International Certificate in Wealth and Investment Management Ed6 PDF

Certificate in Wealth & Investment Management International Certificate in Wealth & Investment Management Edition 6 covering exams from 2 March 2023 to 1 March 2025 Welcome to...

Certificate in Wealth & Investment Management International Certificate in Wealth & Investment Management Edition 6 covering exams from 2 March 2023 to 1 March 2025 Welcome to the Chartered Institute for Securities & Investment’s International Certificate in Wealth and Investment Management (Certificate in Wealth Management) study material. This workbook has been written to prepare you for the Chartered Institute for Securities & Investment’s International Certificate in Wealth and Investment Management (Certificate in Wealth Management) examination. Published by: Chartered Institute for Securities & Investment © Chartered Institute for Securities & Investment 2022 20 Fenchurch Street, London EC3M 3BY, United Kingdom Tel: +44 20 7645 0600 Fax: +44 20 7645 0601 Email: [email protected] www.cisi.org/qualifications Author: Kevin Rothwell, FCSI Reviewers: Martin Mitchell Kevin Sloane, Chartered MCSI Rohan Dholakia This is an educational workbook only and the Chartered Institute for Securities & Investment accepts no responsibility for persons undertaking trading or investments in whatever form. While every effort has been made to ensure its accuracy, no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the publisher or authors. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the copyright owner. Warning: any unauthorised act in relation to all or any part of the material in this publication may result in both a civil claim for damages and criminal prosecution. Candidates should be aware that the laws mentioned in this workbook may not always apply to Scotland. A learning map, which contains the full syllabus, appears at the end of this workbook. The syllabus can also be viewed at cisi.org and is also available by contacting the Customer Support Centre on +44 20 7645 0777. Please note that the examination is based upon the syllabus. The questions contained in this workbook are designed as an aid to revision of different areas of the syllabus and to help you consolidate your learning chapter by chapter. Please note that, as part of exam security, hand-held calculators are not allowed in CISI exam venues. Candidates must use the onscreen calculator for all CISI CBT exams in all languages in the UK and internationally. Workbook version: 6.3 (October 2023) II Important – Keep Informed on Changes to this Workbook and Examination Dates Changes in industry practice, economic conditions, legislation/regulations, technology and various other factors mean that practitioners must ensure that their knowledge is up to date. At the time of publication, the content of this workbook is approved as suitable for examinations taken during the period specified. However, changes affecting the industry may either prompt or postpone the publication of an updated version. It should be noted that the current version of a workbook will always supersede the content of those issued previously. Keep informed on the publication of new workbooks and any changes to examination dates by regularly checking the CISI’s website: cisi.org/candidateupdate Learning and Professional Development with the CISI The Chartered Institute for Securities & Investment is the leading professional body for those who work in, or aspire to work in, the investment sector, and we are passionately committed to enhancing knowledge, skills and integrity – the three pillars of professionalism at the heart of our Chartered body. CISI examinations are used extensively by firms to meet the requirements of government regulators. Besides the regulators in the UK, where the CISI head office is based, CISI examinations are recognised by a wide range of governments and their regulators, from Singapore to Dubai and the US. Around 50,000 examinations are taken each year, and it is compulsory for candidates to use CISI learning workbooks to prepare for CISI examinations so that they have the best chance of success. Our learning workbooks are normally revised every year by experts who themselves work in the sector and also by our Accredited Training Providers, who offer training and elearning to help prepare candidates for the examinations. Information for candidates is also posted on a special area of our website: cisi.org/candidateupdate. This learning workbook not only provides a thorough preparation for the examination it refers to, it is also a valuable desktop reference for practitioners, and studying from it counts towards your Continuing Professional Development (CPD). Mock examination papers, for most of our titles, will be made available on our website, as an additional revision tool. CISI examination candidates are automatically registered, without additional charge, as student members for one year (should they not be members of the CISI already), and this enables you to use a vast range of online resources, including CISI TV, free of any additional charge. The CISI has more than 40,000 members, and nearly half of them have already completed relevant qualifications and transferred to a core membership grade. You will find more information about the next steps for this at the end of this workbook. III IV The Financial Services Sector............................ 1 1 Industry Regulation.................................. 21 2 Asset Classes and Financial Markets....................... 45 3 Collective Investments................................ 113 4 Economics and Investment Analysis........................ 147 5 Investment Management.............................. 229 6 Investment Advice.................................. 289 7 Lifetime Financial Position............................. 343 8 Glossary......................................... 389 Multiple Choice Questions.............................. 407 Syllabus Learning Map................................ 439 It is estimated that this workbook will require approximately 100 hours of study time. What next? See the back of this book for details of CISI membership. Need more support to pass your exam? See our section on Accredited Training Partners. Want to leave feedback? Please email your comments to [email protected] V VI  Before you open Chapter 1 We love a book!...but don’t forget you have been sent a link to an ebook, which gives you a range of tools to help you study for this qualification Open it now to access: Watch video clips Read aloud A A Adjustable text size allows related to your function you to read comfortably syllabus on any device Highlight, bookmark Images, tables and Links to relevant Pop-up definitions and make animated graphs websites annotations digitally The use of online videos and voice functions allowed me to study at home and on the go, which helped me make more use of my time. I would recommend this as a study aid as it accommodates a variety of learning styles. Find out more at cisi.org/ebooks Billy Snowdon, Team Leader, Brewin Dolphin ebook bw 2.indd 1 05/01/2017 12:19:32  Chapter One The Financial Services Sector 1. The Purpose and Structure of the Financial Services Sector 3 This syllabus area will provide approximately 4 of the 100 examination questions 1 2  The Financial Services Sector 1. The Purpose and 1 Structure of the Financial Services Sector This chapter offers an introduction to the financial services sector by looking at the purpose of the sector and its main participants before looking at economics and financial markets. 1.1 The Financial Services Sector in the Economy Learning Objective 1.1.1 Know the function of the financial services sector in the economy: transferring funds between individuals, businesses and government; risk management The financial services sector is central to the global economy and encompasses a wide and diverse series of activities ranging from banking to insurance, stock markets, venture capital and, of course, the management of wealth. 3  Financial Services Sector The scale of the global financial services sector is undoubtedly enormous, and some of the statistics associated with it are of such a size as to render the numbers almost incomprehensible. For example, according to statistics from the Bank for International Settlements (BIS), daily turnover on the foreign exchange (FX) market can be in excess of US$6 trillion, while the total value of shares quoted on the world’s stock exchanges exceeded US$109 trillion as at the end of 2020 according to the World Federation of Exchanges. The growth in financial services across the globe has been greatly helped by the extraordinary development and changes brought about by technology, akin to the industrial revolutions in various countries between 1760 and 1900. The combination of rapid technological change and globalisation has resulted in low inflation, strong growth and rapid proliferation of bond and equity markets. Technology has also heralded significant changes in societies, stemming from urbanisation, growing income disparities and changing patterns of consumption, especially in the developing world as can be seen from China and India, resulting in their requirements for financial services. Some people around the world are moving out of subsistence, towards having disposable income for leisure and saving and investing for the future and other generations. Hence the need for some sort of financial management, be it simple banking accounts to life assurance products. Governments are also investing vast sums in infrastructure, hence the need to raise capital from financial markets. Financial companies provide a vital economic function in bringing together those with money to invest (with the aim of achieving growth or future income) with companies and governments who need capital for investment, expansion or for funding their ongoing operations. 