Chapter 2 · Industry Regulation

Financial regulation exists to achieve a few clear objectives:

• Protect consumers — particularly retail investors who can't realistically assess complex products
• Maintain market integrity — fair, orderly markets where prices reflect real information
• Ensure financial stability — preventing systemic crises (post-2008 emphasis)
• Reduce financial crime — money laundering, fraud, market abuse, terrorist financing

What regulation is NOT designed to do: maximise the profits of regulated firms, eliminate all investment risk, or guarantee returns.

Regulatory breach = violation of a specific written rule.
Ethical breach = behaviour that's legally permitted but falls short of accepted professional standards (eg, fairness, transparency, integrity).

You can have an ethical breach without a regulatory breach. Modern regulation increasingly tries to capture ethical behaviour via principles-based requirements (Treating Customers Fairly, Consumer Duty in the UK, etc.).

TCF is a classic principles-based regulation: firms must achieve specified fairness OUTCOMES for customers — but how they get there is for them to decide. Examples of TCF outcomes:

• Products designed to meet identifiable consumer groups' needs
• Clear information before, during and after the sale
• No unreasonable barriers to changing product, switching provider, or complaining

Central banks typically:

• Conduct monetary policy
• Act as lender of last resort
• Supervise the banking system (in many jurisdictions)
• Manage foreign exchange reserves
• Operate payment systems

What they DON'T do: act as primary dealer in corporate debt, provide retail mortgages, operate stock exchanges.

FATF Recommendations are international standards on AML/CFT that member jurisdictions implement through domestic law. They're not directly binding, but countries that fail to implement face greylisting/blacklisting — which seriously hurts financial relationships and investment flows.

1. Placement — dirty cash enters the financial system. eg, depositing cash, structuring (smurfing) deposits below reporting thresholds, buying high-value goods.
2. Layering — transactions designed to obscure the trail back to the criminal source. Multiple transfers, jurisdictions, asset types. Rapid buying/selling of bonds, shares.
3. Integration — funds re-enter the legitimate economy as apparently lawful wealth. Real estate purchases, business investments, "loans" from offshore entities.

CDD is the AML process for identifying and assessing clients. Standard CDD requires:

• Identify the customer and VERIFY identity from reliable, independent source documents
• Identify the BENEFICIAL OWNER (the natural person who ultimately owns or controls the customer, where relevant)
• Understand the PURPOSE and intended nature of the relationship
• Conduct ongoing MONITORING of transactions for consistency with the customer profile

CDD is performed at onboarding AND ongoing — risk-based, with re-checks at trigger events (unusual activity, material change in customer profile).

EDD applies to HIGHER-RISK situations. Common triggers:

• Politically Exposed Persons (PEPs) — senior government officials, judges, military, heads of state-owned enterprises, plus close family/associates
• Customers from high-risk jurisdictions (FATF greylist/blacklist, sanctioned countries)
• Unusual, complex, or large transactions without obvious economic purpose
• Customers operating in high-risk sectors (gambling, crypto, cash-intensive businesses)
• Non-face-to-face onboarding in some regimes

EDD typically involves: senior management approval for the relationship, enhanced source-of-funds checks, more frequent ongoing review.

SDD may be applied to LOWER-RISK relationships, such as:

• Supervised, listed financial institutions in well-regulated jurisdictions
• Public sector entities (governments, supranationals)
• Customers whose identity is verifiable from public sources

SDD doesn't mean NO checks — it means risk-proportionate, less intensive checks.

Typical AML legislation creates several distinct offences:

• Concealing — concealing, disguising, converting or transferring criminal property
• Arrangements — entering into or being concerned in an arrangement that facilitates the acquisition, retention, use or control of criminal property
• Acquisition / use / possession of criminal property
• Failure to disclose — by an employee in a regulated sector who knew or suspected ML but didn't report it
• Tipping off — informing the subject (or anyone) that a Suspicious Activity Report (SAR) has been made or that an investigation is underway

Tipping off = informing the subject of a SAR (or anyone else likely to prejudice an investigation) that a SAR has been filed or an investigation is underway. It's a separate criminal offence even where the underlying suspicion turns out to be wrong.

Practical implication: if you've reported a suspicion to your MLRO, you cannot give the client ANY indication that this has happened — even if asked directly.

The Money Laundering Reporting Officer (MLRO), also called the Nominated Officer, is the firm's designated AML point person. They receive internal suspicion reports from employees and decide whether to make an external SAR to the Financial Intelligence Unit (eg, NCA in the UK, FinCEN in the US).

Internal reporting (employee → MLRO) is protected — reporting in good faith is what regulators require. It is NEVER an AML offence to report a genuine suspicion internally.

Insider dealing = trading qualifying securities on the basis of INSIDE INFORMATION.

Inside information = precise, non-public information relating to an issuer or financial instrument, that would, if made public, likely have a significant effect on the price.

Insider dealing rules apply to QUALIFYING INVESTMENTS admitted to trading on regulated venues — shares, bonds, derivatives. They do NOT apply to physical commodities, real estate, or open-ended fund units.

Market abuse is a broader umbrella that includes insider dealing PLUS other behaviours such as:

• Market manipulation — wash trades, spoofing, layering, painting the tape
• Dissemination of false/misleading information likely to affect prices
• Improper disclosure of inside information
• Misuse of information — trading on information not generally available

Front-running = trading on advance knowledge of pending client orders. eg, a broker knows a large client is about to buy a stock and personally buys it first, then sells into the price rise caused by the client's order. Conflict of interest + market abuse.

Governments and the UN impose financial sanctions on individuals, entities and countries — typically requiring firms to:

• Screen customers against sanctions lists
• Block transactions involving designated persons
• Freeze assets held for designated persons
• Report to the relevant authority

Identifying a customer (or prospective customer) on a sanctions list means: freeze, report, do NOT deal with them, and do NOT tip them off.

Whistleblowing = confidential disclosure by an employee (or former employee) of suspected wrongdoing within an organisation, to internal or external authorities. Most jurisdictions provide legal protection against retaliation for whistleblowers acting in good faith.

Regulators encourage and protect whistleblowing because internal employees often spot misconduct earliest.