Transparency across the whole custody chain

Many in the industry will remember the SIBOS conference in Dubai 2013 for the stark warning issued by then OFAC director Adam Szubin: He threatened to end omnibus account structures if the securities industry should fail to get a grip on transparency and compliance issues over the entire securities holding chain. I vividly recall thinking that an implementation of this threat could jeopardize our whole industry! Using omnibus account structures enables us to process thousands of transactions every day, efficiently and cost-effectively. Looking into the faces around me, I saw my concerns mirrored. Safe to say that Szubin’s talk was widely perceived as a wake-up call.

In the follow-up, the attention on sanctions enforcement, counterterrorism and anti-money laundering (AML) as well as tax evasion and capital flight measures increased. In 2014, regulators issued significant fines to Brown Brothers Harriman for money laundering violations and to Clearstream for sanction violations, shaking the securities industry to the core.

There was no further convincing needed: It was high time for the industry to act before the regulators would.

The solution: self-regulation

The securities industry has since responded with a solution that will comply with the expectations of regulatory and enforcement authorities.

Fast-forward to 2019 and the whole industry is now in the process of rolling out the Financial Crime Compliance Principles for Securities Custody and Settlement (FCCP), the self-regulation principles established by a cross-industry working group hosted by ISSA, the International Securities Services Association. First agreed in August 2015, they were revised in May 2017 and have now been updated with explanatory notes in May 2019, ready for implementation. By early 2020 the adoption of the ISSA Principles will be completed.

We at UBS were part of the ISSA working group that comprised 17 key players from the industry. And we are glad to have actively contributed to ensuring that the FCCP can be adopted as guiding principles for our industry. By keeping the terminology as precise as possible, these principles can now fulfill their purpose of establishing a standard and of avoiding compliance arbitrage in the market.

By keeping the terminology as precise as possible, the ISSA principles can now fulfill their purpose of establishing a standard and of avoiding ‘compliance arbitrage’ in the market.

ISSA principles explained

Designed to provide an effective market-led framework that improves transparency and guarantees compliance in the securities business, the principles tackle the relationship between the custodian and its account holders. The aim is to ensure that universal compliance standards and legal obligations can be imposed on any member of the custody chain.

This means that in the next months, custodians will communicate due diligence standards, verify account holder compliance with these standards and gather relevant data. All existing and future custody accounts will be assigned to one of these four categories:

  • Proprietary accounts
  • Omnibus accounts
  • Segregated accounts held by natural persons
  • Segregated accounts held by legal persons

Custodians will then review whether omnibus account holders have adequate compliance objectives in place that are compatible with their own and whether they are implemented effectively. For segregated accounts held by a natural person, a disclosure of the beneficial owner’s identity will be mandatory. This will enable custodians to perform Cosima checks to screen for sanctioned persons and institutions as well as PEP’s (politically exposed person) and to use negative news filters.

Stringent due diligence

How each custodian will enforce these measures is up to them. Some will integrate them into their existing generic framework of conducting KYC and due diligence, others, like UBS, may use the standard due diligence questionnaire issued by ISSA and slightly adjust it to their needs. UBS will be handing this questionnaire out to account holders in the course of the next few months.

While it’s the custodian’s responsibility to communicate its KYC standards and other requirements to account holders, the account holder is in turn responsible for ensuring that its third-party clients also know of and comply with these standards. Crucially, securities should only be subdeposited with the custodian if the beneficial owners have been subject to satisfactory due diligence.

For the securities industry, this downstream due diligence procedure may seem unusual. Understandably, new regulatory guidelines are seldom met with enthusiasm – and, make no mistake, their implementation will involve an effort that should not be underestimated. Some banks will need to redraft their GTCs. For other banks there may be stumbling blocks in the form of their country’s legislation. But, the good news is: The effort is a collaborative one. We’ll get there, together.

Crucially, securities should only be subdeposited with the custodian if the beneficial owners have been subject to satisfactory due diligence.

A new form of collaboration will engender a virtuous circle

In payments and trade finance, however, strict transparency measures have already been in place for many years: For each payment, the beneficiary’s details have to be listed and are screened with an AML check. Yet until now, there was no easy and obvious way for custodians to assess the financial crime risk of their business.

Based on the payments industry’s Wolfsberg (due diligence) questionnaire, UBS will now implement the securities industry’s FCCP due diligence questionnaire in order to minimize its risk exposure. Equally, it will be the duty of every downstream account holder and client to implement their due diligence procedures to minimize their risk exposure. The goal of ISSA’s self-regulation principles consists in engendering a virtuous circle of due diligence compliance.

I hope that we can embrace this new collaboration process between banks and their custodians and meet the challenges in the securities industry together. An efficient and pragmatic implementation of the ISSA principles is the right step to avoid potentially destructive regulatory interventions into our structures. The future of our industry at this point depends on its discipline.

Markus Urben is Head Securities Banks at UBS.

Markus Urben is Head Securities Banks at UBS.

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