The costs of financial crime compliance jumped sharply in 2020, as Covid-19 complications caused a host of challenges and forced lots of compliance officers to spend more money on labor, according to a new report from LexisNexis Risk Solutions.
The report surveyed more than 1,000 compliance officers at financial firms around the world, and provides detailed analysis of their answers by geographic region. So if you’re in that sector and looking for some benchmarking data for your own compliance operations, there’s plenty of that material here.
I was more interested in the broader findings of the report. How did compliance staffing levels change in 2020, and why? What specific compliance tasks became more burdensome last year? How much were those changes perhaps driven by covid-19, versus greater regulatory pressures that would have happened even absent the pandemic?
Those are important questions because at least in North American and Europe, covid is now fading as a concern. (And let’s all hope the rest of the world soon follows suit.) So the operational disruptions of 2020 are likely to be a thing of the past soon enough.
That still leaves compliance officers with plenty of other challenges. Foremost is the aggressive anti-money laundering climate in Europe and North America, and fitting the implications of that into your compliance policies, procedures, and training. Close behind is the rise of cryptocurrency around the world, since its attendant fraud and corruption risks will drive that AML scrutiny even more.
Those external forces will lead to pressure on your internal compliance operations, as certain business processes get more onerous to execute — and then we’re talking about lost productivity, or higher costs for client acquisition, and those are not subjects the board or the C-suite like to hear about. Which leaves the compliance officer in an uncomfortable position.
So then, what can this LexisNexis report tell us, so you can avoid that predicament?
Disruption, Labor, and Costs
First, the cost of compliance is up all over the world. Total costs for all financial firms combined rose 22.9 percent, from $130.4 billion in 2019 to $160.3 billion in 2020. Figure 1, below, shows the change in compliance costs by region.
Rising costs unto themselves, however, are not news. More interesting is that most of the spending went to labor costs rather than to technology, and particularly went to hiring entry-level employees rather than mid-career or senior-level staff.
For example, among financial firms in North America, labor costs accounted for 53 percent of their budgets in 2019 — and then jumped to 59 percent in 2020. Meanwhile, technology costs dropped from 47 percent of the budget in 2019 to only 37 percent in 2020. Figure 2, below, shows the labor vs. technology spending shift across various geographic areas.
At the same time, while the average number of full-time staff increased modestly for North American firms (from 134 in 2019 to 138 in 2020) the mix of staff tilted heavily toward entry-level staff. As you can see in Figure 3, at right, entry-level staff rose from 51 to 64 people, while senior-level staff actually fell from 35 to 30. (LexisNexis found a similar dynamic in Asia-Pacific, although not in Europe or Latin America.)
Now, why would that happen? We can ponder several reasons.
First, labor costs include training, and more training is one of the go-to compliance responses when banks run into AML trouble — which has happened quite a lot lately, especially for financial firms in Europe. It’s also true that when you hire lots of entry-level staff, they’re the ones who need training the most; so that drives up your labor costs even more.
Still, why are firms hiring so many entry-level staff? That could be a function of Covid-19 disruption last year. First, the Fed cut interest rates and flooded capital markets with liquidity, so there was more business for financial firms generally. Compliance teams then had more work to do on tasks like customer due diligence, risk profiling, and resolving suspicious activity alerts; and you had to do that in a highly disrupted operating environment, with everyone working from home. So one can see how that might translate into hiring more entry-level or contract workers, to perform all that scut work.
My question is whether staffing levels might change again, as covid recedes into the past and financial activity returns to something more like pre-pandemic “normal.” I’d be curious what others think; drop me a line at [email protected].
What Comes Next
The other interesting finding from the report was the sheer range of new challenges that compliance teams are facing now. Specific challenges varied greatly from one region to the next. Or, as LexisNexis said: “Whereas previously there has been consensus on the top two or three ranked challenges, there is less of that in 2020.”
For example, the biggest compliance challenges among North America firms were sanctions screening (cited by 65 percent of respondents) and customer risk profiling (cited by 58 percent). Among firms in Europe, however, the numbers were 46 percent and 53 percent — and those numbers were lower than the corresponding figures for 2019.
For all that diversity of challenge, however, I’d look at several larger trends to deduce future compliance headaches.
First, we have the persistent problem of cryptocurrency. The Biden Administration has (wisely) framed unchecked use of cryptocurrency as a risk to national security and corruption. Which means regulators will want more assurance from financial firms that their cryptocurrency business isn’t feeding into those threats. Which means that, soon enough, firms will need to do better with issues such as customer due diligence, ultimate beneficial owner identification, and sanctions screening.
We could also say the same for tax avoidance, especially since we now have evidence that the wealthiest persons in the United States routinely pay only a pittance in income taxes. Or about economic sanctions, which will continue to be a popular tool of foreign policy.
Regardless, those challenges of customer due diligence, UBO identification, and sanctions screening are going to persist.
Where things get really interesting, however, is that those are pretty much the same pressures that drove the higher labor costs we mentioned above. That can’t be a sustainable solution for compliance operations, in financial services or any other field. So how might compliance officers change tack to meet today’s burdens?
The LexisNexis report also says firms that invested in technology before the pandemic had better performance during the pandemic; that should be no surprise, since LexisNexis sells compliance technology.
Then again, the point is also true. So I wonder what next year’s report will tell us.