Zoom, Teams, Google and cloud technology have connected us during lockdown to the people in our professional life in a hugely effective manner. But, one aspect of this remote work flow is often overlooked. We usually know the other person or people in the interaction. Throw in audio visual technology and pre-pandemic communication via phone or email almost feels sensory deprived. Superior connectivity is a positive fact of business communication, but what about knowledge? Specifically, who are you dealing with?

Now think about those using or working in financial services. Know Your Customer(KYC) requirements are a fundamental step in conducting any regulated financial transaction. Yes, the process can sometimes be frustrating and time-consuming, but this week’s newsflow had a striking cluster of stories highlighting the serious risks when KYC processes fall down. There also might be a very current twist to these KYC failures. Let’s take a look at the headlines.

German regulator takes oversight of Greensill Capital as crisis deepens – The Guardian

The huge Wirecard scandal seems to have prompted the normally somnolent German regulator, BaFin, to adopt a more proactive approach in this complex story. Greensill Capital and its banking entity in Germany were a very big player in a niche banking activity known as supply chain finance. It’s a $1.3 trillion market, and Greensill was the innovation leader, providing $150 billion of funding to millions of customers since its inception in 2011. Greensill now faces collapse in multiple jurisdictions from Australia to the UK. And the cast of characters in the story is fascinating; the likes of Credit Suisse, David Cameron, BaFin, the UK government and Softbank are the headline names but the critical counterparty is less well known.

It appears Greensill Capital had an outsized, over-exposed, financing relationship with the Gupta Family Group(GFC). The Gupta business portfolio includes the huge Liberty steel group and Wyelands Bank, with the former a hungry recipient of funding from Greensill. The German regulators were not comfortable with the concentration of Greensill’s risk/exposure to one group(GFC) and froze payments in and out of its German banking subsidiary. The picture emerging is that counterparties who thought they were dealing with Greensill were actually funding GFC. Credit Suisse have taken fright and suspended their $10 billion fund JV with Greensill. Tokio Marine acted even earlier pulling insurance policies on Greensill assets. These policies expired on March 1st and dramatically accelerated events.

Greensill is currently hurtling towards insolvency with Softbank writing off their entire $1.5 billion investment in the group. When the litigation teams pick over the carcass of Greensill there will be two key questions. Did counterparties really know Greensill (and its GFC relationship) and should they have known? In Ireland the regulators are answering this question rather emphatically in a very different case of misidentification.

Davy’s CEO steps down after bond deal revelations – The Financial Times

The choice of an international press headline is deliberate. For Irish readers, another tale of financial chicanery won’t exactly stun a nation previously skewered by apparent greed in financial services. However, the story will resonate with international readers on two levels. First, this story emerged from another private deal in the debt markets. Second, there’s a new global sheriff in town.

For transaction context, private debt deals, unlike shares trading on exchanges, are more difficult to monitor and prone to poor visibility/discovery of “fair” prices. So, there are occasions when prices found for clients can subsequently be perceived as unfair, and lead to dispute. Sure enough, a client of Ireland’s pre-eminent stockbroker, J&E Davy, wasn’t happy with a price he received for Anglo-Irish debt instruments he sold back in 2014. The twist here was that the counterparty who made a significant profit at the client’s expense was his paid advisor, the firm itself, J&E Davy. More specifically, a consortium of Davy employees, turned out to be the purchasing counterparty but was never identified as so to the client.

For those that think it would be pretty common for clients not to know the identity of their counterparty they would be almost correct. In this case, the status of the consortium, as advisor to the client, opens up a huge can of worms regarding a potential conflict of interest. Potential, but not actual, the accused firm might have argued. But no. Unfortunately, the J&E Davy compliance department were kept in the KYC dark for 4 long months. If all was tickety-boo, compliance would have known the true counterparty ID on the day of the deal. Now, back to the sheriff.

The titular regulatory sheriff in Ireland is the Central Bank who brought an enforcement action and slapped a €4.13 million fine on the miscreant firm. Seasoned local observers were expecting the ample-necked Dublin outfit to make the usual do-better-next-time PR noises and move on. Not so this time. There’s another sheriff, a bigger one. All governments, banks and companies are signing up to do better in the areas of Environmental, Social and Governance compliance (ESG) at the behest of regulators and asset managers. The big stick being used is international capital flows.

As much as $70 trillion of investment funds now claim to be paying significant attention to ESG compliance. So, Davy’s pretty awful first step in “no heads” PR repair was quickly overtaken by much bigger player concerns. The Irish state’s financing arm and key sovereign bond client counterparty, the NTMA, issued a statement with an accusation of a “breach of trust”. Big corporates, including Bank of Ireland, expressed similar concerns in public and private. And heads are now finally rolling down Dawson Street. The new reality is that states and corporates across the globe have to make real efforts to ensure their commercial eco-system is adhering to similar ESG frameworks. ESG is a game-changer which is increasingly occupying the minds of board directors and executives. Arguably, knowing your client (KYC) is one of many relationship hurdles which have become much more complicated. And if that’s complicated try this….

ARK funds fall into bear market – The Wall Street Journal

This writer first came across the ARK group of funds and its leader, Cathie Wood, in early 2020. At the time this US investment team was taking big bets on innovation darlings like Tesla, Zoom, Shopify, Teladoc and Roku. Total funds being managed by Wood’s team were a little over $13 billion. Fast forward to last month and the fund family was managing more than $50 billion! This was the hottest fund family with the hottest stocks. However, the number of stocks in the portfolio didn’t grow as fast as the fund flows so positions in some stocks have become very heavy e.g as much as 10% of Tesla. That’s not too bad in a rising market as lots of buyers chase up a limited number of available shares. The reverse is not so pretty.

A weaker NASDAQ and jittery bond markets has prompted a vicious 23% fall in the underlying value of the ARK fund holdings. Lots of sellers, right? But there’s more, as in more sellers than you think. Did buyers/clients of the ARK funds know there were other funds mimicking(under licence from ARK) the trading strategy and portfolio? We are now hearing that Japanese fund giant, Nikko, has billions of client funds copying the ARK strategy. So, there are now certain individual stocks in the ARK portfoio where Nikko and ARK combined own up to 25% of the entire share capital. Some of these stocks are illiquid and recent memories of the Woodward debacle in the UK should focus regulatory minds. In simplified terms, investors may ultimately take the view that they should have been told the ARK investment strategy was really an ARK + Nikko strategy. Knowing me, knowing who…..is important.

Technology, financial complexity, ESG, connectivity and regulation continue to move forward. Probably not human behavioural failings and conflicts of interest but they remain critical franchise risks if KYC processes do not keep pace. The good news is Irish companies like Fenergo, ID-Pal and UBO Services are leading the race to upgrade KYC processes. Now it is incumbent on senior executives and board directors to show more tech curiosity in solving KYC issues. The upcoming ‘Senior Executive Accountability Regime’ is a significant step by the regulators in holding individuals to account. And remember that $70 trillion ESG stick too. A post-factum “A-Ha” from a responsible individual won’t cut it. The commercial world will just cut you.