On 9 September 2021, the PRA and FCA co-published a Dear CEO letter on trade finance activity.
The Dear CEO letter reports that during the past 18 months there have been several high-profile failures of commodity and trade finance firms with significant financial loss. The PRA and FCA (together the regulators) remind firms that they need to demonstrate that they have taken a risk sensitive approach to their control environment that ensures the relevant risks are effectively mitigated. Recent assessments by the regulators of individual firms have highlighted several significant issues relating to both credit risk analysis and financial crime controls.
The Dear CEO letter covers:
- Risk assessment. Among other things the regulators mention that their reviews to date have found that there is often insufficient focus on the identification and assessment of financial crime risk factors, such as the risk of dual-use goods or the potential for fraud. Also at the client risk level assessments have been too generic to cover the different types of risk exposures that may exist in trade finance client relationships, such as the industry or jurisdictions in which the client operates. The Dear CEO letter reminds firms that when undertaking trade finance activity they should undertake a holistic assessment of the associated financial crime risks. These risks include money laundering, sanctions evasion, terrorist financing and fraud. The Money Laundering Reporting Officer (SMF17) should be responsible for ensuring that the assessment is subject to appropriate governance, oversight and challenge. In carrying out this assessment the regulators will expect the firm to also consider the issues raised in the Dear CEO letter. The assessment should also be clearly documented within the business-wide financial crime risk assessment and should identify the types of customers or transactions where enhanced due diligence is needed. In future engagement with firms, the regulators may ask to see the risk assessment they have carried out and any follow-up action undertaken as a result.
- Counterparty analysis. The Dear CEO letter reminds firms of the expectation to undertake appropriate credit analysis of all trade finance counterparts prior to formal credit limits being put in place. Firms are also reminded that their policies and procedures should set out clearly when it may be appropriate to conduct due diligence on other parties.
- Transaction approval. The Dear CEO letter states that prior to individual transactions being approved, the regulators expect firms to determine if further specific analysis is required. Such analysis should include, but not be limited to, consideration of the financial and non-financial risk on the end-buyers and the rationale for the transaction. Firms should identify instances of higher risk which require enhanced due diligence. Firms should ensure there is adequate oversight of the work being undertaken, to ensure that the policies and controls are operating effectively. This could include monitoring the discounting of red flags, transaction approval rationales, and the quality of escalations from first line business functions or trade finance operations teams.
- Transaction payments. The Dear CEO letter states that where the end-buyers represent the primary source of repayment under the transaction, prudent risk management is likely to include obtaining formal written acknowledgement from the end-buyer that the amount due and payable under the trade finance transaction is payable to the financing firm, and not to the borrower. The Dear CEO letter also states that for transactions involving credit insurance arrangements, best practice would be for a firm to seek formal confirmation that they are explicitly identified as a loss payee for risk insurance cover on non-payment of debts by the end-buyers and that the firm is in compliance with any requirements set out in the insurance agreement.