Tim Bourgaize Murray: Getting the ‘Easy’ Parts Right

In one of the better movie remakes of all time, The Departed, Jack Nicholson’s crime-boss character, after some colorful conversation in a move theater, asks Matt Damon’s state police mole a simple but philosophical question: “Who knows what’s easy?”

I mention this in the context of new know-your-customer (KYC) models for a few reasons. For one, it has to do with Damon searching for the identity of another mole, played by Leonardo DiCaprio, and the difficulty involved in doing so without making noise or mistakes. But more importantly, it illustrates how some things—even those that seem on first blush to be pretty straightforward—can instead prove immensely complicated, depending on one’s perspective … and what’s come before.

This describes the KYC affairs aptly. In some ways, the idea of digging deep into a counterparty’s background runs completely against the grain of what capital markets today try to do. Safety and stability always come first, yes, but anonymous order matching and electronification really drive at the idea that as long as two parties agree on a price and have the relationships in place to see the clearing or settlement through, there should be as little standing in the way of a trade going through as possible. Indeed, for the buy side, when looking to avoid getting front-run on a large order, this is especially true.

On the other hand, geopolitics dictates that KYC isn’t going anywhere—if anything, it will become more of an issue as time goes on. Ask the firms whose operating capital has been drained in recent years by billion-dollar fines about that.

Backwards
While the banks and their many slight variations on the process carry some blame in KYC becoming, as one source put it, a “crazy mess,” lack of clarity around legal and operational expectations from the authorities is a problem too. As I researched the issue, perhaps the most eye-opening comment was about how the contour of the examination process has rarely been well defined. “Banks often learn about KYC expectations from the examination process, itself,” the commenter said, “and expectations can change over time, from one agency to another, even one examiner to another.”

For a problem that has proven so costly in recent years, it would seem absurd that requirements around KYC are essentially improvised.

For a problem that has proven so costly in recent years, it would seem absurd that requirements around KYC are essentially improvised. But that’s the world we live in, where risk-rating metrics are subjective, contingent upon firms’ history, clientele and geographical exposure. These aren’t capital requirements, with minimum expectations discoverable by hard-and-fast formulas. It’s all so much fuzzier, and given the sophistication that money launderers and other odious characters can now deploy, an exercise in futility too.

Does all this support the recent call to centralize KYC processes and give outsourcing a go? Or does something so anachronistic deserve more internal attention and safeguarding because the fines can be so stiff, and embarrassment so brutal? The jury is still out but from buy-side sentiment seems clear: From authorities’ expectations to client data governance, to systems potentially stitching thousands of institutions together around the world, KYC has to be quicker, more integrated, and more standardized. And that would seem to give utilities and managed services a major leg up going forward, so long as the trust can be established to do so.

Art of Obfuscation
There’s a big caveat there. No matter how much more efficient an expert outsourcer can be, or the cost savings achieved by scalability, the client, they insist, is still yours to do business with (or not). Vendors aren’t taking on the decision, just doing information collection or provision, and helping firms organize it. They understand firms can’t be seen as abdicating that responsibility.

Who knows what’s easy? The only ones with a clear answer right now are the lawyers and offshoring firms around the world paid handsomely to make a tiny few financial services clients look less fishy or sanctioned than they are. It may take some time to get there, but we can all hope fresh solutions to KYC—starting with sound technology—can change that.