Money laundering is Achilles heel of forex fintechs
This article originally appeared in the Australian Financial Review on 2 December, 2019.
AUSTRAC's growing activism is forcing Australia's foreign-exchange fintechs to clear a continually rising bar, warns Skander Malcolm, chief executive of ASX-listed online cross-border payments company OFX.
For Malcolm, this worry was metaphorically keeping him awake at night even before AUSTRAC unveiled its prosecution of Westpac: he revealed in an interview last month, not hitherto published, that he could see a crackdown coming - and it would hit OFX and its rivals in their "Achilles heel".
"The whole [cross-border payments] model rests on you being good at AML [anti-money laundering] and KYC [know your customer]," he said during a visit to London.
"If you screw that up, then your bankers won't support you, the regulators will shut you down, not to mention your clients. And the bar is just rising on that," he says.
Malcolm says a heavily critical 2015 report on Australia's AML regime from the global regulator, the Financial Action Task Force, had stung AUSTRAC - meaning tougher enforcement was only a matter of time. First there was the $700 million fine on Commonwealth Bank of Australia last year. "Now they're looking at Afterpay, they're looking at PayPal, they're getting a lot more aggressive compared to other global regulators," he says.
And the likes of OFX have to keep in step: "If we mess up, the whole model really falls down."
He also singles out another, broader risk to his sector from the worldwide crackdown on AML: banks could start to step away from providing essential services to the forex companies.
"You look at what's going on with AML fines, they've hit the roof," he says.
"So banks are sitting there saying, 'I'm going to bank a service business that's by nature high risk and therefore I should audit it more, I should get satisfied by management, I should get satisfied by the controls, AUSTRAC should give these folks a clean bill of health; and if I can't do all that, well, I'm not a utility, so I don't have to bank them'.
"Because of the manic increase in AML fines, the banks are saying, 'Some of the start-ups are tech disrupters, and if they don't treat this stuff seriously then it's our licence and our fine that gets done here'. So the banks are quietly off-boarding a lot of these companies."
This could make it harder for new entrants to join the likes of OFX and TransferWise in the market, he says.
"You don't get a tick as you come in and the door gets slammed behind you. It's every quarter, and they audit you. And so entering will be much harder than it used to be, and the cost of survival just goes up."
But a hiatus on new entrants might be no bad thing for OFX, which is an established company, subject to the corporate governance and financial disciplines of a listed entity, in a world of edgy, private-funded start-ups.
"It's pretty hard to compete with irrational competitors," Malcolm says.
"There's so much liquidity, these [venture capital] firms say they don't care if the company doesn't make any money for five years, and you sort of go 'how do I compete in this situation?'."
But he's not sure he'd trade places with them. "Being a listed company brings disciplines, which I think is appropriate in our space ... [compared with] nobody picking you up on the quality of your earnings," he says.
"And the reality is that being owned by private equity, it brings other pressures. They're not trying to build the culture. The biggest thing that they benefit from is lack of scrutiny, but I also think that's going to be their undoing."
Looking beyond AML to regulatory pressures more broadly, Malcolm worries about the potential for regulatory arbitrage in his sector.
The British regulator is letting payments companies operate like quasi-banks, and the Australian regulator - which requires forex companies to move money off the balance sheet more regularly - is letting British-registered companies use their looser licence Down Under.
"They're relying on their UK money licence and ASIC says you're entitled to do it. That's not the spirit of it, to my mind," he says.
"It's an unintended consequence: they wanted to create a licence that promotes large-scale payments, which is a good thing. What they didn't see coming was, once you let people leave money in that account you are basically a debit account.
"The e-money licence in the UK is going to come under some pretty substantial scrutiny.
"If you look at their balance sheet they've got a lot of deposits. They're technically not deposits, because they're money held for transfer. But you can leave your money there ... To me, that's a bank.
"At some point that's going to become a problem, because the central banks and the regulators are saying 'if you want to take deposits, we want to safeguard those, that's fundamental to the system'.
"But they're not regulating them like a bank, they're regulating them as a payments company, and it's only going to take one of them to collapse - because they don't make money - for people to go, 'hang on, you guys were asleep'."
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