Understanding Financial Compliance
What is financial compliance?
Financial compliance includes the laws, regulations, and rules that apply to companies and businesses that offer financial services. For instance, Payset is regulated by the FCA, the regulatory body that permissions and authorises EMIs in the UK. By extension, compliance also includes enforcement initiatives from regulators and compliance efforts from within the companies themselves.
Why is financial compliance important?
Financial compliance is important because it keeps clients and customers safe. Regulations are often put in place so that customers can obtain secure and trustworthy services.
For example, regulations may ensure that users can access their funds if a company fails. Regulations can ensure that advertising and marketing materials are not misleading. Regulators can even take steps to shut down fraudulent or dangerous companies.
Other regulations primarily affect companies themselves. Compliance with financial regulations can ensure that a company avoids conflicts of interest, employs staff properly, and maintains appropriate client-advisor relationships. KYC/AML regulations can help companies avoid participating in or facilitating illegal transactions. Regulations may also ensure that a company maintains proper records and pays taxes in full.
Who regulates financial compliance?
Most jurisdictions have local agencies that are responsible for financial compliance and regulations. Often, these agencies work at a national level. For example, the U.K. relies on the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA).
Sometimes, regulators work with multiple countries. The EU’s 27 member states are subject to regulation and standards set by the European Central Bank (ECB) and European Banking Authority (EBA), as well as their own local financial authorities.
In the United States, regulators operate at both the state and the federal level. The U.S. Federal Reserve, the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), and the U.S. Treasury are among the agencies responsible for setting or enforcing nationwide financial rules. Some states have significant state-level regulators, such as New York and its Department of Financial Services.
Regardless of which agency is responsible in any given case, companies have a legal responsibility to comply with regulations. Often, companies employ a legal advisor or general counsel who is tasked with this role — usually called a compliance officer, chief legal officer, or general counsel. Together with regulators, companies themselves are directly responsible for financial compliance.
Positive Financial Compliance Practices
If you operate a company, you should engage in several compliance practices:
- Comply with KYC/AML rules: In order to prevent illegal and fraud-related transactions, most governments require financial companies to identify customers and monitor suspicious transactions. Your company should collect necessary information from customers and report transactions appropriately.
- Focus on customers: Many regulations are intended for the benefit of customers. Compliance with insurance or safeguarding rules and anti-fraud regulations will help customers trust your company with their assets.
- Comply with privacy rules: Some locations, such as the EU, have rules such as GDPR that set rules around user data privacy. These rules may go beyond keeping user information secure and private. They may also determine where you can offer your services, and as such, you should consider privacy rules carefully.
- Be aware of fintech regulations: Online and digital transactions are growing rapidly, and regulations must change in step with technology. Companies should be aware of new regulations around digital transactions, card transactions, peer-to-peer (P2P) transactions, retail investment services, and stablecoins and cryptocurrency.
- Rely on compliance experts: Even if it is not required by law, your company should hire a legal advisor and general counsel or outsource the task to an external compliance consultancy.
- Conduct assessments and audits: Companies can hire external firms to perform audits and assessments. If your company deals with the public, you may choose to publish some of this information in regular reports for transparency.
- Keep records: Keeping proper records is necessary to prove that your business complies with regulations, properly reports taxes, and is operationally sound.
- Train employees: You should educate your employees about compliance even if this is not part of their main job. Doing so can prevent future compliance issues.
Legal and Regulatory Risks
Legal and regulatory risks are inherent threats to a company’s standing that can result from its failure to comply with the rules set out by governing authorities and can lead to losses and damages.
Typically, compliance failures result in financial loss through fines, penalties, and legal settlements. However, wrongdoing can also lead to injunctions that prevent a company from engaging in certain activities or stop it from operating entirely. In severe cases, executives associated with an offending company may face criminal charges and individual penalties.
Not all legal risks concern regulations. Legal risks may also concern contractual disputes or other conflicts that can be resolved through arbitration and mediation instead of lawsuits.