4  The Financial Services Sector The financial services sector plays a critical role in developed and developing economies and provides 1 the link between organisations needing capital and those with capital available for investment. For example, an organisation needing capital might be a growing company and the capital might be provided by individuals saving for their retirement in a pension fund. It is the financial services sector that channels money invested to those organisations that need it and which provides transmission, payment, advisory and management services. The role of the financial services sector can be broken down into three core functions: Provides the link between organisations needing Investment Chain capital and those with capital available for investment Allows risks to be managed effectively and efficiently Managing Risk through the use of insurance, and increasingly through the use of sophisticated derivatives Mechanisms for money to be managed, transmitted Payment Systems and received quickly and reliably In a little more detail, these encompass the following: Through the investment chain, investors and borrowers are brought together, bringing finance to business and opportunities for savers to Investment Chain manage their finances over their lifetime. The efficiency of this chain is critical to allocating capital to the most profitable investments, providing a mechanism for saving, raising productivity and, in turn, improving competitiveness in the global economy. In addition to the opportunities that the investment chain provides for pooling investment risks, the financial services sector allows other risks to be managed effectively and efficiently through the use of insurance and Managing Risk increasingly sophisticated derivatives, to offset certain exposures or to speculate against events (anticipated or unanticipated). These tools help businesses cope with global uncertainties as diverse as the value of currencies, the incidence of major accidents or climate events and protect households against everyday events. 5  Payment and banking services operated by the financial services sector provide the practical mechanisms for money to be managed, transmitted and received quickly and reliably. It is an essential requirement for commercial activities to take place and for participation in international trade and investment. An international example of a payment system is SWIFT, the communications platform that enables its members to exchange financial information securely and reliably Payment Systems and, in so doing, standardise international financial transactions. Access to payment systems and banking services is a vital component of financial inclusion for individuals, although this does vary country by country and is dependent on whether a country is fully integrated into the global financial system. At one time, it was the more advanced countries that had the most sophisticated payment systems, but today the use of technology is changing that. In Africa, for example, mobile phones make online banking payment systems accessible to people who previously did not have a bank account. Across the world, there are disparities in economic development. One of the reasons for this can be linked to how well developed the financial sectors are in a country. For example, deeper financial markets in the US relative to those in Europe are, to a large extent, responsible for the larger increases in productivity and faster pace of industrial innovation. Another piece of evidence supporting this view is the empirical study of Popov and Roosenboom (2009), who found that better access to private equity and venture capital has had a positive impact on the number of patents in Europe. Developing countries are increasingly implementing plans to develop their financial services sector as a key pillar of economic growth. Role of the Financial Services Sector in Economic Growth Research shows that a positive link exists between the sophistication of the financial system and economic growth. A well-developed financial system should improve the efficiency of financing decisions, favouring a better allocation of resources and thereby economic growth. In conclusion, for the effective running and development (health) of an economy, it is vital that there is a functioning financial system – credit provision; liquidity provision; risk management – and to create a marketplace for both buyers and sellers of finance and financial securities. According to the Federal Reserve Bank of San Francisco (January 2005): ‘Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that facilitate the accumulation of capital and the production of goods and services. The combination of well- developed financial markets and institutions, as well as a diverse array of financial products and instruments, suits the needs of borrowers and lenders and therefore the overall economy’. 6  The Financial Services Sector 1.2 Main Institutions and Organisations 1 Learning Objective 1.1.2 Know activities associated with wholesale financial markets and retail financial markets 1.1.3 Know the role of the main institutions/organisations: retail banks; investment banks; pension funds; fund managers 1.1.4 Know activities associated with: custodians The financial services sector comprises a broad range of businesses that provide financial services to governments, business and individuals. The range of activities and services undertaken is wide and ranges from the provision of simple bank accounts to complex structures used for corporate finance to name just two examples. As a result of this, having an appreciation of the breadth and scale of the sector is useful so that different services can be placed in context. A starting point is to try and provide an overall structure that services can be allocated to, and to distinguish between wholesale and retail financial markets. Wholesale and Retail Markets Wholesale financial markets enable companies, public sector organisations, governments and financial institutions to raise short- Wholesale term finance and long-term capital to fund growth; undertake domestic Markets and international trade; manage financial and other risks; and pursue investment opportunities. The effective operation of wholesale markets is critical to both the functioning of retail financial markets and the economy as a whole. Retail financial markets are where companies and firms provide financial Retail Markets services directly to individuals and small businesses. These can range from banking accounts to lending, insurance and wealth management. In simple terms, the wholesale market can be thought of as the provision of financial services in the business to business sector, whereas the retail market is the provision of financial services by businesses to customers. The division into these two markets is a useful way to see the sector; however, there are many areas that do not fit neatly into either area and there are some that straddle the two. The financial activities that make up the wholesale financial sector include: International banking – cross-border banking transactions. Equity markets – the trading of quoted shares. Bond markets – the trading of government, supranational or corporate debt. Foreign exchange – the trading of currencies. Derivatives – the trading of options, swaps, futures and forwards. Fund management – managing the investment portfolios of collective investment schemes, pension funds, insurance funds, hedge funds and private equity. 7  Insurance – re-insurance, major corporate insurance (including professional indemnity), captive insurance and risk-sharing insurance. Investment banking – the provision of tailored banking services to organisations, which includes activities such as corporate finance, undertaking mergers and acquisitions, equity trading, fixed- income trading and private equity. By contrast, the retail sector focuses on services provided to personal customers, including: Retail banking – the traditional range of current (US: checking) accounts, savings accounts, lending and credit cards. Insurance – the provision of a range of life insurance and protection solutions for areas such as medical insurance, critical illness, motor, property, income protection and mortgage protection. Pensions – the provision of investment accounts specifically designed to capture savings during a person’s working life and provide benefits on retirement. Investment services – a range of investment products and vehicles ranging from execution-only stockbroking to full wealth management services and private banking. Financial planning and financial advice – the service of helping to plan a client’s financial future, taking into account mortgages, debts, insurance and pensions. In many financial centres, however, the picture is complicated by the fact that many large organisations span the whole spectrum of financial services, blurring the traditional boundaries between various products and providers. 1.2.1 Banks and Savings Institutions In today’s financial services marketplace, a range of banks and savings institutions exists to provide a wide variety of deposit, lending and investment products to individuals, businesses or both. Types of Bank and Savings Institutions These are the typical well-known banks found in most cities and towns that accept deposits and make loans to and from customers and smaller businesses. Historically, these institutions have tended to operate through a network of branches located in town centres, but increasingly they provide internet-based banking services. Retail and As well as providing traditional banking services, larger retail banks also Commercial Banks offer products such as asset management, pensions and insurance, and sometimes execution-only and other broking services. Traditionally, retail banks offered services and products to individuals, whilst commercial banks dealt directly with businesses. Today, that distinction has become blurred. Retail and commercial banks are owned by their shareholders; but some may instead be owned by the government such as the Industrial and Commercial Bank of China (ICBC). 