FCA outlines its expectations of firms undertaking trade finance activity

The UK Financial Conduct Authority (FCA) today sent a “Dear CEO” letter to firms engaged in trade finance activity.

The regulator notes that, during the past 18 months there have been several high-profile failures of commodity and trade finance firms with significant financial loss. There are inherent risks within trade finance activity, given that it can be complex, global in nature and the large volumes of trade flows utilising multiple currencies.

Firms are advised to demonstrate that they have taken a risk sensitive approach to their control environment that ensures the relevant risks are effectively mitigated.

  • Risk Assessment

In FCA’s reviews to date, the regulator has 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. In other instances, firms have not adequately evidenced their assessment of mitigating controls or recorded the rationale to support conclusions drawn on the level of residual risk to which the firm is exposed.

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 client risk rating will impact the level of due diligence required for individual trade finance transactions, and firms should also consider the risks presented by the specifics of the transaction itself including any apparent transaction specific “red flags”.

“As a firm that undertakes trade finance activity, you should, if you have not already, undertake a holistic assessment of the associated financial crime risks. These risks include money laundering, sanctions evasion, terrorist financing and fraud,” the FCA says.

The assessment should 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.

  • Counterparty Analysis

The FCA expects firms to undertake appropriate credit analysis of all trade finance counterparts prior to formal credit limits being put in place. This analysis should include all parties with an interest in the transaction and not be limited to the borrower i.e. the end-buyer, credit insurer and other parties, where relevant, should form part of the analysis.

A firm’s policies and procedures should set out clearly when it may be appropriate to conduct due diligence on other parties.

  • Transaction Approval

Prior to individual transactions being approved, the FCA expects firms to determine if further specific analysis is required. This 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.

  • Transaction Payments

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.

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.

The FCA expects firms to consider the issues raised carefully.

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