Regulatory Risk vs. Compliance Risk
Risks arising from regulation can be distinguished further as follows:
Regulatory Risk
Regulatory risk is the risk that a change in laws and regulations will materially impact a company. Though companies must adapt to changing laws, this type of risk is partly caused by governments and regulators that may introduce rules that are difficult to comply with.
Typically compliance failures result in financial loss and damages through fines, penalties, and legal settlements.
Compliance Risk
Compliance risk refers to reputational damage, losses, and penalties caused by a company’s own failure to comply with established regulations. Sometimes, these issues are not strictly related to regulations: a company may fail to comply with industry standards or meet its commitments to clients, and it can face the consequences of those failures regardless.
Financial Compliance in International Business
It is important to follow not just local regulations but also global regulations, assuming that your company intends to engage in international business.
Though there is no global financial standards authority, your company should comply with local rules in every country and jurisdiction that it serves. If it is not possible to do so, your company should limit or restrict its services in those countries or jurisdictions entirely.
Though all countries have different laws and regulations, those laws often are similar in a broad sense. Many countries have rules regarding KYC/AML reporting, tax reporting, financial reporting and accounting, employment practices, and trade compliance.
Some rules are intended to apply widely, even if they are not truly universal. The EU’s GDPR data protection laws apply to any company worldwide that handles the data of EU-based customers. Several major credit card companies have also created a payment card security standard called PCI DSS, which is virtually mandatory across all card services.
Benefits of Financial Compliance
Financial compliance can benefit your company in numerous ways. Here are some of the ways that your company can grow by adhering to commonplace standards.
Positive Reputation
Industry reports and rating sites continually evaluate and rate companies based on several factors, including their compliance with regulations. Engaging in proper compliance can help your company establish a strong standing in the financial industry. Having a good reputation may also reduce the severity of government action if your company violates a rule.
Increased Credibility
By complying with regulations, your company will gain credibility, which will help those outside of your organisation trust your statements and public reports. This level of trust is necessary in order to attract customers, form partnerships, maintain industry standing, and directly support the overall integrity and credibility of the financial services industry as a whole.
Customer Safety
Regulations are often designed to keep customers safe, and compliance can ensure that customers have access to their funds in the case of a company failure or an industry-wide crisis. Insurance and safeguarding regulations specifically protect customer access to funds, while other regulations help protect customer privacy and security.
Stable Practices
Financial compliance can help your company provide more stable and reliable products and services. This will help the company avoid risks and potential bankruptcy, and it will also help potential customers and clients avoid loss through investments and services.
Competitive Market
Though compliance is necessary at some level, financial companies also compete to provide the best and most compliant services. As such, your company should not do the bare minimum but should strive to provide highly compliant services to customers.
Conclusion
Financial compliance is a broad area that affects many areas of business. Though compliance is often mandatory, it is important to prioritise compliance with certain laws and regulations in order to ensure that your company operates legally and soundly.
Once your company complies with regulations at a local level, consider expanding to new markets through compliance with additional and foreign regulations and standards. It is important to consider how regulations benefit your company and customers, where and when regulations apply, and how regulations can provide benefits to your business.
Additional Resources
In order to comply with international regulations, it is important to know how to find and contact various agencies and government organisations.
For more information on financial compliance in the U.K., visit:
- The Financial Conduct Authority (FCA) website
- The Bank of England’s Prudential Regulation Authority site
- The U.K. government’s tax compliance pages
For more information in the EU, visit:
- The European Commission’s financial regulation and supervision pages
- The same organisation’s banking regulation pages
- The European Central Bank (ECB) website
- The website for GDPR, the EU’s data protection law
For more information in the U.S., visit:
- The Financial Industry Regulatory Authority (FINRA), a self-regulated organisation that is involved in U.S. financial regulation
- The U.S. Treasury and its Office of Foreign Assets Control (OFAC), which are responsible for sanctions and international restrictions on financial activity
- The Council on Foreign Relations’ background file, which details several financial agencies within the U.S., including the SEC, CFTC, Federal Reserve, and more
- The New York Department of Financial Services (NYDFS)