8  The Financial Services Sector In addition to retail and commercial banks, most countries also have 1 savings institutions that started off by specialising in offering savings products to retail customers, but now tend to offer a range of services similar to those offered by banks. They are known by different names around the world, such as cajas in Spanish-speaking countries. In the UK and Australia, they are usually known as ‘building societies’, recognising the reason why they first came about: they were established in the 19th century when small groups of people would group together and pool their savings, allowing some members to build or buy houses. Japan Post Bank, part of the post office, Savings was the world’s largest savings bank until it listed on the Tokyo Stock Institutions Exchange in 2015. Savings institutions are typically jointly owned by the individuals that have deposited or borrowed money from them – the ‘members’. It is for this reason that such savings organisations are often described as ‘mutual societies’. The major difference between traditional banks and a mutually-owned savings institution relates to its ownership. The latter are owned by the members of the savings institution. Over the years, many savings institutions have merged or been taken over by larger ones. In the past, a number have transformed themselves into banks that are quoted on stock exchanges – a process known as ‘demutualisation’ where the members of the savings institution became shareholders. Consumer finance companies specialise in providing loans to individuals to finance the purchase of items such as cars or household equipment. Car manufacturers often own specialist lenders so they can help finance the purchase of their cars. There are also finance companies that specialise in providing finance Finance to businesses – offering loans and other services such as factoring. Companies Factoring is where the company sells its accounts receivables (ie, its unpaid invoices) to the finance company at a discount. The business then receives the cash immediately which will aid its cash flow. A major difference between these and traditional banks is that banks get some of their funding from accepting deposits, whereas these specialist lenders get their funding from shareholders, banks and the capital markets. As mentioned in section 1.1, technology is breaking down the barrier to entry that retail banks used to enjoy. This is resulting in new providers, such as internet-based banks challenging the traditional role of the existing banks and savings institutions; technological developments have allowed online banks to offer their banking services without an extensive network of offices. Another term entering our lexicon to explain new banks is challenger banks; they have been designed to compete with the larger mainstream retail banks, but are seen as more nimble, with fewer products and, most importantly, are not encumbered by legacy issues. 9 In Asia and Africa, the widespread use of smartphones allows people to receive financial services at their fingertips, as long as an internet connection is available, and payments can be carried out through QR codes, fingerprints and facial recognition. In China, for example, tech giants, such as Ant Group and Tencent, have entered the financial services sector and are changing how financial services products are distributed. Ant Group operates Alipay, the world’s largest mobile and online payments platform. A more recent development in the banking industry has been the emergence of competitors to the traditional role of banks in the form of peer-to-peer lending (P2P). In the traditional banking model, banks take in deposits on which they pay interest and then lend out at a higher rate. The spread between the two is where they earn their profit. P2P lending cuts out the banks so borrowers often get slightly lower rates, while savers get far improved headline rates, with the P2P firms themselves profiting via a fee. In exchange for accepting greater risk, savers can earn higher returns which can be very useful in periods of low interest rates. Available rates vary depending on the type of borrower that the P2P site lends to and the risk the lender is prepared to accept. The deposit is lent out to individuals and businesses, but it may take time before all of a large deposit is lent out and earning interest. No interest is paid while it is waiting to be lent out. Immediate withdrawals are not always possible and, where they are, may take time and incur a charge or a reduced interest rate. A further development seen in many markets is the emergence of shadow banking. This term is a general phrase intended to catch a range of non-bank institutions that provide services similar to traditional banks but outside banking regulations. These range from pawnbrokers and finance companies at one end of the sector to money market funds and specialised investment vehicles at the other. Regulators worldwide have become increasingly concerned about the risks this poses to the financial system and in China, for example, regulators have taken action to rein in shadow banking to curtail the risks they can pose. 1.2.2 Investment Banks While investment banks may be called ‘banks’, their operations are far different from deposit-taking commercial banks. Investment banks provide advice to and arrange finance for companies that want to float on the stock market, raise additional finance by issuing further shares or bonds, or carry out mergers and acquisitions. They also provide trading services for institutions that might want to invest in shares and bonds; in particular pension funds and asset managers. In addition, investment banks support the trading activities of alternative vehicles such as hedge funds. Typically, an investment banking group provides some or all of the following services, either in divisions of the bank or in associated companies within the group: Corporate finance and advisory work, normally in connection with new issues of securities for raising finance, takeovers, mergers and acquisitions. Banking, for governments, institutions and companies. Treasury dealing for corporate clients in currencies, with financial engineering services to protect them from interest rate and exchange rate fluctuations. 10  The Financial Services Sector Investment management for sizeable investors, such as corporate pension funds, charities and 1 high net worth private clients (see section 1.3). In larger firms, the value of funds under management runs into many billions of dollars. Securities-trading in equities, bonds, derivatives and the provision of brokerage and distribution facilities. Only a few investment banks provide services in all of these areas. Most others tend to specialise to some degree and concentrate on only a few product lines. A number of banks have diversified their range of activities by developing businesses such as proprietary trading, servicing hedge funds or making private equity investments, but their ability to do so is now being restricted by regulatory changes introduced following the global financial crisis of 2007–08, such as the Dodd-Frank Act in the US (the Volcker Rule). 1.2.3 Pension Funds Pension funds receive contributions from, or on behalf of, employees and then provide an income on retirement. Pension funds are large, long-term investors in shares, bonds and cash. Some also invest in physical assets such as property. Given their aim of providing a pension on retirement, the sums of money invested in pensions are substantial. 1.2.4 Fund Managers Fund managers, also known as asset managers, run portfolios of investments for others. They invest money held by pension funds, insurance companies, high net worth individuals and others. Some are independent companies; others are divisions of larger entities such as insurance companies or banks. Fund managers will buy and sell shares, bonds and other assets in an attempt to increase the value of their clients’ portfolios. Fund managers manage portfolios for different types of client with widely varying sizes of funds. For convenience, they can be subdivided into three main types reflecting the market they are serving as shown in the following below. Institutional fund managers work on behalf of institutions, for Institutional Fund example, investing money for a company’s corporate pension fund Managers or an insurance company’s fund. These fund managers operate mutual funds that are available Mutual Fund to the general public to invest in, often with relatively low initial Managers investment amounts. These are sometimes called private client fund managers or Discretionary portfolio managers to make the distinction that they are running Investment Managers individual portfolios for private clients. These may be portfolios that are bespoke to the client or model portfolios. Obviously, institutional funds typically provide the fund managers with larger sums of money than do retail or private clients, although retail pooled pension funds can rival institutional mandates for size. Fund managers make a profit by charging their clients money for managing portfolios. The charges are often based on a small percentage of the fund being managed. 11 1.2.5 Custodians Custodians are banks that specialise in safe custody and asset services, looking after securities, eg, shares and bonds on behalf of others such as fund managers, pension funds and insurance companies. The activities they undertake include: Holding assets in safekeeping, such as equities and bonds. Arranging settlement of any purchases and sales of securities. Asset servicing – collecting income from securities, such as bonds and equities of the actual underlying companies and then paying them out to either the client holders or the wealth management house for that company to pay to their client accounts, and processing corporate actions. Providing information on the underlying companies and their annual general meetings (AGMs) to their clients. Managing cash transactions. Performing foreign exchange transactions where required. Providing regular reporting on all their activities to their clients. Reconciliations of assets held to tally with what the funds expect that they are holding. This function is also called trade support. They may also offer other services to their clients, such as measuring the performance of the portfolios and maximising the return on any surplus cash. Custodians, like fund managers, make money by charging fees for their services. In common with both fund managers and stockbrokers, some custodians are independent while others are divisions of larger entities, such as investment banks. Custodians can operate either domestically, regionally or globally. Global custodians, such as Bank of New York Mellon and State Street, provide custody services in most markets by either having a branch in the market or using a local agent. A regional custodian provides specialist services across a region, as the global custodian HSBC Securities Services does, for example, in Asia and the Middle East. 1.3 Wealth Management Learning Objective 1.1.5 Understand the roles of investment management and financial planning in the wealth management sector: investment managers; financial planners; private banks; platforms Wealth management refers to the provision of financial services that have the goal of preserving and enhancing clients’ wealth. As we have already seen, it includes the provision of financial advice as there has been a move to integrate financial advice and investment management. Hence, the sector is seeing the consolidation of those two sectors that were previously separate services. 