As the adoption of alternative digital payments accelerates, financial firms are rushing to make sure their anti-financial crime systems can cope.
Alternative payment systems such as Apple Pay, Google Pay and PayPal have grown rapidly during the pandemic due to the need to replace germy cash with more hygienic contactless solutions. Growth in online purchases and awareness of digital options have also contributed.
Cap Gemini’s 2021 World Payments Report shows alternatives are rapidly becoming the norm, with 45% of consumers regularly using mobile wallets, up from 23% in 2020.
But, while it helps keep our hands clean, this radical change creates some dirty-great challenges for the compliance community.
Exploiting new structures
John Joy, managing attorney at FTI Law, says new payments technologies often make it easier for bad actors to hide their identity through layering, obfuscation or exploiting immature compliance structures.
‘The biggest risk for compliance specialists dealing with alternatives will be facilitating a payment to an individual or entity on a sanctions list,’ he says. ‘Sanctions are strict liabilities, meaning even if the firm is not negligent it can still be liable for such facilitation.’
Joy says compliance professionals should respond by making senior management aware of the significant risks in alternative payments, while preparing for their growth.
‘For example, if executives plan 30% volume growth over two years, compliance should expand their department now to prepare,’ he says. ‘The market for hiring anti-money-laundering (AML) specialists will get tight, and companies will need to rethink compensation to attract and keep talent.’
New technologies can help screen alternative payments, if companies can merge the tech successfully with existing AML infrastructure. This will take time, so they should start as early as possible.
‘Rather than resist these technologies, compliance officers need to lobby for more funding and specialised staff to accommodate them,’ says Joy.
‘But the most important thing is having an experienced staff with excellent understanding of alternative payments infrastructures and risk.’
Start-up payment platforms may not have this, so be careful who you work with, and weigh the opportunities of accessing new markets with the risk it will hurt you down the line.
Increased laundering risk
Eric Young, senior managing director at compliance, investigations and consultancy firm Guidepost Solutions, says another likely problem is that alternative systems also remove financial institutions one step from surveillance of payment senders and beneficiaries. But laundered proceeds may still eventually end up in their system.
It increases the importance of fast and robust know your customer (KYC), due diligence, detection reporting and risk classification structures, says Young.
‘Is the alternative processor high, medium or low risk? How good is their regulatory reporting around payments, transfers, clients such as payment processors, and customers such as merchants and buyers?’ he says.
Young says many alternative payment vehicles link to bank accounts, debit or credit cards, so existing compliance processes in those systems can provide some protection.
‘However, many compliance officers know their tools can also lack the speed and accuracy to capture, escalate, and investigate the volume of alternative payment transactions,’ he says.
Yet another issue is that, as alternative payment processes increasingly allow cryptocurrencies this makes them more vulnerable to fraud, money laundering, terrorist financing and sanctions risks.
New screening technologies can help solve all these problems, says Young. Institutions should also collaborate with each other and with alternative providers to fight these crimes. Collaborative networks could pool intelligence about red flags, and suspicious activities and players; and develop beneficial owner registries.
Checking smaller payments
David Utzke, researcher and educator in distributed ledger technology, cryptographic protocols, and XR, says compliance departments are often poorly equipped and trained in dealing with alternative payments.
‘Criminals can hide their identity by moving money in alternative systems but they have to keep the amounts small – a few thousand dollars at a time. It’s too difficult to move millions in one go on those platforms. But on a small scale, it’s very possible.
‘Some case officers have shown me records of a $5,000 alternative payment transaction. They think that’s too small and immaterial compared to a million-dollar money laundering case. I say “but did you request records? The $5,000 isn’t necessarily the full depth of their activity. It could be part of a much larger network and the payment system may not have noticed it. Until you summon those records from the provider, you won’t understand the full extent.”’
Utzke says too often compliance officers do not understand the alternative provider’s ledger systems. Some have never even used an Apple Pay wallet, Google Pay wallet or a cash app. So they have little knowledge on how these things work.
‘It’s like becoming the head of a nuclear plant if you have no knowledge of nuclear science,’ he says.
Risk-based screening technology is important, providing it is flexible and scalable enough to keep up with current risks.
‘Many banks’ internal systems don’t update regularly enough to keep up with developments in alternative payments,’ says Utzke. ‘Sometimes they only re-evaluate it when it breaks, which may be five years later.
‘Also, lack of understanding about alternative payment risks makes it important to use technology you understand. Too often, compliance officers use “black box” technology that does not explain its conclusions. You have no evidence of the type you typically need in court.
‘My advice is stay up-to-date with developments in alternative payments and share them with your colleagues. Be aware of new technologies that can aid compliance, embrace them, and don’t be scared of them.’