COMPLIANCE - Financial Regulations & Compliance PDF

# COMPLIANCE ## What is Financial Compliance? - Regulation and enforcement of laws/processes in finance & Capital Markets. - Ranges through the entire financial spectrum: From investment banking to retail banking practices. ## Importance of Financial Compliance - To maintain the public’s trust i...

# COMPLIANCE ## What is Financial Compliance? - Regulation and enforcement of laws/processes in finance & Capital Markets. - Ranges through the entire financial spectrum: From investment banking to retail banking practices. ## Importance of Financial Compliance - To maintain the public’s trust in Capital Markets and the banking system. ## Who Oversees Financial Compliance? - Covers a broad spectrum. - Compliance varies internationally. ## US: Regulators in Financial Systems ### The Federal Reserve: - Central bank of the US. - Regulates the monetary policy: - Ensures that inflation is maintained. - How much money to print. - Federal Funds Rate. - Interest rates from lending other banks. - Regulated/Managed by a board of Governors. - Completely independent from other branches of government to ensure stability and lack of influence. ### Securities & Exchange Commission (SEC): - Regulatory Agency independent from government. - Oversees US securities market. - Monitors security exchanges. - Enforces securities law: - Looks for fraud etc. - Monitors rating agencies. - Main Goal: Establish market transparency by requiring quarterly/annual financial reports to the public. ### Federal Deposit Insurance Corporation (FDIC) - Offers insurance for accounts with banks and thrift institutions to preserve and promote public confidence in the US Financial system. - Only insures deposit accounts; eg checking/savings accounts/certificate of deposits (CDs). - No cover for stocks/bonds/mutual funds. - Helps in compliance by examining many banks for operational safety/soundness. - Ensures that banks comply with consumer protection laws. ## Know Your Client - A standard practice to help investment advisors identify the client they're working with. - Ensures: - Client is who they say they are. - Know client’s tolerance to risk. - Advisor is aware of client's financial position. - Prevent: - Reduction of fraud. - Client protection, by tailoring the perfect investment option to them. - Ensure financial system is not being used for criminal activities (ie money laundering (fraud/forgery). - Maintaining trust in all financial systems. ## Money Laundering - Illegally passing obtained funds through a complex system in order to make funds appear legal/legitimate. - Monitored in the US by: FinCEN - Financial Crimes Enforcement Network. - By analyzing financial transaction reports and detecting suspicious activity. - AML/CFT - AML: Anti-Money Laundering - CTF: Counter-Terrorism Financing - International adopted standards to help protect the finance sector from criminal activities. - AML regulations require financial institutions to: - Verify identity of their customers. - Assess the risk of money laundering. - Monitor transactions for suspicious activities. ## Risk Assessment vs Suspicious Transaction Monitoring (STM): - Risk Assessment: Identifying and assessing the risk of terrorist financing. - STM: Monitoring transactions for suspicious activity related to terrorism. ## Common ML Red Flags 1. **Unusual transaction patterns**: - High volume of transactions with no business purpose. - Transactions below/above thresholds. - That involve very small parties/jurisdictions. 2. **Transactions involving high-risk jurisdictions**: - Transactions with high-risk countries should be monitored more closely. - Monitor countries with weak or non-existent money laundering laws. 3. **Large cash transactions**: - Or large amounts of small cash deposits. ## Politically Exposed Persons (PEP): - Transactions with people who are politically exposed/hold prominent positions. - Higher risk of money laundering. ## [SAR] [STR]: Suspicious Transaction Report - Suspicious Activity report: Tool to flag suspicious activity that wouldn’t be normally written in other reports. - They alert law enforcement agencies to potential cases of: - Money laundering - Terrorist financing ## Identifying Suspicious Transactions: - **4 Steps**: 1. **Establish Red Flags**: Ie. warning signs. - Eg: Customers refusing to provide identification. - Large payments of cash for no reason. - Spurt of large amount of novelty. - Multiple deposits/withdrawals from the same place. - Brambles. - Investigated/convicted customers. - Having complex hard to understand company structures. - 3rd party transactions. 2. **Screening provides**: To identify red flags. 3. **Review all customer info**: See if it matches with how transactions were conducted. 4. **Evaluate customer/transactions**: If not suspicious, move on. If suspicions file a STR/SAR. ## Financial Intelligence - Ability to understand financial matters and effectively manage one’s financials affairs. - Being familiar with the concepts of saving/budgeting/everyday financial choices. ## Fin Intelligence vs Fin Literacy - Fin Literacy: Basic understanding of financial principles (saving/investing/lending) - Fin Int: All skills of fin lit + strategic use/analysis of financial knowledge ## Compliance in Finance - Adhering to a set of rules/regulations and ethical standards designed to protect the financial system/clients & broader economy. - Financial institutions follow compliance to prevent fraud/legal issues & to ensure transparency. ## Purpose of Compliance 1. Protect consumers and investors: - Fair practices. - Transparent dealings. - Fraudulent activities. 2. Maintain market integrity: - Create stable/transparent/fair system. - All operate under same standards. 