What is KYC and Why do Brokers Implement it?

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Financial institutions are particularly susceptible to unlawful criminal activity in a globalizing economy. Know Your Customer (KYC) requirements protect financial institutions from fraud, corruption, money laundering, and terrorist funding.

KYC requires many procedures to

• Establish client identification
• Comprehend the nature of the customer’s actions and ensure that the source of funding is authorized
• Evaluation of consumers’ money laundering risks

Effective KYC processes are the foundation of every effective compliance and risk management program, and the need to comply with KYC requirements is rising. With the significance of anti-money laundering (AML) and KYC compliance expanding as more strict regulatory requirements are implemented, banks and corporations are devoting substantial resources and time to KYC compliance processes.

Although banks and regulators have signaled a readiness to adopt standardized KYC regulations and harmonize internal systems, much work remains. Numerous global and local initiatives aiming to enhance the process worldwide have come and gone. A proactive and collaborative strategy is required to develop change and overcome these obstacles.

KYC compliance also plays a vital role in real-time, cross-border payments, fostering higher levels of trust, transparency, and collaboration while limiting risk. A community-based strategy is crucial for accelerating compliance and developing new, more collaborative approaches to combating financial crime.

Top factors required to design and implement an efficient KYC program

The following factors are required to design and implement an efficient KYC program:

1.   Customer Identification Program (CIP)

How can you know if someone is who they declare to be? According to Bureau of Justice statistics, identity theft is prevalent, impacting approximately 16.7 million U.S. customers and resulting in the theft of $16.8 billion in 2017. It’s not only a financial risk for obligated businesses, such as financial institutions; it’s the law.

The CIP requires individuals making financial activities in the United States to have their identification confirmed. The Patriot Act established the CIP to restrict money laundering, funding for terrorism, corruption, and other illicit acts. Over 190 governments worldwide have committed to implementing the suggestions of the Financial Action Task Force (FATF), an intergovernmental body that battles money laundering. These proposals contain techniques for verifying identification.

The expected result is for required entities to identify their consumers correctly.

A risk assessment, both at the institutional level and the level of processes for each account, is essential to the effectiveness of a CIP. While the CIP gives advice, it is the responsibility of each institution to define the precise degree of risk and policy for that level of risk.

In the CIP, the minimal prerequisites for opening a personal financial account are specified in detail:

• Name
• Age at birth
• Address
• Identifying number

Even if collecting this information upon account opening is sufficient, the institution must verify the account holder’s identity within a reasonable period. Documents, non-documentary procedures (such as verifying the information given by the client with consumer reporting agencies and public databases, among other due diligence processes), or a mix of the two are used for identity verification.

These regulations are fundamental to CIP; like other AML compliance requirements, they shouldn’t be followed arbitrarily. They must be explained and formalized to give ongoing direction to workers, executives, and regulators.

The specific policies rely on the institution’s risk-based strategy and may consider the following:

• The bank provides the account kinds
• The bank’s account opening procedures
• The sorts of available identifying information
• The bank’s size, location, and client base, including the goods and services utilized by consumers in different regions

2.   Customer due diligence

For every financial organization, one of the initial considerations is whether or not to trust a new client. Customer Due Diligence (CDD) is essential to efficiently manage risks and safeguard yourself from criminals, terrorists, and politically exposed persons (EP) who represent a threat.

Three degrees of due diligence exist:

1. Simplified Due Diligence (SDD) refers to instances in which the danger of money laundering or terrorist financing is low, and a comprehensive CDD isn’t required. For example, accounts or accounts with a low value.
2. Essential CDD collects information on all customers to verify their identification and assess their risks.
3. Enhanced Due Diligence (EDD) is the collection of additional data on customers with a higher risk profile to gain a better knowledge of customer activities and reduce related risks. In the end, even though some EDD criteria are mainly established in a country’s legislation, it is the commitment of the financial organization to assess its risk and take precautions to guarantee that its clients are not bad actors.

