Safeguarding Finance: The Crucial Role of Sanction Screening

Financial crime continues to be a major issue, undermining the trust and safety of global financial systems. The United Nations estimates that a staggering 2 to 5% of global GDP, or between EUR 715 billion and 1.87 trillion, is laundered each year. Moreover, about 50% of companies worldwide have experienced fraud in the last two years, underscoring the urgent need for effective measures against financial wrongdoing.

Financial crimes fall into three main categories: money laundering, financial fraud, and sanctions evasion, each with its own implications. However, sanctions evasion stands out for its direct threat to global economic stability and security.

Sanctions are punitive measures imposed on entities or individuals to restrict their trade or financial transactions. Sanction evasion aims to bypass these restrictions, often through methods like using shell companies or exploiting legal loopholes, making detection and prevention challenging for financial institutions.

Sanction screening is crucial in fighting these crimes, designed to identify, prevent, and disrupt illegal financial flows. However, this task is fraught with challenges:

• Decoding Sanction Lists: The initial step involves navigating through various sanction lists, each with its own focus and territorial applicability. These publicly available documents, issued by national or international bodies, include entities or individuals subject to financial or trade restrictions. Examples include the OFAC, UN, and EU Consolidated lists, among others. These ever-evolving watchlists contain unique and sometimes conflicting restrictions, making compliance complex.

• Maintaining Accurate Customer Data: The foundation of effective sanction screening is reliable and up-to-date customer data, necessitating systems for regular updates and checks to identify evasion attempts. Data collection ranges from basic personal details for individuals (such as full and alternate names, birthdates, nationality, addresses and national register numbers) to quite complex information for businesses, including connections to directors, UBOs (Ultimate Beneficiary Owners), and trading partners. This is crucial for adhering to implicit sanctions, which are based on associations with sanctioned entities or sectors rather than specific names. E.g. any entity doing business with Iran, Cuba or Sudan is implicitly covered by the sanction lists. As implicit sanctions are less clearly defined, they are much more complex to cover and more open to interpretation.
  Apart from collecting the data, the accuracy also has to be validated. This is accomplished by cross-checking the collected data against other sources, such as public registers, official documents and/or third-party data providers.

• Sophisticated Matching Techniques: The heart of sanction screening lies in accurately matching customer data with entries on sanction lists, a task complicated by variations in names and aliases. Sophisticated algorithms and fuzzy matching are critical for ensuring precision while minimizing false positives.

• Investigation and Reporting: When a potential match is found, it triggers a detailed investigation to verify the findings, distinguishing false alerts from genuine matches. Confirmed matches necessitate the submission of a Suspicious Activity Report (SAR) to authorities, as neglecting to report can result in severe penalties. These reports allow law enforcement agencies to take necessary actions. In 2022 more than 3.6 million SARs were filed, which shows the scale of the challenge.

Sanction screening is  not a one-time activity but a continuous commitment, necessitating regular re-screening to account for updates in sanction lists and customer profiles. This includes screening at customer onboarding and at regular intervals or triggered events, such as new transactions or account openings, to ensure ongoing compliance. Additionally regulators impose as well that counterparties in financial transactions (Know Your Transaction - KYT) are also screened, even if those are not customers of the financial institution.

Meeting this challenge efficiently calls for the adoption of sophisticated technologies to automate processes as much as possible. Many RegTech solutions provide comprehensive services that distribute common efforts across banks. Integrating sanction screening into a broad financial crime prevention strategy, combining AML, KYC, and fraud detection, can lead to more effective outcomes, as these crimes often overlap. Continuous monitoring (via a so-called risk-based approach) of all the activity of customers and the use of AI and rule engines can significantly improve results, reducing both false positives and negatives.

With regulators intensifying scrutiny and imposing heavier fines and legal actions for non-compliance, the pressure on financial institutions to enhance their sanction screening practices is mounting. High-profile cases of fines for breaches, such as those involving Standard Chartered, BNP Paribas or Société Générale, underscore the stakes involved. This drives institutions to heavily invest in automation to decrease compliance costs while improving adherence to regulations.