3. Reduce institutional & systemic risk: - Enforce rules. - Reducing risk of financial crimes. - Promoting financial stability of institutions/markets. ## Key Components ### Regulatory Bodies and Laws: - **a) Regulatory Agencies**: Government bodies responsible for creating/enforcing rules to protect public/maintain fair practices. - Security & Exchange Commission (SEC): Regulates/maintains fair efficient security markets to protect investors. - Federal Reserve: Central banks: Manages monetary policy/supervises & regulates banks/maintains financial stability/controls inflation. - Financial Industry Regulatory Authority (FINRA): Self-regulatory, oversees brokerage firms & exchange markets to protect investors. - **b) Key Legislation**: Significant laws passed by governments to regulate industries to prevent citizen’s rights & well-being. - Dodd-Frank Act: To prevent financial crisis by mandating transparency & restricting excessive risk-taking. - Bank Secrecy Act (BSA): Requires financial institutions to help detect & prevent money laundering. - USA-PATRIOT Act: Guidance laws enforcement ability to counter terrorism, including through financial oversight. ### Anti-Money Laundering (AML) - **a) Purpose**: Prevents financial crime. - Requires banks to monitor transactions. - Report suspicious activity. - Reduce risk of illegal funds entering the financial system. - **b) Requirements**: - Fin institutions must verify customer Identities. - Track large transactions. - File Suspicious Activity Reports (SARs): File documents with regulators to report suspicious money laundering or fraud. ### Know Your Customer (KYC) - **a) Purpose:** Verify customer identities to prevent fraud, money laundering & financial crimes. - **b) Steps:** - Collect & verify customer data. - Assess risk. - For high-risk clients, conduct Enhanced Due Diligence (EDD): More thorough monitoring process. - For high risk countries. - For high transaction volumes. ### Data Protection & Privacy - **a) Purpose**: Ensure financial institutions protect client information. - Institutional Privacy Laws: GDPR (in Europe): Protects personal data/privacy by setting strict data handling/security laws. - CCPA: State law gives residents the right to access/delete/opt out of the sale of their personal data. - **b) Data Security Practices:** Institutions are required to use strong data protection practices like: - Encryption. - Restrictive access. - Regular audits. ### Risk Management - **a) Identifying & Managing Compliance Risks**: Implementing strategies to minimize & identify: - Areas of high risk. - Potential fraud. - Cyber threats. - Market manipulation. - **b) Risk Based Approach**: Prioritize monitoring based on risk levels. - Focus on areas like: - High value transactions. - Operators in high risk sectors. ## Insider Trading & Market Abuse - **a) Insider Trading**: Trading based on non-public information, to give unfair advantages. - Illegal & requires monitoring. - Prevented: Enforcing strict policies such as: Restricting trading during certain times, tracking employee transactions. - **b) Market Abuse**: Activities that manipulate the market: - Fake rumors. - Artificially inflating stock prices - Prohibited by regulations to protect market integrity. ## Ethics & Code of Conduct - **a) Corporate Code of Conduct**: Enforced by financial institutes: - Outlines acceptable behavior. - Addresses conflict of interest. - Confidentiality and integrity. - **b) Promoting ethical practices**: - Focus on creating ethical cultures. - Ensure employees act with honesty/transparency/respect for regulatory standards. ## Audits & Monitoring - **a) Internal Audits**: Regular checks conducted by company’s own compliance dept. - Ensures policies are followed (I think to company policy/standards). - **b) External Audits:** Independent 3rd party reviews/regulatory bodies. - Ensures adherence to industry standards & compliance laws. - Adds accountability. - Helps identify areas for improvement. ## Sanctions & Screening - **a) Sanctions Compliance**: The restriction of financial institutions from having transactions with sanctioned entities/individuals. - Governmental/International restrictions. - Eg: OFAC: Office for Foreign Assets Control. - Treasury Department agency that enforces economic sanctions against targeted countries/orgs/individuals. - **b) Screening process**: Screen customer and transactions against sanction violations. - Ensures they don't engage with prohibited parties. - Used by companies within the scope of special software. ## Importance of Compliance 1. **Reduces legal & financial penalties**: - As non-compliance leads to hefty fines/legal actions/reputational damage. 2. **Enhances institutional trust**: - Adhering to compliance: - Seen more trustworthy. - Attracts customers/investors who value transparency & ethical practices. 3. **Stabilizes the economy**: - Since it stabilizes financial environments, it reduces the risk of financial crises. ## Monetary vs. Fiscal Policy ### Monetary - Managed by central banks. - Main purpose: Control inflation. - Stabilize currency. - Support employment. - Uses: - Interest rates. - Open market operations. - Reserve requirements. - Short Term Effects: - Alters borrowing costs/money supply. - Affects spending/investment/inflation. - Long Term Effects: - Sustained inflation control. - Price stability/employment levels/economic growth. ### Fiscal - Controlled by government. - Main purpose: Influence economic growth. - Demand. - Public debt. - Uses: - Adjusts spending. - Taxes. - Short Term Effects: - Impacts GDP & unemployment (boost/reduce) quickly by changing government spending/taxes. - Long Term Effects: - Affects national debt/economic structure/growth potential. - By allocating resources (ie infrastructure/welfare program) ## Bonds ### What are Bonds? - Definition: Fixed income investments where investors lend money to entities. - Repaid with interest over a set period. - Investors tend to be governments/corporations. - Purpose: - Used by entities to raise capital for: - Projects. - Operations. - Refinancing debt. - Structure: - Fixed interest rate (coupon). - Fixed term to maturity, when principle (face value) is repaid. ### Types of Bonds - **a) Government Bonds:** Issued by federal governments to fund national projects. - Low risk. - Lower yields (returns investor earns on a bond). - **b) Corporate Bonds:** Issued by companies. - Higher risk. - Higher yields (than Gov).