B20: AMLO | FinTecha and New Technologies: AML/CTF Perspectives (5 Jul 2017)
- 1. FinTech and New Technologies: AML / CTF Perspectives Anti-Money Laundering Office 5 July 2017
- 2. © 2017 Baker & McKenzie Ltd. What is FinTech? 2 • a contraction of “finance” and “technology” • use of technology and innovative business models in financial services • innovation applied to traditional financial services • innovative financial services offerings which disrupt the existing financial services market • FinTech companies, tech firms, incumbent financial service providers (e.g. banks, securities companies, insurance companies, etc.)
- 3. © 2017 Baker & McKenzie Ltd. FinTech Trends in Financial Markets 3 Payments • e-Payment / Mobile Payment • P2P Value Transfer Networks • Cryptocurrencies Deposits and Financing • P2P Lending • Automated Lending • Alternative Credit Adjudication • Online invoice finance Investments • Micro-Investing • Social Trading Platforms • Robo Advice Capital Raising • Equity crowdfunding • Virtual Exchanges • ICO Capital Markets • AI • Automated Trading Platforms • Blockchain and Smart Contracts
- 4. © 2017 Baker & McKenzie Ltd. FinTech Risk Events 4 Fintech Risk Events 1. Entity 2. Publication Date 3. Country 4. Category 5. Event Description 6. Event Type 7. Loss Amount 8. Links MtGox Jun 2011 Japan Cryptocurrency Security Breach EF 2,609 BTC Wikipedia Clinkle Jan 2014 US Payments API Security Breach EF N/A Techcrunch Wonga April - Oct 2014 UK Payday Loans Bad Debt Collection Practices, Debt writeoffs CPBP ~240mln Pounds Wikipedia MtGox Dec 2014 Japan Cryptocurrency Theft IF 744,408 BTC Wikipedia TrustBuddy Aug 2015 Sweden P2P Lending Misuse of client funds, Bankruptcy IF N/A FT, Telegraph Prosper Dec 2015 US P2P Lending Enabling financing to suspected terrorist CPBP N/A LAT Powa Technologies Feb 2016 UK POS, Payments Bankruptcy Business Failure N/A Wikipedia Ezubao Feb 2016 China P2P Fake investment products to one million retail investors CPBP $7.6bln NYT Dwolla Mar 2016 US Online Payments Poor Consumer Data Protection Practices CPBP $100k WSJ LendingClub May 2016 US P2P Lending Altering Loan Information IF,CPBPN/A Wikipedia Slock.io Jun 2016 Germany Cryptocurrency Software Hack EF, BE 3,641,694 ether NYT Bitfinex August 2016 Hong Kong Cryptocurrency Security Breach EF 120,000 BTC Reuters LendUp September 2016 US Payday Loans Misleading borrowers about pricing, failing to report credit information CBPB $6.4 million in fines WSJ Wonga April 2016 UK Payday Loans Client Data Breach EF N/A BBC Prosper May 2017 US P2P Lending Overstating Returns BE N/A Bloomberg Source: http://www.openriskmanual.org/wiki/Fintech_Risk_Events
- 5. © 2017 Baker & McKenzie Ltd. 5 Case Study: Ezubao - a large peer-to-peer lending platform in China - most of the projects on the platform were fake - police had arrested 21 people connected to Ezubao for defrauding about 900,000 online investors (value around $7.6 billion) - China started to regulate P2P lending platform In Thailand, BOT will regulate P2P lending platform reduce risks of ponzi schemes requires customer identification (both investors and borrowers)
- 6. © 2017 Baker & McKenzie Ltd. What is blockchain? 6 “A blockchain is a digital, distributed transaction ledger, with identical copies maintained on multiple computer systems controlled by different entities” (Davit Schatsky and Craig Muraskin, Beyond Bitcoin: Blockchain is Coming to Disrupt your Industry, Deloitte University Press, 2015, page 2) How does blockchain work?
- 7. © 2017 Baker & McKenzie Ltd. Key Elements of Distributed Ledger Technology 7 Ledgers Distributed Ledgers Blockchain Crypto currency Cryptography to ensure identity authentication for each transaction Non-repudiation to preserve integrity of data and create an audit trail. Smart contracts for the automatic execution of business logic when certain criteria are met. Share ledger so each participant sees the same view of the same data, updated in real time. Distributed consensus to ensure the state of the ledger represents the agreed-upon truth of all stakeholders.
