Navigating Transaction Monitoring: Key Challenges and Strategic Solutions

Transaction Monitoring (“TM”) presents one of the most complex problems within firm’s financial crime frameworks. It is a regulatory obligation[1] to scrutinise transactions to ensure they are consistent with the firm’s knowledge of the customer, the customer’s business, and their risk profile; yet how you perform this exercise is left up to firms to decide. The difficulty lies not just in the principles-based regulations but also in the lack of clear guidance from the Financial Conduct Authority (“FCA”) on how TM should be conducted—only that it must be in place.

This leaves businesses uncertain about the best approach, faced with a multitude of technological and manual solutions and a choice between in-house and outsourced platforms. Adding to the challenge, while the FCA insists on the importance of TM, it frequently highlights insufficient ongoing monitoring as a common failing in financial crime prevention.

Based on our experience, firms often set up inefficient solutions, with either far too many false positives to make the exercise useful or having incorrectly calibrated rules meaning that genuinely suspicious transactions slip through the net. Or even worse, they have no TM solution in place at all!

Drawing from Novatus’ extensive experience in setting up TM rule sets and systems, assisting with vendor selection, and developing comprehensive policies and procedures, we are sharing three key challenges that financial services firms frequently face when conducting TM.

1. Balancing False Positives and False Negatives

One of the most significant challenges in TM is managing the balance between false positives and false negatives. Too many false positives can lead to inefficiencies, wasting valuable resources on investigating non-suspicious activities. Conversely, an abundance of false negatives can result in missed risks, exposing the firm to potential financial crimes. Striking the right balance requires finely tuned TM systems.

To effectively manage this challenge, firms should adopt a comprehensive approach to TM maintenance. This includes regularly reviewing and updating their TM testing criteria and thresholds to ensure they align with the latest regulatory feedback and emerging trends, such as the rise in complex money laundering schemes or the use of digital currencies. It is crucial to emphasise periodic testing and validation of TM systems to continually enhance their accuracy and effectiveness, using both historical data and scenario analysis.

Firms should consider their business nature and customer base while reviewing, testing, and enhancing their TM rule sets. For example, retail banks should regularly review transaction patterns across different customer segments to update TM rules and thresholds that capture anomalies for specific customer types. Insurance companies, on the other hand, should focus on detecting unusual claims patterns that might indicate fraud or money laundering, particularly in policies involving large sums or high-risk clients.

Additionally, firms should implement robust procedures for ongoing monitoring and adjustment of their TM processes to optimise both efficiency and security. Collaboration between compliance, IT, and operational teams is essential to ensure that TM systems are not only compliant but also adaptable to evolving threats. Novatus, with its extensive expertise, excels in supporting firms with independent validation of solutions, ensuring they remain compliant and in tune with industry developments.

2. Building Your Own TM Platform vs. Using a Vendor

Choosing between developing an in-house TM system or acquiring a vendor solution presents a significant strategic decision for firms. While the upfront cost of an in-house development might seem attractive, it’s crucial to factor in the long-term implications. Maintaining such a system requires ongoing investment in IT staff, regulatory updates, and adapting to ever-more sophisticated criminal tactics. This can quickly erode any initial cost savings. Vendor solutions offer the advantage of pre-built functionality, expertise in Anti-Money Laundering (“AML”) compliance, and access to the latest regulatory frameworks. However, customisation options might be limited, potentially hindering the system’s ability to perfectly align with your firm’s specific risk profile and workflows.

Traditionally, TM systems have been designed with banks in mind, reflecting the high volume of transactions and the diverse range of services offered by these institutions. These systems are typically geared towards monitoring a broad spectrum of financial activities. However, the landscape of financial crime has evolved, and the need for robust TM extends beyond banks. Other financial services firms, such as asset managers, insurance companies, and payment providers, now face their own unique risks and regulatory requirements, necessitating TM solutions tailored to their specific operations.

For asset managers, the challenge is particularly nuanced. Unlike banks, which handle a high frequency of relatively low-value transactions, asset managers deal with fewer but often more complex and higher-value transactions. This includes the movement of large sums across borders, investments in high-risk jurisdictions, and dealings with private equity and hedge funds. Traditional bank-centric TM systems may not be equipped to effectively monitor these activities, which involve different risk factors and require a more sophisticated analysis of client behaviours and investment patterns.