Companies can include the following practical actions in their CDD program:

1. Determine the potential customers’ identity and location and obtain a thorough grasp of their company operations that is as easy as locating paperwork that proves the customer’s identity and address.
2. Before saving this information and any additional evidence digitally, assess a potential client’s risk category and identify the sort of customer they are when authenticating or validating them.
3. Beyond basic CDD, it is essential to follow the proper procedures to determine whether EDD is required. Current clients have the potential to move into higher risk categories over time; therefore, it might be advantageous to do periodic due diligence studies on existing customers. To evaluate whether EDD is necessary, examine, among other things, the following:

• Position of the individual
• Occupation of the individual
• Variety of transactions
• The pattern of expected activity in terms of transaction categories, money amount, and frequency
• Method of expected payment

In the event of a regulatory audit, it is required to keep records of every CDD and EDD completed on each client or prospective customer.

3.   Ongoing monitoring

It isn’t sufficient to examine your customer only once. You could have software to monitor your customers continuously. Continual monitoring comprises financial activities and accounts oversight based on risk profile-determined criteria.

Depending on the consumer and your risk mitigation approach, the following additional aspects may need to be monitored:

• Increase in activity
• Unusual or out-of-region cross-border actions
• The inclusion of individuals on penalty lists
• Adverse media mentions
• If the account behavior is judged strange, a Suspicious Activity Report (SAR) may need to be filed.

In addition, periodic evaluations of the account and related risks are regarded as excellent practices:

• Is the account information current?
• Are the nature and quantity of transactions consistent with the account’s declared objective?
• Is the risk level commensurate with the nature and volume of transactions?

In general, the amount of transaction monitoring can be determined by a risk analysis.

What are KYC documents?

Typically, account holders must submit a government-issued identification card as confirmation of identity. Some organizations need two kinds of identification: a driver’s license, a birth certificate, a social security card, or a passport. In addition to identification verification, they also verify the address, which can be accomplished using identification or a document proving the client’s residence. This is important for KYC in banking.

What is KYC verification?

KYC verification is a collection of regulations and procedures used in the investing and financial services sectors to guarantee that brokers have appropriate information about customers, risk levels, and finances.

The importance of KYC verification

As with banks and insurance organizations, brokerage firms confront the risks of identity theft and financial crime on a global scale. Brokerage businesses are urged to comply with KYC/AML laws to protect their clients from becoming victims of identity fraud. These laws have significant ramifications for onboarding new customers, considering the number of transactions on online trading platforms.

In addition to other KYC verification methods, brokers implement identity verification to maintain compliance with international standards. During the onboarding process, one of the main tasks is to acquire the customers’ personal information and execute rigorous methods to authenticate their identification. Additionally, stock exchanges are advised to establish safeguards to identify their consumers when they engage in financial transactions.

In the event of legal entity onboarding, firms employ KYC processes to acquire extra information. The brokers should protect the accounts, funds, and documents associated with the business or corporation. Before money is transmitted or received, every entity undergoes these checks and is approved by the brokerage or online trading platform.

In addition to hazards posed by businesses and their consumers, linkages between customers and political bodies may also pose problems. In the event of high-risk consumers, brokerage companies are also obligated to do EDD. To prevent money laundering, bribery, and corruption, EDD entails screening the consumer against worldwide sanctions lists and PEP lists. Adopting a risk-based strategy enables stock exchanges and trading platforms to limit the risks of fraud and financial crimes and avoid penalties for noncompliance.

Financial Industry Regulatory Authority (FINRA) Rule 2090 KYC and FINRA Rule 2111 regulate KYC (Suitability).

Rule 2090 of the FINRA mandates that all broker-dealers make reasonable efforts when creating and managing client accounts and are expected to know and retain records on the profile of each customer as well as identify each individual who has the power to act on behalf of the consumer.

A broker-dealer has a reasonable opinion that a recommendation is acceptable for a client based on the client’s financial status and requirements, per FINRA Rule 2111. Before purchasing, selling, or exchanging a security on a client’s behalf, this regulation presumes that the broker-dealer has reviewed the current facts and profile of the client, including the client’s existing securities and investments.

The final analysis

KYC is a collection of criteria and regulations that investment and financial services organizations employ to verify the identity of their clients and any risks connected with the client relationship. KYC requires clients to submit a personal identity profile and guarantees that investment advisors know a client’s risk tolerance and financial standing.

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