Month: July 2018
Anti-Money Laundering in an Era of Crypto-currencies
Anti-Money Laundering in an Era of Crypto-currencies
Anti-Money Laundering laws and mechanisms prevent money obtained illegitimately from entering the formal economy thereby legitimizing its source. However, it is a constant battle between the launderer and the regulator.
Anti-Money Laundering in an Era of Crypto-currencies
Anti-Money Laundering laws and mechanisms prevent money obtained illegitimately from entering the formal economy thereby legitimizing its source. However, it is a constant battle between the launderer and the regulator. As the financial ecosystem keeps evolving with new products, instruments and processes so do the potential for misuse of these avenues for laundering.
This blog examines one such contemporary evolution i.e. the advent and growth of crypto-currencies, the challenges it has presented for anti-money laundering efforts and the checks and balances that are being put in place worldwide to plug the loopholes that it exposed.
Money laundering attempts have been part and parcel of the growth of human civilization. As early as 2000 BC Chinese merchants are known moved their wealth to remote provinces or overseas to avoid taxation. The term money laundering comes into being around the 1920s as a result of the ingenious use of laundromats to conceal money from illegal activities by the legendary American gangster Al Capone. Very soon money laundering became a major facilitator for a flourishing of narcotics trade and terrorism.
As the ill-effects of money laundering started manifesting themselves in different spheres of public life, the focus started shifting towards taking remedial measures. Nations started adopting legislative measures to tackle this menace with laws such as Bank Secrecy Act, US(1970), Money Laundering Directive, EU (1991), Money laundering Regulations, UK (1993), Prevention of Money Laundering Act, India (2002), AML/CTF Law, Australia (2006), Anti-Money Laundering Ordinance, China (2011), etc.
However, it was soon evident that money laundering is a global phenomenon, tackling it required a cohesive global approach. The Financial Action Task Force (FATF) was formed in 1989 by the G7 nations for achieving international AML objectives. An inter-bank institution called the Wolfsberg group was formed in 2000 and it publishes the Wolfsberg Standards for the financial industry in the banking space relating to anti-money laundering.
The financial industry is very dynamic in nature. Innovation leading to new developments is an integral part of its evolution. Money launderers are always on the lookout for exploiting vulnerabilities relating to new financial instruments, mechanisms and processes to legitimize illegal money. One of the latest developments, particularly relevant in this context is the introduction and usage of crypto-currencies.
Cryptocurrency is a digital currency implemented using a decentralized distributed ledger technology such as blockchain. The most widely prevalent cryptocurrency today is Bitcoin. There are over 4000 other cryptocurrencies which have been created that are collectively called altcoins. Some of these include Litecoin, Zcash, Monero, Ripple, etc. As per a 2017 research by the University of Cambridge, there were between 2.9 million – 5.8 million unique cryptocurrency users. The value of a single bitcoin in USD has increased from 0.005 USD in 2009 to over 6000 USD in 2018.
With a rising user base, increasing transaction volumes and distributed decentralized control, cryptocurrencies provide an enticing target for laundering activities. The relative anonymity offered by cryptocurrencies makes it particularly appealing for money launderers.
Innovations like zero proof technology and cryptocurrency tumbler have made extracting sender or receiver information from transaction data virtually impossible and hence transaction tracing and link analysis can no longer be used in the cryptocurrency world. However, transactions relating to the conversion of fiat currency to cryptocurrency (e.g. USD to bitcoin) and vice versa can still be analyzed to detect anomalous behaviour.
As the laundering challenges presented by the crypto-currencies increase, there are corresponding changes in the legal landscape to fight the problem. US Commodity Futures Trading Commission (CFTC) has designated trading in bitcoin as a commodity transaction. EU has implemented the fifth money laundering directive (MLD5) to include Cryptographic exchanges and wallet providers. From April 3, 2018, AUSTRAC began regulating digital currency exchanges (DCE) under the AML/CTF laws.
Japan which recognizes bitcoin as a legal tender has also formed a Japanese Virtual Currency Exchange Association to promote regulatory compliance. In India, RBI does not recognise bitcoin as legal tender and has issued several advisories classifying any cryptocurrency related transaction as risky.
Given the evolutionary environment in this domain and expanding compliance requirements, traditional EFM/AML vendors have a big opportunity to extend their offerings to cover cryptocurrencies, particularly with reference to transactions at the cryptocurrency exchange. They can use traditional methodologies like fraud detection, anomaly detection and suspicious transactions to identify money laundering attempts and help the enforcement agencies in this regard thereby minimizing the use of cryptocurrencies for parking illegal funds.
