RapidAML Team
2024-06-18
As the regulatory landscape evolves, Know Your Transaction (KYT) technology remains at the forefront of combating financial crime.
This blog addresses how taking the extra mile in transaction monitoring can go a long way for businesses to save significant legal costs and improve their business reputation.
Know Your Transaction (KYT) is a means of transaction monitoring adopted by regulated entities such as businesses and financial institutions. Financial transactions executed by customers are scrutinised to detect anomalies that indicate money laundering or terrorism financing (ML/TF) risks by leveraging innovative technologies.
Know Your Customer (KYC) is an identification and verification tool for creating customer profiles. On the other hand, KYT verifies transaction patterns to examine unusual behaviour.
| Know Your Customer | Know Your Transaction |
| The focus is on the customer profile | The focus is on the transaction pattern |
| It is an event-based process, e.g., Conducted before onboarding or in the event of changes to customer profile | KYT is a continuous evaluation of customer transactions |
| It ensures that the customer does not pose ML/TF risks | It ensures that customers’ transactions do not pose ML/TF risks |
While there are technical differences between KYC and KYT, regulated entities are required to conduct comprehensive due diligence, combining both elements, to form a complete picture of a customer’s risk profile.
Constantly Evolving ML/TF Risks
The techniques used to finance illegal activity and launder the proceeds of criminal activities are constantly evolving. The exploitation of natural resources, social media, innovative payment goods and services, such as dubious payment aggregators, and Foreign Terrorist Fighters (FTFs) are recent phenomena in money laundering and terrorism financing. KYT is required to promptly identify such evolving modes to prevent greater harm with higher recovery rates.
KYT allows businesses to carefully evaluate and keep an eye on transaction details, thereby improving transparency and confidence in financial transactions.
Conformity with Regulatory Requirements
Transaction monitoring is an essential component of AML compliance. However, there are additional requirements set by international regulatory bodies such as the FATF, which regulated entities such as Financial Institutions, Designated Non-Financial Businesses and Professions, and Virtual Asset Service Providers must adhere to.
Recommendation 16 and the famously termed “Travel Rule” requires regulated entities to monitor originator information and beneficiary information when monitoring virtual asset transfers to identify and report suspicious transactions, take freezing actions, and prohibit transactions with designated persons (natural and legal).
Subsequently, many nations have adopted the FATF recommendations in their national regulatory framework.
Jurisdictions with robust AML/CTF frameworks require regulated entities to promptly report any suspicious transactions. For instance, UAE requires regulated entities to identify the originator, and the beneficiary involved in a fund transfer or virtual asset transfer. Also, the regulated entities must share this information with other regulated entities, capturing the details of the originator (payer) or the beneficiary (payer), along with the fund or virtual asset transfer request.
Proactive Risk Management
A reactive and remediation stance adopted by regulated entities not only impacts the economy and security of a country but also incurs huge financial losses for the regulated entities themselves. KYT is a means to implement the “Follow the Money” strategy.
Customer Due Diligence
KYC is undoubtedly the most significant component of Customer Due Diligence. However, the due diligence process cannot be comprehensively concluded without verifying the customer’s real-time, updated transaction details, as many regulated entities still use manual, rigid procedures for due diligence and KYC today. This implies that after a client’s credentials have been validated, there is frequently little to no maintenance or follow-up. KYT can, thus, facilitate Enhanced Due Diligence.
Know Your Transaction as a concept, though versatile in its application, gained prominence with the rise of cryptocurrency, blockchain, and distributed ledger technology.
Crypto Exchanges
KYT in cryptocurrency exchange is a procedure used to ascertain the origin and type of transfer of digital assets. KYT seeks to determine the origin, destination, and intended purpose of cryptocurrencies. KYT systems can identify suspicious activities and provide essential information by examining transaction patterns, the source of funds, and the risk profile of the parties involved.
NFT Marketplaces
NFT marketplace is a digital platform where you can buy, sell, and trade Non-Fungible Tokens (NFTs). NFTs represent ownership of unique digital or physical assets like digital art, collectables, etc.
KYT can be utilised to ensure the legitimacy and safety of these NFTs by identifying duplicate NFTs, detecting poison addresses that are used for online theft, or tracing rug pulls where NFT projects are ghosted after fundraising.
Decentralised Applications (dApps)
dApps, or Decentralised Applications, are applications that run on a blockchain network. Unlike traditional apps that are controlled by a single entity, dApps are distributed across a network of computers.
KYT solutions construct intricate graphs representing the flow of funds between different wallet addresses to recognise suspicious patterns. KYT tools extract relevant entities such as wallet addresses, exchange platforms, and smart contracts from blockchain data.
By linking these entities, the system can uncover hidden connections and potential illicit activities.
Detecting Unusual Transactions
Dynamic monitoring of transactions executed by customers, especially high-risk customers, with the help of advanced analytics to check for any deviation from the usual transaction pattern or behaviour.
Customer Identification
In-depth transaction analysis through KYT offers thorough insights into a customer’s transaction history and improves customer due diligence.
Identifying High-Risk Transactions
KYT solutions can alert suspiciously high transactions that occur within a dubiously fast timeframe and flag transactions exceeding certain thresholds in real-time. Risk scores can be assigned to transactions based on factors such as the sender and receiver addresses, transaction amount, and the associated network.
Supporting Regulatory Compliance
Regulatory authorities such as the Financial Action Task Force (FATF) require regulated entities to implement robust transaction monitoring systems. KYT helps fulfil regulatory requirements and prevent fines, penalties, and regulatory actions by enabling regulated entities to monitor transactions, identify suspicious patterns, and report suspicious transactions.