12  The Financial Services Sector Wealth management delivers a wide range of services that enable an individual to manage their 1 financial affairs and assets effectively, such as: tailored banking products investment management secured lending against investment portfolios to allow them to be leveraged investment products in areas such as foreign exchange, structured investments, property and alternative investments trusts and estate management tax planning, and estate planning. The provision of these services is typically segmented according to wealth, with clients classified as mass affluent, high net worth or even ultra-high net worth. The value applied to define each segment will clearly change from market to market, but the following gives an indication of the asset profile of individuals making up each segment: Mass affluent – investable assets over US$100,000. High-net-worth individuals (HNWIs) – investable assets of over US$1 million. Very-high-net-worth individuals – investable assets of over US$5 million. Ultra-high-net-worth individuals – investable assets of over US$30 million. The 2020 World Wealth Report published by Capgemini estimated that the value of assets managed on behalf of HNWIs exceeded US$74 trillion. HNWI wealth remains on course to reach US$100 trillion by 2025. 1.3.1 Financial Planning The role of the wealth manager will vary depending on the value of the client’s assets and the services offered by the firm they work for. The areas that a wealth manager may get involved in on behalf of a client include financial planning, tax planning, investment management, asset protection and estate planning to name just a few of the main areas of advice. This wide spectrum means that a wealth manager may be the primary contact for the client and sub-contract other activities to specialists. Wealth management involves an ongoing service to clients, and includes both financial planning and the provision of appropriate solutions. Before proceeding further, it is useful to specify what is meant by financial planning. 13 The Chartered Institute for Securities & Investment (CISI) website explains it in the following way: CISI Wayfinder Financial Planning is an ongoing process to help you make sensible decisions about money that can help you achieve your goals in life; it’s not just about buying products like a pension or an individual savings account. It might involve putting appropriate wills in place to protect your family, thinking about how your family will manage without your income should you fall ill or die prematurely, spending money differently, but it involves thinking about all of these things together, ie, your ‘plan’. You can build a plan on your own, or if your needs are more complex you might want the help of a financial planner. Start by working out your goals in life, in the short, medium and long term. Prioritise them, and think about the likely cost of those goals and when you will need the money, so you can start to plan your finances to work out how to achieve them. Don’t forget you also have to plan for some of the hurdles you may have to overcome too. It’s about getting organised; being in control of your finances rather than letting your finances control you. From this, we can immediately see that financial planning is an evolving plan of action, distinct from financial advice which is a one-off recommendation at a single point in time. A financial plan may be very simple or very complex. However, the production of a plan will always result from following a financial planning process. A description of the steps involved in the financial planning process is defined by the Financial Planning Standards Board (FPSB) which describes the process as including at least six steps that form an ongoing cycle. Financial Planning in Six Steps Establish client relationship Collect client’s information Review client’s situation Analyse client’s Develop solutions Implement Source: Financial Planning Standards Board ltd 14  The Financial Services Sector The FPSB is a non-profit organisation that manages, develops and operates certification, education 1 and related programmes for financial planning organisations. Its professional qualification – Certified Financial Planner (CFP) – is used globally, including by the CISI. The solutions developed from the financial planning process may also include the selection of investments, investment management, protection products and estate planning, and each of these is considered in later chapters of this workbook. 1.3.2 Wealth Management Providers Wealth management refers to a financial service that addresses the investment, tax, protection and estate planning needs of a client. It, therefore, goes beyond financial planning or investment management by taking a holistic view of a client’s needs and developing solutions to meet those needs. The type of services offered and the minimum amount of funds needed for the service will differ not just from country to country, but from firm to firm depending on their area of specialism. It is a service offered by private banks, stockbrokers, subsidiaries of banks and increasingly by financial planning firms. Financial Advisers A financial adviser is one that can provide a financial planning service that may look at a client’s entire financial position from budgeting, savings, investments, mortgages to tax planning. Some provide holistic advice for a client’s entire affairs, while others specialise in certain areas. When providing financial advice, a financial advisory firm may offer independent advice where they select products and solutions from the best available in the market or they may be restricted to the products of one or just a few product providers. Typically, they do not manage investment portfolios for clients and instead select a discretionary fund manager or a series of mutual funds to meet their clients’ needs. Increased competition, cost pressures and the need to improve service offerings have, however, seen many financial advisory firms change their business model to operate more like a typical wealth manager and manage a client’s assets themselves or using an investment platform. Commercial Banks Banks typically operate wealth management divisions that offer the same range of services as financial advisers to their mass market customers. They will often cover the same range of services and may be either independent advisers or be restricted in the advice they offer. Wealth Managers There are a number of other firms that fall within the description of wealth managers, such as stockbrokers and discretionary asset managers. A stockbroker buys and sells securities on a stock exchange for its clients. Some stockbroking firms restrict their activities to just this type of activity, but many in the retail field have for years managed investment portfolios for clients and so moving into managing a client’s overall wealth position is a natural extension. 15 Discretionary asset managers manage portfolios on behalf of clients on either a discretionary or an advisory basis. Many have been active in this field for years and so are a natural fit into the wealth management structure and act as wealth managers or as discretionary asset managers for other firms. Private Banking Where financial advisers and commercial banks have typically catered for the mainstream retail customer market, private banks have traditionally focused on the wealthier end of the market and restricted their services to the wealthy or very wealthy. This kind of service is usually offered to HNWIs on an individual bespoke basis. Originally, it just covered banking services, but it now includes wealth advice and management. Private banks provide a wide range of services for their clients, including wealth management, estate planning, tax planning, insurance, lending and lines of credit. Their services are normally targeted at clients with a certain minimum sum of investable cash, or minimum net wealth. Private banking is offered both by domestic banks and by those operating offshore. In this context, offshore banking means banking in a different jurisdiction from the client’s home country – usually one with a favourable tax regime. Family Offices A single-family office fulfils a role whereby it acts as an advisory and wealth manager to a single ultra- high net worth family. A multi-family office helps multiple families with advice and wealth management services and has become more popular recently as it allows for the cost sharing of investment and consulting expenses. A multi-family office will offer a range of services beyond investment advice and management, these can include philanthropic advice, estate planning, tax services, insurance, household management, private school arrangements and more. They often also provide services to family-owned businesses, advising on issues such as governance and business management. Many major wealth management firms now offer a boutique service to international family offices and private investment offices. Private Investment Offices Private investment offices are independent firms, usually structured as a partnership, where partners invest their money alongside clients. Like multi-family offices, they tend to focus on the upper end of the wealth scale. However, as the name suggests, they deal solely with the investment affairs of clients. They offer asset allocation and bespoke investment management services which may be handled in-house or by external advisers. A private investment office manages the risks, conducts due diligence, prevents frauds, and monitors asset allocation; it seeks long-term investment results for the families and its individuals members. Again, they tend to remain independent as they seek best-of-breed solutions for a client. 