Featured Expert Contributor, Legal & Regulatory Challenges for Digital Assets

Alter_Daniel_web2_8784879218361By Daniel S. Alter, a Shareholder in the New York, NY office of Murphy & McGonigle P.C.

I’ve banged on this drum before in American Banker but—given recent and exciting developments in blockchain technology—it’s time to beat on it again.  The costs of Bank Secrecy Act and Anti-Money Laundering (BSA-AML) compliance are an enormous regulatory burden on financial institutions, particularly for small and middle market firms.  And considering the global security implications posed by terrorist financing and other criminal money-laundering operations, there are no corners to cut in meeting these requirements.

Yet, as one major vendor of compliance systems has observed, criminals are “increasingly laundering money through smaller regional banks, believing that these institutions do not have the millions to invest in the processes and technology needed” to combat the problem.  I say again, there is a private-market solution to this public-safety challenge.

Small financial institutions should be using their resources to provide clients with much-needed products and services.  They should not be making massive capital outlays for BSA-AML compliance—with each firm reinventing the wheel for its own client base.  That costly effort is neither efficient nor necessary.

Last October—in an interagency statement—the Federal Reserve Board, FDIC, FinCEN, NCUA, and OCC all agreed.  They linked arms and acknowledged that the “cost of meeting BSA requirements and effectively managing the risk that illicit finance poses to the broader U.S. financial system may be reduced through sharing employees or other resources in a collaborative arrangement with one or more other banks.”

Although U.S. regulators have now endorsed the idea of small banks defraying compliance costs by pooling bank efforts and assets, their logic should also extend to the industry’s use of specialized private vendors.  These third-party vendors would “provide access to specialized expertise that may otherwise be challenging [for banks] to acquire without collaboration.” After all, facilitating such access was the whole point of the regulators’ joint statement.

Indeed, the most basic principles concerning the division of labor and efficiencies of scale support the formation of private financial intelligence companies that can supply comprehensive compliance services at reasonable rates to multiple clients.  At least one enterprising consulting company already offers such services, and the financial services  community (including regulators) should foster the concept more broadly.

What makes this idea especially compelling now is the development of adequate technology to serve the purpose.  This past December, the Abu Dhabi Global Market (in conjunction with several banks and the region’s financial regulator) announced that it had successfully completed a trial of a blockchain application that “radically simplified” the Know Your Customer (“KYC”) process central to anti-money-laundering controls.  As reported, this blockchain “KYC app provides financial institutions with a single location where customer identification and verification can be performed once for a customer, rather than multiple times by different entities, for the same customer,” and provides “an unalterable audit trail, secure data sharing, compliance with the EU’s GDPR data privacy rules, [and] interoperability with third-party systems.”

A similar advancement was reported last June, when a group of 39 banks and financial regulators from around the world used another KYC blockchain application “to conduct over 300 transactions in 19 countries across eight timezones.”  According to R3, the platform’s developer, the use of blockchain “can lead to improved efficiency and lower costs at financial institutions by ‘eliminating the need for each institution to individually attest and update KYC records.’”

Over the past several years of blockchain development in the financial services world, the lion’s share of attention has been paid to the cryptocurrency and digital asset markets.  Fair enough—speculative fortunes have been amassed and lost there with record speed.  But money is to be made in regulatory cost savings, too.  And when money is to be made while simultaneously increasing the strength and efficiency of compliance infrastructure, financial regulators should get behind those efforts whole heartedly.

How ironic.  Blockchain technology was originally feared as an invincible tool of money launderers.  It actually could be one of the most effective weapons against them.