1. Risk-Based Approach
A risk-based approach in KYT ensures that resources are allocated efficiently by focusing on higher-risk transactions and activities. It can be implemented by assigning risk ratings to transactions based on factors like the amount, currency, and the parties involved. KYT systems can rely on machine learning and AI to analyse the transaction details and history to monitor high-risk transactions more strictly than low-risk transactions.
2. Transaction Pattern Analysis
KYT systems focus on identifying unusual patterns by comparing transaction data against a model of normal behaviour. KYT systems follow an anomaly-based detection that is updated daily instead of leaning on pre-defined fraud patterns.
3. Origin of Funds Investigation
The investigation of the origin of funds is a vital component of Enhanced Due Diligence (EDD) as regulated entities are required to verify the source of wealth and source of funds. AML compliance software powered by KYT solutions access digital bank statements and advanced AI analytics to analyse the financial data available and verify customers’ source of funds and source of wealth.
4. Risk Profiling of Involved Parties
KYT solutions integrate the data generated from KYC processes, transaction pattern analysis, and investigation of the origin of funds to determine the risk profile of a customer.
5. Real-Time Alerts for Suspicious Activity
KYT systems process available data in real time and use a combination of pre-defined rules like flagging unusually large transactions, multiple hops or transactions without any real economic purpose and advanced analytics to trigger alerts notifying relevant compliance personnel through various channels such as email, SMS, and push notifications with a detailed description of the transaction, parties involved and reasons for the alert.
6. Integration with AML Software for a 360-degree Viewpoint
KYT systems can achieve their maximum utility when integrated with AML case management systems. A synchronised customer, transaction, and business information can help regulated entities achieve greater efficiency in case management workflow integration due to dynamic risk assessment and consolidated risk profile, which allow regulated entities to file comprehensive regulatory reports through timely and accurate compliance.
7. Regulatory Reporting
Real-time monitoring of transaction data resulting in early detection of suspicious patterns and activities coupled with automated alerts and escalation for further investigation can result in prompt regulatory reporting.
Efficiency
KYT systems automate the monitoring and tracking of transactions, significantly reducing the need for manual processes. Since automated systems can process large volumes of data with speed and accuracy, it lets the compliance officer focus on the more strategic tasks.
Streamlines Compliance Processes
KYT can improve operational efficiency by automating the monitoring and tracking of transactions, eliminating the need for manual intervention and hence, generating accurate results.
Enhances Transparency
KYT shows a real and accurate picture of customer transactions without any bias or hidden considerations, also leading to prompt and accurate regulatory reporting. This enhances transparency in information sharing with the Financial Intelligence Unit (FIU).
Trust Building
Enhanced transparency, proper regulatory compliance, and effective business safeguards create an overall trustworthy environment and goodwill for the regulated entities, leading to healthier customer and investor relationships.
Risk Reduction
KYT identifies and prevents risks associated with specific transactions or customers, leading to effective risk reduction.
Data Quality and Consistency
Transaction data often originates from diverse sources that can cause inconsistency in formats, units, and naming conventions. In many cases, the data retrieved by the systems are incomplete or inaccurate with respect to the amount or date of the transaction. Additionally, fragmented data sets or duplicate data sets add to challenges in data integration and analysis complex.
User Training and Awareness
Inadequate training and awareness programs or insufficient practical application can lead to a lack of understanding and resistance to change that can significantly impact human judgment.
Scalability for Growing Transaction Volumes
As the volume of transactions grows multifold, it is important for software solutions to have such an infrastructure in place that can accommodate all the information that is collected.
Using traditional data storage solutions can make it hard for businesses to keep up with the changes, as traditional computer hardware cannot store gigabytes and terabytes of information without additional equipment or tools.
Data Privacy Concerns
The KYT mechanism requires sensitive customer information, raising privacy and data protection concerns.
KYT Strategy Formulation
A well-formulated KYT strategy works on the principle of a risk-based approach, which takes into account the specific customer profile, geography, transaction, and product/service-related risks. Further, setting clear alert criteria and data quality standards can improve the efficiency of the KYT systems.
AML/CFT Policy and Procedures
AML/CFT Policy and Procedures comprehensively document the legal obligations, the customer onboarding process, the reporting requirements, etc. Well-defined policies and procedures ensure consistency in applying KYT measures across the organisation.
KYT Technology Adoption
Regulated entities looking for advanced technologies in the KYT space should venture into all-in-one software solutions that can perfectly synchronise case management systems with KYT solutions.
Training and Awareness
User training and awareness is a cornerstone of the effective implementation of KYT systems, as it is the people utilising the software who can make the best use of it.
Collaboration with Regulators
Collaboration with regulators can foster better information sharing, thus improving the data quality of KYT systems data sets.
Algorithms using Artificial Intelligence and Machine Learning can examine transactional data in real-time, spot trends, and spot irregularities. By constantly learning and adjusting to evolving risks and typologies, these technologies increase the precision of spotting suspicious transactions.
Conclusion
In today’s complex financial landscape, robust KYT solutions are no longer a luxury but a necessity. By embracing advanced KYT technology, regulated entities can proactively combat money laundering and terrorism financing risks, safeguard their reputation, and ensure long-term sustainability.
Pathik is a Chartered Accountant with over 26 years of experience in governance, risk, and compliance. He helps companies with end-to-end AML compliance services, from conducting Enterprise-Wide Risk Assessments to implementing robust AML compliance frameworks. He has played a pivotal role as a functional expert in developing and implementing RegTech solutions for streamlined compliance.
Pathik's expertise extends to guiding businesses in navigating complex regulatory landscapes, ensuring adherence to FATF and other international standards, and mitigating financial crime risks. He is a recognised thought leader in AML/CFT, frequently sharing insights on emerging compliance challenges on various platforms.