16  The Financial Services Sector 1.3.3 Investment Management 1 A wide range of firms provide wealth management services to clients, each of which specialise in different segments of the market. Each of these firms will usually undertake portfolio or investment management. Portfolio management is the management of an investment portfolio on behalf of a private client or institution with a primary focus on meeting their investment objectives. Portfolio management can be conducted on the following bases: Discretionary basis – where the portfolio manager makes investment decisions within parameters agreed with the client. Non-discretionary or advisory basis – an investment manager (or via a client relationship manager) would recommend an ongoing investment strategy and changes, but ultimately all the decisions would need to be made by the client. Ultimately, it is the client leading the investment management and just relying on the investment management firm for investment advice, execution and settlement. The client is under no obligation to take this advice, although they do pay a fee for this. In both cases, the portfolio manager usually has the choice of investing directly in a range of asset classes and/or indirectly via collective investment funds. Obviously, this is a simplified explanation – the provision of a wealth management service would include understanding what the client requires, fact- finding information, an understanding of the client’s risk tolerance and expected returns to meet certain goals or future events and taking account of their investment timeline/horizon. 1.3.4 Platforms Platforms are online services used by intermediaries, such as independent financial advisers, to view and administer their clients’ investment portfolios. They offer a range of tools which allow advisers to see and analyse a client’s overall portfolio and to choose products for them. As well as providing facilities for investments to be bought and sold, platforms generally arrange custody for clients’ assets. Platforms enable advisers to take a holistic view of the various assets that a client has in a variety of accounts. Advisers also benefit from using these accounts to simplify and bring some level of automation to their back office using internet technology. Platform providers also make their services available direct to investors, and platforms earn their income by charging for their services. The advantage of platforms for fund management groups is the ability of the platform to distribute their products to financial advisers. 1.3.5 Wealth Management and Technology Wealth management is going through a period of significant change – changing client needs, stricter regulation, and technological development mean that the market is changing rapidly. Technology is embedded in everything we do, changing the way we live, work, and experience the world. Advances in technology have radically altered how we use the internet and communicate, and are disrupting traditional industries. 17 Financial technology (FinTech) is disrupting the traditional wealth management industry and requiring the development of digital wealth services and platforms. People across many generations are now digitally proficient and they desire constant access to sophisticated tools and services, and clients of wealth management firms are no different. Below, we look at some of the developments affecting the wealth management sector. Communications Today, we communicate with the latest apps around the globe or buy online based on the artificial intelligence (AI) recommendations of digital providers. Wealth management clients are demanding what is already a matter of fact in the retail industry, namely a full range of digital infrastructure capabilities. For example, China’s fund management industry has gone from fledgling asset management to global pioneer in a short number of years in terms of how fund purchases take place. In 2012, only a handful of investors made fund purchases online, but according to a survey by the Asset Management Association of China (AMAC) more than two-thirds now subscribe to funds via mobile phone apps. Online Solutions With the rise of digital wealth management solutions, many clients are taking their wealth management experience online, resulting in many points of contact across multiple devices that need to be streamlined. In-person contact and consistency remain important as well, as very few are comfortable with an interaction model that is purely digital or online. This calls for improved connectivity between the client and their adviser across all contact points. Additionally, with the interaction between clients and wealth managers moving from voice conversations to messenger-based communications, this will require an unanticipated level of compliance to monitor all interactions between advisers and clients. Robo-Advice Robo-advice is the application of technology to the process of providing financial advice, but without the involvement of a financial adviser. Robo-advisers are able to provide wealth management advice with the use of algorithms, and some are even able to make financial transactions on the client’s behalf. A prospective investor enters data and financial information about themselves, and the system then uses an algorithm to score the information and decide what investments should be chosen. The system then presents an investment strategy, which is usually passively focused around index funds or exchange-traded funds (ETFs), and allows easy implementation. 18  The Financial Services Sector End of Chapter Questions 1 Think of an answer for each question and refer to the appropriate section for confirmation. 1. What role does the investment chain perform? Answer reference: Section 1.1 2. How does a traditional bank differ from a mutually-owned savings institution? Answer reference: Section 1.2.1 3. If an investment bank is trading in bonds, is it likely to operate in the wholesale or retail market? Answer reference: Section 1.2 4. Who are the typical customers of an investment bank? Answer reference: Section 1.2.2 5. Which market participant is responsible for the safekeeping of assets? Answer reference: Section 1.2.5 6. How does discretionary investment management differ from advisory investment management? Answer reference: Section 1.3.3 19 20  2 Chapter Two Industry Regulation 1. Financial Services Regulation 23 2. Financial Crime 30 3. Ethical Standards 40 This syllabus area will provide approximately 5 of the 100 examination questions 21 22  Industry Regulation 1. Financial Services Regulation 2 Learning Objective 2.1.1 Know the objectives and benefits of regulation; the main differences between rules-based and principles-based approaches to financial regulation; the role of the main international regulatory organisations; how regulations are implemented at a national level; and the importance of ethical standards With the increasing globalisation of financial markets, there is a demand from governments and investment firms for a common approach to regulation in different countries. As a result, there is a significant level of cooperation between financial services regulators worldwide and, increasingly, common standards, money laundering (ML) rules probably being the best example. In this section, we will start with looking at the purpose and benefits of regulation, the types of model encountered before looking at the role of international regulatory organisations. 1.1 Purpose and Benefits of Regulation Effective financial markets are an essential part of developed and developing economies. They fuel economic development and aid wealth creation. As a result, confidence and trust in these markets is vital; loss of confidence and trust can result an adverse impact on customers and the economy. 23 Due to the inherent risk of monetary loss in many financial transactions, financial markets require rules and codes of conduct to protect investors and the general public. A key characteristic of financial markets is therefore a set of standards, rules and codes of conduct to define standards of acceptable conduct by regulated firms and individuals. The objectives and benefits of regulation are typically achieved through a combination of law and regulation. Regulation is a combination of rules and standards generally covering matters such as observing proper standards of market conduct, managing conflicts of interest, treating customers fairly, and ensuring the suitability of customer advice. Objectives and Benefits of Regulation The objectives and benefits of regulation can be summarised as follows: Increasing the confidence and trust in financial markets, systems and products. Establishing an environment to encourage economic development and wealth creation. Reducing the risk of market and system failures including their economic consequences. Enhancing consumer protection by giving them the reassurance they need to save and invest. Reducing financial crime by ensuring financial systems cannot easily be exploited. 1.2 Models of Regulation Originally, financial markets operated using self-regulation, but over time different models of self- regulation have evolved. The main types are rules-based and principles-based, with self-regulatory organisations having a role in both approaches. 