- 8. © 2017 Baker & McKenzie Ltd. Blockchain applications 8
- 9. © 2017 Baker & McKenzie Ltd. Key use cases relating to financial services 9 Global payments • international money transfers • real-time settlement • reduce costs • new business models (e.g. micropayments) • newer models of regulatory oversight Syndicated lending • automate syndicate formation, underwriting and disbursement of funds • reduce loan issuance time and operational risks Trade finance • store financial details in DLT • replace paper with digitalized processes via blockchain • facilitate real-time approval of financial documents • reduce counterparty risk & enable faster settlement (eliminate correspondent banks) • e.g. PoC by BAML+HSBC+IDA Automated compliance • store financial information in DLT • eliminate human errors/fraud • reduce reporting costs • support deeper regulatory oversight Equity Post-Trade • using DLT and smart contracts to facilitate post-trade activities • disintermediate processes • reduce counterparty and operational risk • and potentially reduced settlement time and costs • e.g. ASX
- 10. © 2017 Baker & McKenzie Ltd. bitcoin 10 What are bitcoins? - decentralized virtual currency / digital currency / cryptocurrency - used to transfer and exchange values online without intermediary trusted third party - proof of possession and payment stored in multiple public ledgers allowing peer-to-peer review of bitcoin spending quicker and cheaper way to transfer money How to acquire bitcoins? How to use bitcoins? Bitcoin challenges – especially AML/CTF
- 11. © 2017 Baker & McKenzie Ltd. Bitcoin wallet 11
- 12. © 2017 Baker & McKenzie Ltd. Case Study: Silk Road 12 • Online black market where the virtual currencies could be used to buy illegal drugs and other goods • Virtual currencies are anonymous “Silk Road – Anonymous Market” • Shut down by the FBI on 10/2/2013 and leader was arrested • Many millions of dollars worth of BTC were confiscated from people all over the world (US$ 100 million) • Main Operator sentenced to life imprisonment
- 13. © 2017 Baker & McKenzie Ltd. Case Study: Silk Road 13
- 14. © 2017 Baker & McKenzie Ltd. Case Study: MtGox 14 - was the largest bitcoin exchange in the world, handling 70 percent of all bitcoin transactions - thousands of bitcoin owners found their assets frozen as the exchange shut down - bitcoins worth more than $500 million USD had been stolen from the site
- 15. © 2017 Baker & McKenzie Ltd. Case study: Ransomware 15
- 16. © 2017 Baker & McKenzie Ltd. Case Study: Ethereum and DAO 16 • Ethereum - open software platform based on blockchain technology that enables developers to build and deploy decentralized applications • The Ethereum Virtual Machine - allows creation of various types of blockchain applications on one blockchain platform (smart contracts, loan services, title registries, voting systems, regulatory compliance etc.) • Ethereum was used to build Decentralized Autonomous Organizations (DAO) • DAO - owned by everyone who purchases tokens, which are used to give people voting rights instead of shares • 2016 hack of a DAO (The DAO) almost lead to USD 53M in stolen token sales • Although here problem was mitigated, evident potential risk that cryptocurrency can be stolen and could potentially be paid out in context for ML/TF purposes
- 17. © 2017 Baker & McKenzie Ltd. Legal status of bitcoin by country 17 Source: http://www.coindesk.com/bitcoin-legal-map/ More AML/CTF issues - see FATF Report: Virtual Currencies: Key Definitions and Potential AML / CFT Risks (June 2014) - EU 4th Anti-Money Laundering Directive - amended to encompass virtual currencies (2016)
- 18. © 2017 Baker & McKenzie Ltd. Case Study: ICO 18 ICO - Initial Coin Offering, fund raising for a new cryptocurrency venture • supporters buy some of the distributed cryptocoins with fiat or another virtual currency (similar to crowdfunding) • these coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction • ICOs don’t offer equity, instead offer discounts on cryptocurrencies before they hit the exchanges ICO could potentially fall under some securities law: • Comments by regulatory agencies in US suggest that desire to regulate ICOs still present problem of approach • Switzerland and Singapore view ICOs as assets, not securities ICO Risks to AML/CTF • For IPOs, intermediaries are FIs and reporting entities subject to AML requirements • For ICOs, no AML/KYC legal frameworks in place • prone to be fraud/scam
- 19. © 2017 Baker & McKenzie Ltd. Case Study: ICO 19
- 20. © 2017 Baker & McKenzie Ltd. 20 Case Study: Online gaming • Chinese cyber-criminals stole e-wallet and credit card information from small-business owners • Using this stolen information, they purchased in-game accessories on gaming accounts (No KYC/CDD required) • After making the purchases, they resold the online game accounts to buyers for cash • The total sales of gaming accounts totaled USD 48M before being apprehended by police
- 21. © 2017 Baker & McKenzie Ltd. 21 RegTech: Basics Regulatory Technology the use of new technologies to solve regulatory and compliance requirements more effectively and efficiently. (Institute of International Finance, “Regtech: exploring solutions for regulatory challenges,” Washington DC, October 2015.) Relevant in the context of regulatory monitoring, reporting and compliance benefiting the finance industry Two aspects the use of technology by (i) institutions and market participants to improve the compliance function, and (ii) regulators to enhance oversight. Utilizes many technologies e.g. AI, big data, blockchain, biometrics, cloud computing
- 22. © 2017 Baker & McKenzie Ltd. 22 RegTech: Advantages cost savings by replacing costs in manual analysis of data and regulatory compliance real-time and proportionate regulatory regime enhance efficiency and accuracy of regulatory compliance trained to identify transactions over time using many factors: e.g. home address, time of account opening, duration between transactions, patterns among merchants, location of transactions, relationships between customers and merchants, use of mobile phone, and even change in social media presence
- 23. © 2017 Baker & McKenzie Ltd. 23 RegTech: Uses Automate risk management processes Facilitate regulatory reporting Fraud prevention AML/CTF including KYC/CDD/ reporting requirements Examples: IBM Watson (AML/CTF) Currently used by ABANCA (Spanish FI) Thomson Reuters (Org ID KYC Managed Service) identify and classify a client’s risk category, verify their identity, and screen and monitor all related parties to create a KYC record. Ayasdi System (AML+) Used by HSBC to reduce unnecessary investigations by 20% Also used to comply with FED “Stress Test” Accuity (KYC)
- 24. © 2017 Baker & McKenzie Ltd. 24 RegTech: Market and Potential Global demand of RegTech to reach USD 118.7M by 2020 (Medici report) GBP 2.7B could be saved globally by use of RegTech (FortyTwo Data) 55% of False Positives could be eradicated leading to 42% Reduction in Cost for regulating AML/CTF(FortyTwo Data) Companies adopting modern machine learning technologies are expected to reduce the capacity of their compliance departments by at least 75% by 2025 (FortyTwo Data)
- 25. © 2017 Baker & McKenzie Ltd. Contact 25
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