To enable informed decision-making, firms should conduct a comprehensive evaluation of their specific needs and resource constraints. It is essential to facilitate a rigorous vendor assessment process, ensuring seamless integration with existing infrastructure. This is particularly important for non-bank financial institutions, where the unique nature of transactions and client relationships may demand more specialised functionalities. Additionally, testing shortlisted vendor solutions is crucial for assessing their effectiveness in detecting suspicious activity specific to the firm’s operations.

For those opting for in-house solutions, developing robust TM rule sets is vital. Keeping up with the latest AML trends and typologies ensures these rules effectively detect suspicious activity without generating excessive false positives. By understanding the distinct challenges posed by different financial services sectors, firms can better tailor their TM strategies, ensuring they are both compliant and capable of addressing the specific risks they face.

3. Evading Static Rule-Based Systems

One of the primary challenges in TM lies in the inherent inflexibility of many existing TM systems, whether in-house or outsourced. These systems are traditionally designed to identify pre-defined red flags based on known suspicious activities, such as large cash transactions, sudden account activity spikes, or transfers to high-risk jurisdictions. However, this kind of framework struggles to keep pace with the evolving tactics of financial criminals. As these criminals continuously develop new methods to exploit system vulnerabilities—such as using layering techniques, creating synthetic identities, or leveraging new financial instruments—the static nature of the monitoring systems becomes a drawback.

To effectively combat evolving financial crime strategies, firms must move beyond static rule-based systems and towards more dynamic, data-driven approaches to TM. This shift involves integrating behavioural monitoring with traditional static rules, creating a more comprehensive compliance framework. Behavioural monitoring, for instance, allows firms to analyse the patterns and habits of individual clients over time, flagging deviations from their typical behaviour that might indicate suspicious activity. For example, if an asset manager notices a client suddenly shifting large investments into uncharacteristically high-risk ventures, this could trigger a closer investigation, even if the transaction itself doesn’t trip any pre-set alarms.

Moreover, employing advanced analytics and machine learning can revolutionise how TM systems operate. These technologies can sift through vast amounts of data, identifying emerging trends and suspicious patterns that may not have been previously recognised. For example, an advanced TM system might detect a subtle but concerning pattern across multiple accounts, where small, seemingly innocuous transactions gradually accumulate into significant sums—a classic sign of structuring. Unlike static systems, which might overlook these transactions individually, a dynamic, analytics-driven approach could identify the cumulative risk.

To maintain the effectiveness of their TM strategies, it is also crucial for firms to stay informed about the constantly changing regulatory landscape. Regulatory bodies frequently update their guidelines in response to new threats, and staying abreast of these changes ensures that TM systems remain compliant and effective.

Novatus supports clients by translating complex regulations into actionable insights, helping them develop and maintain robust, future-proof compliance strategies through expert regulatory consulting services. By leveraging this expertise, firms can ensure their TM systems are not just compliant, but also flexible enough to adapt to new threats and sophisticated enough to detect the subtle signs of evolving financial crimes.

How Novatus Can Help

By partnering with Novatus, you gain the confidence of making an informed decision that optimises your transaction monitoring capabilities and safeguards your firm’s financial integrity. Our comprehensive support includes:

• Regular testing, validation, and updating TM rules and thresholds to align with regulatory feedback and emerging trends, as well as to enhance accuracy and effectiveness.
• Reviewing alerts against your customer risk profiles to ensure accurate risk categorisation and alignment of monitoring rules with identified risks.
• Facilitating rigorous vendor assessments and seamless integration with existing infrastructure.
• Leveraging advanced analytics and developing robust in-house TM rule sets tailored to your firm’s specific patterns, risks, and needs.

With a team of financial crime professionals, Novatus is committed to delivering unmatched expertise and support, ensuring your transaction monitoring processes are resilient, effective, and prepared for future challenges.

[1] Regulation 28 of The Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 (“MLRs 2017”)