24  Industry Regulation Models of Regulation This approach involves a high degree of prescriptive procedures including very detailed rules stipulating what individuals and firms 2 must do to ensure they comply. Rules-Based A rules-based approach requires a strict adherence to precise rules with little allowance for interpretation. It is typically inflexible and may result in a tick-box exercise. For regulators, maintaining a comprehensive rules-based model is challenging, particularly in evolving and fast changing markets. In this approach, the focus is on principles and therefore the types of behaviour and outcomes, as opposed to just following the rules. Principles-based regulation acknowledges that firms and individuals are different and adopt different approaches – by applying principles rather than hard and fast rules, the regulator allows firms to make their own decisions about their operating model and as long as they can explain why they chose a particular Principles-Based approach (and it aligns with the principle), there is scope for different approaches. This means that firms do not have to slavishly follow prescriptive rules and can decide how they want to meet a principle – as long as they can justify their approach, principles-based regulation can work well. The challenge faced by regulators with a principles-based approach is ensuring that firms apply consistent interpretations to their implementation of the principles. SROs have a key role to play in effective regulation as recognised by the International Organization of Securities Commissions (IOSCO): ‘Self-regulatory organisations (SROs) can be a valuable component to the regulator in achieving the objectives of securities regulation’. Many different forms of self-regulation exist for financial markets such as industry self-regulatory organisations, exchange self- Self-Regulatory regulatory frameworks and professional bodies. Organisations (SROs) In the financial services sector self-regulation is typically a unique combination of private interests with government oversight, which is recognised as having delivered an effective and efficient form of regulation for the complex and dynamic environment. SROs in some countries have been replaced by a government/ legal entity (such as in the UK), but still have a role to play in other markets as seen in the US - for example, the Financial Industry Regulatory Authority (FINRA). As financial markets have become increasingly global in nature and interdependence has grown, the financial sector has moved from self-regulation alone to a statutory approach. This has facilitated international cooperation and the development of improved and common standards. 25 1.3 International Regulatory Bodies As the financial services sector becomes more and more international, many regulations and laws have application beyond national borders, and there is increasing cooperation between international regulatory authorities and national regulators. In this section, we will look at the role of some of the main international bodies. 1.3.1 Bank for International Settlements (BIS) The Bank for International Settlements (BIS) is based in Switzerland and is owned by 60 central banks from around the world. It acts as the ‘central bank’ for central banks and does not accept deposits from, or provide financial services to, private individuals or corporate entities. Its role is to serve central banks in their pursuit of monetary and financial stability and to foster international cooperation in those areas. It is perhaps best known for the Basel Accords that set the capital adequacy standards for banks worldwide. The BIS promotes international cooperation among monetary authorities and financial supervisory officials through its meetings programmes and through the Basel Process. The Basel Process refers to the committees it hosts that have a key role in helping to strengthen the stability and resilience of the global financial system. These include the following: Basel Committee on Banking Supervision (BCBS): develops global regulatory standards for banks and seeks to strengthen micro- and macro- prudential supervision of financial institutions. Committee on the Global Financial System (CGFS): monitors and analyses issues relating to financial markets and systems. Committee on Payments and Market Infrastructures (CPMI): establishes and promotes global regulatory/oversight standards for payment, clearing, settlement and other market infrastructures, and monitors and analyses developments in these areas. The outcome of the Basel Process is internationally agreed guidance. International agreement is the precondition for globally consistent standards produced by the standard-setting committees. But it does not substitute for national legislation. In order to become binding, the agreements reached in Basel have to be approved and implemented at the national level, following due regulatory and legislative processes in each individual jurisdiction. 1.3.2 Financial Stability Board (FSB) The Financial Stability Board (FSB) has a mandate from international governments to promote financial stability. It supports the development and implementation of internationally accepted economic, financial and statistical standards that can help promote sound domestic financial systems and international financial stability. Notably, one of its objectives is to assess vulnerabilities affecting the global financial system and the actions needed to address these. Its decisions are not legally binding on its members – instead the organisation operates by moral suasion and peer pressure, in order to set internationally agreed policies and minimum standards that its members commit to implementing at national level. 26  Industry Regulation 1.3.3 International Organization of Securities Commissions (IOSCO) The International Organization of Securities Commissions (IOSCO) is an international association of securities regulators created in 1983. Its 38 principles of securities regulation are supported by the G20 2 and the FSB. Its principles are based on the following three objectives of securities regulation: 1. The protection of investors. 2. Ensuring that markets are fair, efficient and transparent. 3. The reduction of systemic risk. The 38 principles do not have any legal force themselves but need to be practically implemented under the relevant legal framework in member countries. The principles are grouped into ten categories as follows: 1. Relating to the Regulator 2. Self Regulation 3. Enforcement of Securities Regulation 4. Cooperation in Regulation 5. Issuers 6. Auditors, Credit Rating Agencies and other Information Providers 7. Collective Investment Schemes 8. Market Intermediaries 9. Secondary Market 10. Clearing and Settlement Its members regulate more than 90% of the world’s securities markets, and the IOSCO is today the world’s most important international cooperative forum for securities regulatory agencies. Through this forum, regulators cooperate in the development and enforcement of standards and surveillance of international transactions. They use IOSCO structures to do the following: Cooperate to promote high standards of regulation. Exchange information to promote development of markets. Unite their efforts to establish standards and effective surveillance of international securities transactions. Provide mutual assistance to promote integrity of markets by a rigorous application of standards and by effective enforcement against offences. 1.4 National Regulators Governments are responsible for setting the role of regulators and, in so doing, will clearly look to see that international best practice is followed through the adoption of IOSCO objectives and principles and by cooperation with other international regulators and supervisors. Below we look at how this has been translated into the regulatory structure in a selection of countries. In each country, there is often more than one regulatory body, so we will concentrate on those that most directly affect securities markets and the provision of wealth management services. 27  National Regulators Given the size and maturity of the US financial system, it is unsurprising that responsibility for financial regulation is spread across many regulators. Two of the most well known are the Federal Reserve and the Securities and Exchange Commission (SEC). The SEC is an independent government agency tasked with overseeing US securities markets, enforcing securities law, and monitoring exchanges. The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisers, US and mutual funds. The Financial Industry Regulatory Authority (FINRA) is a self-regulatory organisation charged with overseeing business between brokers, dealers and the investing public. It is supervised by the SEC and is authorised to license individuals, admit firms to the industry, write rules, undertake audits of regulatory compliance and, where necessary, to discipline registered representatives and member firms for failure to comply with the rules or securities laws. It also provides education and qualification examinations to industry professionals. A key feature of the EU is its single market in financial services. European legislation involves a Directive passed by the European Council and European Parliament, which is then turned into detailed rules before being implemented at a national level in each EU state. The regulation of financial services across Europe is overseen by three supervisory authorities – the European Banking Authority (EBA), the European Union European Securities and Markets Authority (ESMA) and the European (EU) Insurance and Occupational Pensions Authority. ESMA has three objectives – investor protection, orderly markets and financial stability. One of its key roles is to develop the technical standards that national regulators in EU countries use to implement EU Directives. It also issues guidelines such as the requirement for financial services staff to obtain certain appropriate qualifications to be able to perform their role. China established the Financial Stability and Development Committee in 2017 as a super financial regulator. Its role is to coordinate the overall strategy for the financial sector and supervise China’s monetary policy and financial regulation. It coordinates the activities of the People’s Bank China of China (PBC) and the China Banking Insurance Regulatory Commission (CBIRC). As the central bank of China, the PBC is responsible for implementing monetary and exchange rate policy and the CBIRC supervises the establishment and ongoing business activities of banking and insurance businesses. 