Rise of the machines: Will the robo-advisor elbow out its human counterpart?
Rise of the machines: Will the robo-advisor elbow out its human counterpart?
Of the several significant innovations in the financial services universe, one key technology innovation has been the robotized financial advisor aka the robo-advisor.
Rise of the machines: Will the robo-advisor elbow out its human counterpart?
Of the several significant innovations in the financial services universe, one key technology innovation has been the robotized financial advisor aka the robo-advisor.
A robo-advisor is a self-guided online wealth management service that provides automated investment advice at low costs and low account minimums, employing portfolio management algorithms.
A robo advisor can be ideal for those who don’t want to hire a financial advisor, don’t have enough assets to hire a financial advisor yet, or for those who have typically been DIY investors, but no longer want to select investments, rebalance and place trades on their accounts.
Some of the advantages and benefits of robo-advisors include:
- Bias-free, error-free, logical and transparent advisory
- Advise-on-demand with real-time, 24/7 access
- Speed and agility of analysis
- Better ROI for banks and wealth management firms over the long-term
- Risk profiling and advisory will get better with enhancements in cognitive computing, AI and behavioral analytics
Robo-advisors have been increasingly making their mark since a decade. Stats reveal the use of robo-advisors is steadily increasing. Robo-advisors managed $100 billion under assets in 2016 and this will increase to $2.2 trillion by 2021 (Fitch).
Some key factors contributing to the rise of intelligent robotized advisory services in financial services firms are:
- Explosion of data – data is doubling every 14 months and is expected to reach 10.5 zettabytes by 2020. This data is both financial (revenues, profits, growth) and non-financial (customer sentiment, employee engagement, marketing effectiveness, product feedback, and partner ecosystems). The availability of this data creates fertile ground for robo-advisors to provide algorithmic insights and recommendations that deliver highly predictive, error-proof and low-cost advisory services.
- AI is growing exponentially – many established firms worldwide (with about 20% in the U.S.), are making sizeable investments in AI. Venture capitalists are more interested in firms that are innovating robotized process automation. They invested between $4 to $5 billion in AI in 2016 alone with PE firms investing another $1 to $3 billion.
- Cost and availability – the costs of AI-enabled tools are falling, while availability is increasing. Proprietary as well as open-source tools are widely available and fueling the trend is the availability of low-cost cloud-based hardware.
Financial services firms are aware of the benefits of robotizing advisory services, including that it fundamentally lowers costs and helps broaden the range of service offerings.
While AI has brought about more innovation and greater competition, for an area such as financial advisory services that traditionally has a combination of trust, experiential expertise and human interface as its cornerstone, there will be some challenges to customers readily adopting robo-advisory services.
Leading financial services firms with in-person advisory operations servicing complex financial planning needs are aware of customer expectations around trust, financial growth goals and customized experiences. Also, certain investors are overwhelmed when trying to choose a reliable robo-advisor among a multitude of options available.
Tradition and mindset are also factors that make investors chose between engaging with a faceless software or with a human being. A lot of investors prefer human financial advisors, even though their advice may not be entirely accurate in certain cases. For instance, even when markets were indicating bottoming out, investors continued to apply the recommendations of their advisors.
A hybrid robot/human advisory model that blends the best of both worlds, could be a way forward.
Investment managers can optimize the quality of advisory services that require quick turnaround for portfolio-rebalancing or asset re-allocation and use human interface for consultative/iterative actions like goals achievement analysis.
Financial advisory firms can combine the best of client-centered technology and the benefits of the human touch in providing advice. For example, many traditional advisory firms already provide secure client portals on their sites where clients can login and view their account information and other valuable information. Some traditional advisors also offer mobile apps to facilitate client communication. Similarly, certain robo-advisors have an option to chat with a human financial advisor.
Blending the human touch of traditional financial advisors with the logic, fee transparency, methodology and accessibility of robo-advisors can be a useful combination for investors. They can access their portfolios and most of the advice online but can still receive guidance and personal advice from a human. This will make a difference as investors’ financial situations will evolve and market dynamics will continue.
References:
- AI and robo-advisors, TechRules
- Robo-advisors can’t create trust, CNBC
- How AI will change the role of financial advisors, Accenture
- How AI with robo-advisory works, MoneyControl
- Preferred payment methods of online shoppers worldwide – Statista
- Machine learning, AI and robo-advisers: The future of finance?, CFA Institute