundering necessitates international coordination to ensure countries have legislation and regulatory processes in place to identify and prosecute those involved.

International Bodies Involved in AML Efforts

The Financial Action Task Force (FATF), United Nations (UN), and the European Union (EU) are key international bodies involved in AML efforts.
The FATF conducts studies of money laundering and terrorist financing methods, trends, and techniques and responds to these threats.

Customer Due Diligence (CDD)

Customer due diligence (CDD) helps financial institutions verify the identity of their customers and assess the risk they may pose in terms of money laundering or terrorist financing.

Key Concepts

Proliferation financing refers to providing funds or financial services used for the manufacture, acquisition, or use of nuclear, chemical, or biological weapons.
Transaction laundering involves processing illicit funds through the merchant accounts of legitimate businesses, often through the sale of goods and services.
Beneficial ownership refers to the true ownership or control of an entity, often concealed through layers of legal entities or arrangements.

FATF Recommendations

Recommendation 21 of the FATF advises financial institutions to give special attention to business relationships and transactions with persons from countries that do not comply with FATF recommendations.
The FATF sets international standards, assesses compliance, and provides guidance on combating money laundering and terrorist financing.

Challenges in AML Efforts

The challenge of jurisdictional differences in AML efforts arises from different countries having varying levels of compliance and enforcement, complicating international AML/CFT efforts.
Technology raises new challenges, such as the use of electronic currencies, but also provides tools for detecting suspicious activities through data analysis.

Detection and Prevention of Money Laundering

Financial institutions detect money laundering activities through systems and procedures that look for patterns or unusual activities within transactional data.
Indicators of potential money laundering include large cash transactions, frequent international transfers, and complex company structures.
Due diligence plays a crucial role in AML efforts, verifying the identity of customers, assessing their risk level, and monitoring their activities for suspicious transactions.

International Cooperation

International cooperation is essential in AML efforts, ensuring a coordinated approach to combat money laundering and terrorist financing.
The IMF supports AML/CFT regimes through technical assistance, training, and assessments to help countries improve their AML/CFT frameworks.
The FATF promotes global AML/CFT standards by issuing recommendations, monitoring compliance, and providing guidance and best practices.

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Learn about the importance of building a good relationship with regulators in the compliance industry. Understand the principles of mutual trust, open discussion, and cooperation.