28  Industry Regulation National Regulators The Middle East contains a number of countries with different regulators but the country with the largest financial services sector in the region is 2 Saudi Arabia. Financial services regulation in the Kingdom is split between two regulatory bodies. The Saudi Arabian Monetary Authority supervises the banking system, insurance companies and exchange dealers. The Capital Middle East Markets Authority’s (CMA’s) role is to regulate and develop the capital market to create an appropriate investment environment, reinforce transparency and disclosure standards in all listed companies, and to protect investors and dealers from illegal acts in the market. Dubai and Qatar have growing financial services sectors and have seen the authorities in both countries look to adopt best practice from other regulators such as the EU, UK and Australia into their regulatory structures. In the UK, the two main regulators are the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The PRA is part of the Bank of England (BoE), the UK’s central bank, and is responsible for the financial soundness of deposit-taking institutions, UK insurers, and significant investment firms. The FCA is responsible for the conduct of all firms and the prudential regulation of firms not supervised by the PRA. The FCA focuses on the day-to-day regulation of all firms in retail and wholesale financial markets, as well as the infrastructure that supports these markets. As you will see from the above, there are different regulatory structures in each country ranging from a single integrated financial regulator, the separation of prudential and conduct supervision between different regulators, to a sector-based regulatory model. Financial institutions that want to establish themselves in a jurisdiction typically need to apply for a licence. Regulators will ensure that minimum entry standards are applied and approve those applications where it is certain that the firm will be sensibly managed with a viable business model and effective controls for risk mitigation. This could lead to a regulator imposing limitations and requirements on any part of the business model or even refusing to authorise a firm and grant permission for it to undertake regulated activities. The methods used by regulators will typically involve the following: The setting of prudential requirements to ensure that an authorised firm or person maintains sufficient capital resources commensurate with the level of risk they are running. Establishing business conduct rules, evidential provisions and guidance that will govern an authorised firm’s relationship with its customers or counterparties. Providing detailed product regulations often in the areas of retail products, such as collective investment schemes and pensions, which set minimum standards aimed at the protection of retail investors and establish dispute resolution and compensation arrangements. The setting of requirements and processes for investigation, supervision and enforcement of the rules. 29 Regulators will seek to maintain arrangements to supervise compliance with the requirements imposed on authorised persons. Due to the number of firms for which a regulator may be responsible, the regulator must consider how to align its resources with the risks each firm may pose to market stability. Where its risk assessments indicate that a firm may pose a risk to the regulator’s objectives, then its approach may be one of intensive oversight. Regulators have a range of tools they can use to aid their supervision of regulated firms. Typically, these are as follows: Diagnostic tools – designed to identify, assess and measure risk. Monitoring tools – to track the development of identified risk, wherever it arises. Preventative tools – to limit or reduce identified risks and so prevent them happening or increasing. Remedial tools – to respond to risks when they have happened. The complex character of securities transactions and the sophistication of fraudulent schemes require strong and rigorous enforcement of securities laws. Investors in the securities markets are particularly vulnerable to misconduct by intermediaries and others. This means that regulators should, therefore, have comprehensive investigatory and enforcement powers and, where necessary, cooperate with other regulators where there are cases of cross-border misconduct. 2. Financial Crime Financial crimes are crimes where someone takes money or property, or uses them in an illicit manner, with the intent to gain a benefit from it. There is no single definition of financial crime, but it encompasses any kind of criminal conduct relating to money or to financial services or markets and typically includes: bribery and corruption, fraud, tax evasion, cybercrime, identity theft, money laundering, terrorist financing, insider trading and handling the proceeds of crime. Reducing financial crime is a key priority for regulators, authorities and governments globally. Organised crime groups, terrorists and fraudsters are increasingly using sophisticated international networks and financial systems to move or store funds and assets or commit fraud. Financial institutions are particularly vulnerable due to the nature of their businesses and the volume of transactions and client relationships they manage. In today’s complex economy, financial crime can take many forms, but some of the main areas are money laundering and terrorist financing, market abuse, fraud, bribery and corruption. We consider some of these areas in the following sections. 2.1 Money Laundering and Terrorist Financing Money laundering (ML) is the process of turning dirty money (money derived from criminal activities) into money that appears to be legitimate. Dirty money is difficult to invest or spend and carries the risk of being used as evidence of the initial crime. Clean money can be invested and spent without risk of incrimination. Money laundering disguises the proceeds of illegal activities as legitimate money that can be freely spent. Increasingly, anti-money laundering (AML) provisions are being seen as the front line against drug dealing, terrorism and organised crime. 30  Industry Regulation 2 Money laundering can take many forms, including: turning money acquired through criminal activity into clean money handling the proceeds of crimes such as theft, fraud and tax evasion handling stolen goods being directly involved with, or facilitating, the laundering of any criminal or terrorist property, and criminals investing the proceeds of their crimes in a whole range of financial products. There can be considerable similarities between the movement of terrorist funds and the laundering of criminal property. Because terrorist groups can have links with other criminal activities, there is inevitably some overlap between AML provisions and the rules designed to prevent the financing of terrorist acts. However, these are two major differences to note between terrorist financing and other money laundering activities: Often, only quite small sums of money are required to commit terrorist acts, making identification and tracking more difficult. If legitimate funds are used to fund terrorist activities, it is difficult to identify when the funds become ‘terrorist funds’. Terrorist organisations can, however, require significant funding and will employ modern techniques to manage their funds and transfer them between jurisdictions, hence the similarities with money laundering. 31 2.1.1 International Approach to Combating Money Laundering Learning Objective 2.2.1 Know the role of the Financial Action Task Force (FATF) The cross-border nature of money laundering and terrorist financing has led to international coordination to ensure that countries have the legislation and regulatory processes in place to enable identification and prosecution of those involved. Examples include: The Financial Action Task Force (FATF), which has issued recommendations aimed at setting minimum standards for action in different countries to ensure AML efforts are consistent internationally; it has also issued special recommendations on terrorist financing. Standards issued by international bodies to encourage due diligence procedures to be followed for customer identification. Sanctions by the United Nations (UN) and individual countries to deny individuals and organisations from certain countries access to the financial services sector. Guidance issued by the private sector Wolfsberg Group of banks in relation to private banking, correspondent banking and other activities. The FATF In response to growing international concerns over money laundering, the FATF on money laundering was created by a G7 summit in 1989. The FATF was given the responsibility for examining money laundering techniques and trends, reviewing existing initiatives and producing recommendations to combat money laundering. In 1990, it issued a report containing a set of 40 recommendations which provide a comprehensive plan of action for fighting money laundering and which have been subsequently added to with recommendations on tackling terrorist financing (TF). Its recommendations form the international standards for combating money laundering and terrorist financing and their implementation is regularly reviewed by audits of national systems. The FATF focuses on three principal areas: Setting standards for national anti-money laundering and counter-terrorist financing (CFT) programmes. Evaluating how effectively member countries have implemented the standards. Identifying money laundering and terrorist financing methods and trends. The FATF has established four regional groups covering the Americas, Asia Pacific, Europe and the Middle East and Africa. Using input from these groups, the FATF has undertaken an exercise to identify countries with inadequate anti-money laundering measures, referred to as ‘non-cooperative countries and territories’. Its purpose has been to put pressure on those countries to bring their anti-money laundering systems up to international standards. The FATF monitors members’ progress in implementing necessary measures, reviews money laundering and terrorist financing techniques and countermeasures, and promotes the adoption and implementation of appropriate measures globally. In performing these activities, FATF collaborates with other international bodies involved in combating money laundering and the financing of terrorism. 32  Industry Regulation Role of Other International Agencies A number of other international agencies are actively involved in combating money laundering and the financing of terrorism. 