Compliance Risk Becoming Tougher to Navigate

In June 2014, Europe’s second-largest bank, BNP Paribas, agreed to pay an extraordinary $8.9 billion to settle sanctions violations accusations from the U.S. Justice Department. Following this largest sanctions fine in U.S. Justice Department history, at least six banks in Germany, France, Italy, and Japan fell under investigation by federal authorities for processing transactions linked to countries under U.S. sanctions for allegations of terrorism or human rights abuses. Such violations are in part emblematic of the risks associated with the growing global finance sector. They demonstrate why more than ever before, investors need to understand the environments within which they operate and take appropriate measures to help shield themselves from risk.

As investors tap into new markets, abiding by regulations becomes more complex. What is legal in one part of the world may not be legal elsewhere, and these discrepancies between laws in major markets can complicate investment in emerging market countries. In fact, disagreements over which markets deserve to be sanctioned, and what behavior necessarily constitutes sanctions violations, are likely to proliferate.

For example, the U.S. has long regarded Lebanon-based Hezbollah as a terrorist organization. It wasn’t until last year, however, that political pressure compelled the EU to blacklist the organization’s military wing. The designation necessarily meant sanctions. But U.S. efforts to persuade the EU took time. Using Europe as a financial conduit, Hezbollah had, for a while, been able to fund its operations. The different sanction treatment concerning Hezbollah, in addition to creating political dissonance between two of the largest economic regions in the world, sows confusion and complicates business for investors working on both sides of the Atlantic. More recently, Germany demonstrated its resistance to U.S. and EU-backed sanctions against Russia, warning of Russia’s pivot towards China if its business in Europe is compromised. As governments shift and newly imposed sanctions jeopardize economic interests, such differences will continue to emerge and complicate the investment landscape.

Compliance challenges confront banks in emerging markets too. As investors increasingly target emerging markets, banks in developing countries frequently lack the infrastructure to comply with the demands of Western governments. This equation could easily result in more fines for Western banks unless local banks in developing countries are properly vetted to determine whether they are abiding by specific regulations. Trades involving emerging markets, such as south-south trade, are expected to represent 40 percent of global trade by 2030, heightening compliance-related risks outside of banks’ local markets.

An announcement by World Trade Organization Director-General Roberto Azevedo in late 2013 helped shed light on a global escalation in international trade and investment. With governments cracking down hard on sanctions violators, combined with an uptick in international finance and trade, companies are increasingly apt to seek due diligence services. Some companies, in efforts to avoid the fates of BNP Paribas and others, have moreover invested millions in compliance programs to better meet and understand regulations. While emerging markets often provide highly profitable opportunities, investors need to understand the regulatory risks they face as well as how those risks are defined differently by different countries. In the knowledge-based finance industry, understanding the complex political landscape governing sanctions laws in multiple jurisdictions can help investors avoid major fines.

By Eli Lovely, a former analyst in Kroll's Compliance practice.