Capital markets with its intricate web of transactions, high volumes, multiple intermediaries, and fast speed of execution makes it ripe for exploitation by parties subject to sanctions regime.

Financial institutions (FIs) operating in global markets face significant sanctions risk and must adapt their controls using decision intelligence systems to safeguard against these evolving threats. Find out how a new approach–Decision Intelligence–can help to strengthen controls and improve risk detection.

Sanctions risk in financial markets

In simple terms, securities and investment sector firms must not engage in prohibited activities with sanctioned individuals, entities, and countries.

Entities also include securities and issuers in the financial markets. For instance, sectoral sanctions might restrict transactions involving debt or equity instruments of a companies in the energy or defense sector of a sanctioned country. It can also apply to government, for example Executive Order (E.O.) 13808 issued by the Trump Administration prohibits transactions relating instruments issued by the Government of Venezuela.

Protecting against doing business directly with these prohibited entities is a relatively easier challenge, most of the large security firms use an automated screening system. These systems perform strict and various degrees of fuzzy matching of customer and transaction data against sanctions lists to uncover potential breaches.

The more complex challenge however for these firms is to identify indirect exposure or where the presence of the sanctioned party in the transaction is not obvious. In December 2022, Office of Foreign Asset Control (‘OFAC’) released an update to the 50 percent rule and stated that that an entity is blocked entity is blocked ''if one or more blocked persons own, whether individually or in the aggregate, directly or indirectly, a 50 percent or greater interest in the entity''.

Finding true beneficial ownership or control structure can be challenging, sanctioned parties often use complex networks of connections to avoid detection.

Understanding indirect exposure

Let us look at a hypothetical example of indirect exposure:

A US-based global custodian holds and manages securities on behalf of various institutional clients, including mutual funds, pension funds, and hedge funds. One of its mutual fund clients invests in a diverse range of assets, including equities, bonds, and ETFs.

Indirect exposure happens when this mutual fund client has invested in a bond issued by Northern Infrastructure Corp, a large conglomerate operating in Eastern Europe. Northern Infrastructure has a wholly owned subsidiary, Moore Energy Ltd which conducts significant business in a country under international sanction. This scenario exposes the custodian firm to potential indirect exposure to sanctions.

Similarly, when a broker dealer on-boards a new customer to facilitate transactions, it might not be possible to detect any indirect exposure to sanctions from this new customer entity unless a 360 degree view of this entity is created revealing their complete ownership structure and network of relationships.

Challenges and solutions

FIs need to think differently to navigate the complexities of indirect exposure and look beyond simple list matching. A contextual approach with strong data foundations using entity resolution and network analysis at its core is needed to uncover not so obvious risk.

How Quantexa can help

Quantexa’s Decision Intelligence systems stitches together internal and external data to build a trusted data foundation that enables FIs to strengthen sanctions related controls and potential direct and indirect risk exposure. Quantexa employs advanced capabilities to connect data and build enriched networks of relationships helping investigators to act quickly and decisively to mitigate risk exposure. Continuous understanding of the customer, counterparty and issuer risk exposure beyond simple list matching allows FIs to proactively manage their sanctions risk.

You can learn more about how decision intelligence can strengthen your controls in capital markets.