Dominic Hobson

Dominic Hobson talks to Mark Gem The future of the omnibus account KYC, AML and sanctions screening are symptoms of rising regulatory operating in the securities industry that omnibus pressure for greater transparency into and custody accounts require scrutiny. The prin- who lies behind cash payments, securi- cipal issue cited by OFAC was that the securities ties transactions and assets in custody. were held in an account structure where Clear- For custodian banks, this has implica- stream did not know who the beneficial owner was. tions for the future of the omnibus account, which is a primary source of That account structure was an omnibus account, in which fungible interests in the same secu- operational efficiency. rities are commingled, and held in the name of the Dominic Hobson asked Mark Gem, custodian bank. It is such a standard feature of the head of compliance at Clearstream, securities services industry today that global custo- why he sees these developments as an dians are reluctant to enter markets that do not per- opportunity rather than a problem. mit omnibus accounts, and expect their sub-custodians to plead with local regulators for them to be allowed. Both at the time of the Clearstream settle- In January this year, Clearstream ment and in subsequent guidance to the industry as agreed to pay $151.902 million to settle with the a whole, OFAC has made clear that it expects cus- Office of Foreign Asset Control (OFAC), a de- todian banks to undertake closer scrutiny of omni- partment of the United States Treasury, in rela- bus accounts to identify the ultimate beneficiaries. tion to serving back in 2007-08 as the route by which a country subject to American and United The attraction of the omnibus account to Nations sanctions held securities in the United custodians is its operational efficiency. It creates States. The general learning point that the indus- economies of scale, lowers transaction costs, and try drew from OFAC was a clear alert to firms enhances liquidity, not least by allowing securities 1 to be lent or used as collateral without having to “Until recently, regulators themselves thought check who owns them first. However, this cre- reliance on the first gatekeeper in the chain was ates extended chains of owners, in which the le- sufficient, provided it was a regulated entity,” gal ownership of interests in securities changes says Gem. “Because it was a regulated entity, ev- hands many times without regard to the claims of ery entity behind it was deemed to be okay too.” the original beneficial owner. “Omnibus accounts These expectations are now changing, ini- also reduce transparency, by substituting a record tially in the payments industry. In February of the identity of the custodian for the identity of 2013, the Financial Action Task Force (FATF) the beneficial owner,” explains Mark Gem, head obliged banks to conduct full due diligence on of compliance at Clearsteam in Luxembourg. their correspondent banks, including an assess- ment of their anti-money laundering controls, As he points out, official thinking on seeking senior management approval of the transparency into customer accounts relationship, and ensuring the correspondent has changed. In its 2004 paper on conducted thorough customer due diligence the issue of client identification, the of their own. Importantly, the FATF warned at International Organisation of Securities the time that applying similar obligations to the Commissions (IOSCO) did not require cus- securities industry was “under consideration”. todians to look at owners behind omnibus accounts. Until 2009, the official guidance In Europe, the Market Abuse Directive from another department of the United States (MAD), adopted by the European Parliament Treasury, the Financial Crimes Enforcement in January 2014 and scheduled for implementa- Network (FinCEN), was that financial in- tion in all member-states of the European Union termediaries were not required to look be- (EU) in 2016, makes the “aiding and abetting” yond their immediate counterparties either. of market abuse a criminal offence. According to Mark Gem, this may argue for more thorough “If as an industry we do not investigation of beneficial ownership. “If as an make that level of inquiry of industry we do not make that level of inquiry, beneficial ownership, then then some future regulator could argue that a some future regulator could custodian or a market infrastructure should have known that market abuse was taking place, and argue that a custodian or a could therefore face criminal charges,” he says. market infrastructure should have known that market abuse Gem warns that assuming MAD applies mainly to the front office rather than the back is was taking place, and could a mistake. “The regulators will go for the tallest therefore face criminal guy in the room and will not distinguish between charges.” Mark Gem front and back office,” warns Gem. “They have done so many investigations in payments they In fact, in 2003 FinCEN and the Securities are only now turning their attention to securi- and Exchange Commission (SEC) had issued a ties. The securities services industry is going to rule under the PATRIOT Act of 2001 specifical- have to raise its game. The huge remedial pro- ly exempting brokers from looking through om- grammes banks have launched since being fined nibus accounts. SEC and Commodity Futures for issues in the cash and payments industry have Trading Commission (CFTC) guidance issued yet to wash through to the securities industry.” in 2003 and 2006 had advised brokers to treat the holder of an omnibus account as the only At Clearstream, unsurprisingly in the af- customer whose identity they needed to know. termath of recent events, the hard thinking about 2 what to do is already well under way. “It got me tity of both the payor and the payee of any pay- thinking about combining two things,” says Gem. ment. It is a measure of the rising regulatory fo- “What can we do to preserve the benefits of the cus on this issue that the Basel Committee on omnibus account model while better regulating Banking Supervision nevertheless argued the the potential for abuse?” The obvious solution is same year that existing payments message stan- for the securities industry to abandon omnibus dards did not go far enough in delivering full accounts and switch to beneficial owner accounts transparency, because they do not carry infor- everywhere. Gem thinks this would be inad- mation about originators and end-beneficiaries. equate, since it would still not identify any ben- “The securities services eficiaries beyond the immediate principals to a trade. It would also be inefficient for the industry. industry is going to have to raise its game. The huge “It would not be good for the industry remedial programmes banks we work in,” says Gem. “Omnibus accounts create tremendous economies of scale, with con- have launched since being sequent reductions in processing costs, which fined for issues in the cash and makes markets more open to a wider range of in- payments industry have yet to vestors. It is difficult, on a named account basis, wash through to the securities to see how capital markets could operate in the way that they do today.” As he points out, this is industry.” Mark Gem precisely why TARGET2-Securities (T2S) en- dorses omnibus accounts. Gem accepts regula- Gem thinks the securities industry needs tions (such as the Alternative Investment Fund to develop messages which include at least the Managers Directive, AIFMD, which insists on same level of information as the MT 202/5 segregation of customer assets) and investors messages. A SWIFT securities settlement in- (who think it provides additional protection in struction currently allows the instructing party case of bank failure) are driving the industry to mention all the receiving and delivering towards segregated accounts. But he still ar- parties to the transaction, the cash settlement gues it is better to regulate the flaws in omni- parties, and a number of other parties that are bus accounts than to get rid of them altogether. sometimes required in specific markets for “Omnibus accounts create tre- regulatory or tax purposes. In other words, securities settlement instructions already cover mendous economies of scale, a wide range of parties that could easily meet with consequent reductions in any regulatory requirements enforced in the processing costs, which makes future, but existing standards require only two markets more open to a wider parties in the settlement chain to be disclosed. range of investors. It is difficult, This is actually one fewer than the on a named account basis, to SWIFT Securities Market Practice Group rec- see how capital markets could ommends. “In terms of transparency, a gap has operate in the way that they opened between payment standards and securities standards,” says Mark Gem. “If you look do today.” Mark Gem at the structure of the typical payments mes- One way to do this is to copy what the sage and compare it with the typical securities payments industry has done. The SWIFT MT settlement instruction, you can see that screen- 202/5 message series has since 2009 ensured ing for PEPs, money launderers and sanctioned that correspondent banks always know the iden- countries is quite an industry in payments, 3 but that there is nothing similar in securities. match the trade details of the customer of their Transparency in the securities industry and customer and not just the trade details of their in the payments industry is not equivalent.” own customer. In other words, the details of the “Screening for PEPs, money second-level beneficiary of a transaction would be included in settlement instructions along launderers and sanctioned with the details of the originator of the message.

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