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Effective implementation of No. 3 Decree
Promulgated by the PBOC on December 28, 2016, the No. 3 Decree is an important milestone in China’s AML regulatory development. A highlight of the No. 3 Decree is a set of requirements pertaining to the reporting of suspicious transactions. The Decree has repealed the previous prescriptive transaction monitoring parameters and thresholds, which were universally applied to all financial institutions in 2007. Instead, the No. 3 Decree requires every financial institution to develop their own transaction monitoring rules and implement them by July 1, 2017. In addition, all financial institutions will need to:
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Conduct ongoing tuning and assessment of the effectiveness of their transaction monitoring rules;
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Perform detailed analysis of alerts; and
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Keep detailed records of the decision-making process during an alert review such as the rationale behind why an alert was cleared or why further investigation was initiated.
The Decree also mandates that a suspicious transaction report (STR) is filed when the financial institution knows or has reasons to suspect that their client, client’s funds or assets, or transactions conducted or attempted by their client may involve potential money laundering or terrorism financing related criminal activity, regardless of the amount involved.
In order to ensure the quality of the alerts, financial institutions will need to develop an effective set of transaction monitoring rules, while taking into account their money laundering risk profile (Products, services, customers, transactions, and geographic locations) and risk appetite. This can be a challenge for the following reasons:
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Excessive low quality alerts will cause financial institutions to invest unnecessary human and capital resources through the hiring of more compliance staff to analyse the alerts. It could also lead to relationship managers having to spend more time on gathering information to explain a customer’s transactional behavior, which may adversely affect a customer’s experience. On the other hand, if a financial institution’s aim is to minimise the number of alerts in a bid to save compliance costs, it defeats the purpose of developing the transaction monitoring rules in the first place.
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The establishment and tuning of the transaction monitoring rules such as parameters, thresholds, and algorithms require ongoing and substantial testing and analysis, which is a long term task. For example, this could include above and below threshold analysis as well as, the analysis of potentially vast amounts of historical data.
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The effectiveness of transaction monitoring relies on and is influenced by various components of the AML compliance program. This includes the adequacy of institutional risk assessment (covering all business lines, products, services, customers, transactions and geographic locations of the institution), robustness of the Know-Your-Customer (KYC) process, and the sophistication of the transaction monitoring system and KYC system (whether it can link customer segmentation with the threshold setting). In addition, data management (including data integrity, data flows and the interplay between upstream and downstream systems), detailed alert management and analysis procedures, STR decision-making and reporting process, continuing activity and post-STR filing actions, and the experience and competency of compliance personnel are important elements as well.
The key challenge will be how to utilise and improve a financial institution’s existing processes and IT infrastructure in order to implement the No. 3 Decree efficiently and effectively.
