- Person 1 - Stefano Chierici, Senior Product Manager, SIX
- Person 2 - Oliver Bodmer, Senior Product Manager, SIX
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Stefano Chierici: Welcome to Tax & Reg Insights by SIX, the video series where we explore the latest developments in tax, regulation and digital assets with experts from across the industry.
I’m Stefano, and today I’m here with Oliver to talk about sanctions, or should I say, sanctions as a market risk?
Welcome, Oliver. It’s great to have you here.
Let’s start immediately with the first question and perhaps with a brief look back. Could you tell us about the evolution of sanctions screening? How has this area changed over time?
Oliver Bodmer: Thanks for having me, Stefano.
I think it is important to take a step back. The sanctions landscape underwent a major development in the 1970s, when the Bank Secrecy Act came into force in the US. The goal was mainly to protect the financial system from malicious actors.
Back then, the focus was primarily on identifying a bank’s customer base, which is what we now know as the Know Your Customer, or KYC, business.
The challenge back then was similar to one we still face today. For instance, imagine the name Mohamed Ali. How is it spelled? How is it written? It could be written in Cyrillic or Chinese. At the end of the day, one challenge remains: is Mohamed the first name or the last name? The same applies to Ali.
As we moved from the 1980s into the 2000s, the world became more interconnected. Trade groups were founded, and the SWIFT messaging system was introduced. Transactions were no longer just domestic; they became international. As a result, the focus shifted towards effectively screening transactions, but securities were still not really in scope.
The big game-changer came in 2014, when the securities market came into scope in connection with the Crimea crisis. At that time, the US imposed sanctions on several Russian banks to prohibit the financing of the conflict.
Financing was also taking place through the securities industry, so investing in newly issued debt instruments was prohibited. This was also when we at SIX launched our service.
Securities have been in scope since 2014. For around ten years, we did not see enforcement actions. More recently, however, we have seen enforcement actions against large brokers.
We are therefore seeing another shift, from KYC and anti-money laundering to securities compliance. Sanctions are becoming a market risk because securities must also be screened.
Stefano Chierici: Interesting. Looking in more detail at the technicalities and how sanctions screening is conducted in the market, how has the process evolved over time?
Oliver Bodmer: In 2014, it was relatively simple. When we created the service, only a handful of Russian banks were affected.
SIX already had a comprehensive reference data structure. Because we collect reference data for several of our services, we based our sanctions service on the SIX reference database.
We identified the relevant banks in the reference database and linked them to their securities. Initially, it was a relatively simple issuer-to-instrument relationship.
Over time, however, we saw that circumvention was also taking place in the securities market, creating additional risks that needed to be addressed.
For instance, a debt instrument might be issued by a sister company of a sanctioned entity, even though that sister company is not itself sanctioned. However, the beneficial owner or ultimate borrower of the funds could still be the sanctioned company. That is something we would also want to screen.
There are also sectoral sanctions. In the case of Belarus, for example, the objective was to limit the flow of new money. This means that the issue date of a security must be taken into account.
We have also seen circumvention involving grandfathered securities, meaning securities issued before the effective date of the sanctions. Capital increases can subsequently take place, allowing new money to flow into the security and become mixed with the existing capital.
It then becomes difficult to distinguish between new and old money. These are all situations that we flag.
Stefano Chierici: I think it is already a very complex environment when looking only at equities and debt. But I imagine that there is an additional layer of difficulty when ETFs and funds are added to the mix because you also have to examine their underlying constituents.
How does that work, and how does screening by SIX address it?
Oliver Bodmer: Once you open up that universe, identify the securities and consider the volumes flowing through it, you see similar challenges with options and structured products.
Options issued by exchanges or structured products issued by non-sanctioned issuers can include payment conditions under which, when the option or structured product is exercised, the holder can be paid in either cash or securities.
Ultimately, you could buy an option or structured product and end up receiving a share that you are not permitted to hold. That is clearly problematic.
More recently, we have seen significant volumes flowing into ETFs. At SIX, we have a strong database to support the necessary analysis.
A regulation introduced during President Trump’s first term focused on companies associated with China’s military-industrial complex. The regulation specified that derivatives and other products providing investment exposure to such securities could not be purchased by a US person.
Consequently, if an ETF holds one of these securities, the ETF may also be subject to restrictions for US persons.
The complexity does not end there. Regulations may differ across jurisdictions. Something may remain legal under US rules while being prohibited in Europe.
This presents a significant challenge for banks, which must determine what they can and cannot do according to their client base and local footprint.
Stefano Chierici: Let’s take a slightly different perspective.
Considering how quickly the financial world moves, how rapidly circumstances change and how frequently regulations evolve, how often must screening be conducted?
The starting point was the annual review. Are we still there, or are we moving towards more continuous screening? What is the current situation?
Oliver Bodmer: That is a good point.
Back in the 1970s, firms conducted an annual review and then determined whether they needed to report anything.
The process subsequently became more frequent. When a payment transaction occurred, it had to be screened. In that area, the market is still moving towards real-time screening.
In the securities industry, our service has always operated in near real time, with multiple deliveries to clients each day.
There are many constantly changing variables. A new sanction can be issued, a new stock can be listed, a new debt instrument can be launched, or an ETF portfolio can be rebalanced.
Screening is therefore moving increasingly towards real time. The question is no longer, “Were you compliant at the last check?” Instead, the question is, “Are you compliant today?”
That is probably the best way to summarise it.
Stefano Chierici: Thank you, Oliver. It has been a very insightful discussion.
And thank you to everyone watching Tax & Reg Insights by SIX. To stay informed about the latest developments in digital assets, tax and regulatory data, visit our website or follow us on LinkedIn.
Oliver Bodmer: Thank you.