2 United Nations The United Nations Office on Drugs and Crime (UNODC) has a mandate (UN) to assist member states in combating illicit drugs, crime and terrorism. The IMF’s broad experience in conducting financial sector assessments, providing technical assistance in the financial sector, and exercising surveillance over members’ economic systems has been particularly International helpful in evaluating countries’ compliance with the international AML/ Monetary Fund CFT standard and in developing programmes to help them address (IMF) identified shortcomings. Its Financial Sector Assessment Program (FSAP) of countries and its Offshore Financial Centers Assessment incorporates a full AML/CFT assessment. Emerging markets are increasingly becoming the venue for large- scale money laundering operations. If left unchecked, this activity will eventually undermine the credibility of the formal financial sector. The World Bank is involved in supporting developing countries and in its financial sector operations; it promotes measures to counter the flow of illicit funds into the financial systems of countries and arranges World Bank for external assistance. The Stolen Asset Recovery Initiative (StAR) is a partnership between the World Bank Group and UNODC that supports international efforts to end safe havens for corrupt funds. StAR works with developing countries and financial centres to prevent the laundering of the proceeds of corruption and to facilitate a more systematic and timely return of stolen assets to their country of origin. 2.1.2 Money Laundering Offences and Firms’ Regulatory Obligations Learning Objective 2.2.2 Know the main offences associated with money laundering and terrorist financing and the regulatory obligations of financial services firms While the specific rules and regulations in relation to money laundering will differ from country to country, it is worth noting that there are common features in the types of offences and the regulatory obligations placed on financial services firms. 33 The main types of offences involved in money laundering are: Concealing – it is an offence for a person to conceal or disguise criminal property. Arrangements – it is an offence for a person to enter into an arrangement that they know or suspect facilitates the acquisition, retention, use or control of criminal property for another person. Acquisition, use and possession – it is an offence to acquire, use or have possession of criminal property. Failure to disclose – three conditions need to be satisfied for this offence: The person knows or suspects (or has reasonable grounds to know or suspect) that another person is laundering money. The information giving rise to the knowledge or suspicion came to the person during the course of business in a regulated sector (such as the financial services sector). The person does not make the required disclosure as soon as is practicable. Tipping off – it is an offence to tell a person that a disclosure of a suspicion has been made. Money laundering regulations usually place requirements on firms that cover three main areas: Firms are required to carry out certain identification procedures, implement certain internal reporting procedures for suspicions and keep records in relation to anti-money laundering activities. The regulations also require firms to train their staff adequately in the regulations and how to recognise and deal with suspicious transactions. There is a catch-all requirement that firms should establish internal controls appropriate to forestall and prevent money laundering. This includes the appointment of an employee as the firm’s money laundering reporting officer (MLRO). The MLRO is used in various international rules to refer to the person responsible for overseeing a firm’s anti-money laundering activities and programme and for filing reports of suspicious transactions with the national financial intelligence unit (FIU). It is the MLRO’s role to be aware of any suspicious activity in the business that might be linked to money laundering or terrorist financing, and if necessary to report it. They are responsible for the following: receiving reports of suspicious activity from any employee in the business considering all reports and evaluating whether there is – or seems to be – any evidence of money laundering or terrorist financing reporting any suspicious activity or transactions to the appropriate law enforcement agency by completing and submitting a suspicious activity report (SAR), and asking the law enforcement agency for consent to continue with any transactions that they have reported and making sure that no transactions are continued illegally. Management and officers of firms that fail to comply with a country’s money laundering regulations are potentially liable to a jail term and fine, and firms may have their licence to trade terminated. Regulators, post the global financial crisis, are keen to be able to pinpoint individuals responsible for any wrongdoing within a firm, especially by an officer who has an important control function within the firm. As noted above, it is an offence to fail to disclose a suspicion of money laundering. Obviously this requires the staff at financial services firms to be aware of what constitutes a suspicion, and this is why there is a requirement that staff must be trained to recognise and deal with what may be money laundering transactions. 34  Industry Regulation 2.1.3 Stages of Money Laundering Learning Objective 2 2.2.3 Know the stages of money laundering There are three stages to a money laundering operation: placement, layering and integration. Placement is the first stage and typically involves placing the criminally derived cash into some form of bank account. Layering is the second stage and involves moving the money around in order to make it difficult for the authorities to link the placed funds with the ultimate beneficiary of the money. Disguising the original source of the funds might involve buying and selling foreign currencies, shares or bonds. Integration is the third and final stage. At this stage, the layering has been successful and the ultimate beneficiary appears to be holding legitimate funds (clean money, rather than dirty money). The placement stage requires the money launderer to introduce cash into the financial system. This requires cash in hand to be replaced by some valuable claim on assets or benefits. In recent years, the use of electronic currency (eg, Bitcoin) has raised much interest regarding the disruptive impacts of technology, but should also be considered in the light of money laundering considerations. Any transaction by which someone converts actual currency for an electronic currency could be an example of placement. For most financial services firms, layering represents the biggest risk as any transaction that exchanges one asset for another, or changes the registered owners of an asset, could be a step of layering. As the purpose of layering is to disguise the original source of the money and the eventual end recipient, layering processes will often be protracted and detailed, yet each individual step will be designed to appear innocent, such as the usual activity of an investor managing their affairs. Integration can be more difficult to demonstrate, because the cleaned money may not actually be removed from the financial system. In some cases, the integration phase may see the criminal making withdrawals from a bank account, while in others the money may remain invested in some long-term project or investment. The money launderer’s purposes are satisfied providing the illegal source of the money can no longer be identified by firms or law enforcement. Broadly, the AML provisions are aimed at identifying customers and reporting suspicions at the placement and layering stages and keeping adequate records that should prevent the integration stage being reached. 35 2.1.4 Client Identification Procedures Learning Objective 2.2.4 Know the client identity procedures Money laundering regulations require firms to adopt identification procedures for new clients and keep records in relation to this proof of identity. This obligation to prove identity is triggered as soon as reasonably practicable after contact is made and the parties resolve to form a business relationship. Failure to prove the identity of your client could result in an unlimited fine and a jail term. Along with ‘know your client’ (KYC) rules, it is just as important to know where the source(s) of money for investment has come from and the source of wealth, to make sure that the money has not come from any illegal activities. The identification procedures that a firm must carry out are usually referred to as customer due diligence (CDD) and the procedures that must be carried out involve: identifying the customer and verifying their identity identifying the beneficial owner, where relevant, and verifying their identity, and obtaining information of the purpose and intended nature of the business relationship. It is also a requirement that financial institutions undertake checks to determine the source of funds that the client wishes to invest. They must also check international sanction blacklists to ensure that the client is not one with whom doing business is prohibited. Firms must also conduct ongoing monitoring of the business relationship with their customers to identify any unusual activity. The types of documentary evidence that are acceptable to prove the identity of a new client would include the following: For an individual – an official document with a photograph will prove the name, eg, passport or international driving licence; a utilities bill (gas, water or electricity) with name and address will prove the address supplied is valid. For a corporate client (a company) – proof of identity and existence would be drawn from the constitutional documents (Articles and Memorandum of Association) and sets of accounts. For smaller companies, proof of the identity of the key individual stakeholders (directors and shareholders) would also be required. Checks should be made that the client is not a politically exposed person (PEP). In such cases of higher risk and if the customer is not physically present when their identity is verified, enhanced due diligence (EDD) measures must be applied on a risk-sensitive basis. Note that a ‘politically exposed person’ (PEP) is a term used by regulators to identify persons who perform important public functions for a state. These are individuals who require heightened scrutiny because t