AML Compliance and the Risk-Based Approach: Practical Guidance for Cyprus Financial Firms
Table of Contents
Introduction
Category: AML & Compliance
In the Cypriot financial institutions, from Cyprus Investment Firms (CIFs) to Crypto-Asset Service Providers (CASPs), auditors, and lawyers, the environment is fashioned by the EU directives, circulars issued by CySEC, requirements set forth by ICPAC regarding AML, and FATF standards. All these frameworks embrace the risk-based approach (RBA) in principle, a maxim that requires firms' AML compliance measures to be commensurate with the particular risks that they face.
The RBA recognizes that risks differ according to client profile, nature of the business, geography, or modes of delivery, in contrast to the compliance model where, in the past, a one-size-fits-all approach to compliance was simply applied. Hence, the embedding of RBA means Cyprus firms not only comply with their regulators' expectations under law but also utilize their compliance resources more effectively.
In this article, we shall consider the regulatory environment, the impediments to the industry, and will offer practical guidance for firms attempting to implement RBA as a compliance strategy for AML.
The Risk-Based Approach in AML Compliance
The risk-based approach operates on the general principle that firms will identify, analyze, and reduce AML risks to the extent that reflects the actual risks themselves. Therefore, instead of accepting that uniform checks are applied to all clients, firms should:
- Classify customers into risk categories (low, medium, high).
- Apply varying due diligence measures depending on the risks.
- Use ongoing monitoring appropriate to actual customer behavior.
For example, a new retail customer buying locally and with low value will be subject only to simplified due diligence, whereas a PEP or high-net-worth international client will be subject to enhanced monitoring.
The RBA model was internationally endorsed by the FATF and adopted in EU directives. Hence, AML compliance in Cyprus is primarily based on the RBA.
EU and Cyprus Regulatory Context
EU Framework: AMLD 6 and the FATF Standards
The 6th AML Directive mandates the implementation of the allegedly stronger AML systems by each member State, with the major provisions including:
- Widening money laundering offenses.
- Senior management being held criminally responsible for compliance failure.
- Augmented cooperation amongst the different jurisdictions in the EU.
The recommendations by FATF strengthen the RBA as an international standard, obliging firms to assign their resources appropriately in areas which show higher risk, instead of treating all scenarios the same.
Supervisory Bodies in Cyprus
The competent authorities that supervise AML compliance in Cyprus are:
CySEC: Cyprus Securities and Exchange Commission supervises CIFs, CASPs, and investment funds.
- Central Bank of Cyprus (CBC): Credit institutions and payment firms.
- ICPAC: Regulates accountants and auditors.
- Cyprus Bar Association (CBA): Ensure lawyers comply with AML obligations.
Each body issues directives, circulars, and enforcement actions that direct firms as to how they should apply the risk-based approach in practice.
Industry Challenges in Applying the RBA
Due to their importance, Cyprus-based firms encounter the following impediments to effective implementation of RBA:
1. Complexity of Risk Assessments
Many firms are in trouble trying to draw up risk-scoring models that satisfy regulatory requirements and, at the same time, are manageable operationally.
2. Changing Risks of Fintech and Crypto
CASPs have particular challenges with the detection of suspicious activities during remote onboarding and in cross-border transfers.
3. Resource Constraints
Smaller firms may lack human resources and work with RegTech tools that enable continuous monitoring.
4. Overlapping Frameworks
AMLD 6, MiFID II, and MiCAR impose overlapping obligations, yet compliance officers have to somehow consolidate all these requirements.
These problems point to the need of AML training, so that practitioners remain up-to-date and can apply the RBA uniformly across their organizations.
Practical Guidance for Cyprus Financial Firms
For AML compliance to gain maturity in Cyprus, the RBA has to be embedded in everyday operations of companies. Practical actions include:
Customer Risk Assessment
- Create a risk scoring system for clients based on geography, occupation, transaction patterns, and delivery channels.
- Apply simplified due diligence (SDD) on those customers who have been determined as low risk, local clients with transparent income, etc.
- Apply enhanced due diligence (EDD) to fill in the higher-risk categories, including PEPs, offshore structures, and clients from high-risk jurisdictions.
Transaction Monitoring
- Put in place automated systems for monitoring and alerting about suspicious activity.
- Set procedures to manually review transactions exceeding the set threshold.
- Periodically review the customer profiles to detect any alteration in risk.
Due Diligence
Given their high-risk category, cases will have to undergo more stringent checks:
- PEPs from the EU and UN sanctions lists.
- Verification of source of wealth for high-value transactions.
- An independent verification of documentation, particularly for cross-border clients.
Remote Onboarding and Digital Risks
As remote onboarding becomes a great practice with more and more firms, the RBA surely must evolve as well to the digital channel and:
- Use biometric verification and video KYC tools.
- Use AI fraud detection tools.
- Monitor newly onboarded digital clients continuously for legitimacy.
Supervisory Expectations and Case Examples
The regulators in Cyprus want companies to implement the RBA consistently. The recent actions against enforcement show what can go wrong:
• Case Study 1 – CIF fined by CySEC
The CIF was penalized for treating all clients in a uniform manner, without imposing enhanced checks for high risk categories.
Lesson: In conducting due diligence, firms must take into account the level of risk posed by their clients.
• Case Study 2 – Crypto firm onboarding failures
The CASP failed to detect the use of falsified IDs during remote onboarding.
Lesson: Fraudulent use of digital channels remains a risk and must be countered with enhanced verification tools.
• Case Study 3 – Audit firm negligence
The accounting firm disregarded warning signs about client transactions, thus ICAP had to intervene.
Lesson: The monitoring of KYC should be as rigorous as the initial KYC checks.
These sets of cases illustrate that regulators anticipate a documentable risk-based framework supported by trained personnel, all being regularly reviewed.
Conclusion
The risk-based approach is no longer an alternative approach—Cyprus has longstanding with it for AML compliance. In so doing, companies should classify customers and perform due diligence fore and aft, depending on perceived risk, and protect themselves with the technology at hand from incursion of regulatory penalties and damage to reputation.
Effective application of the RBA, on the contrary, requires continuous training and practical advice. Compliance officers, AML officers, auditors, and attorneys need to always keep updated with the latest developments related to EU directives, CySEC expectations, and FATF standards to maintain a compliant environment.
Centre 8 offers AML Compliance Training on the Risk-Based Approach, equipping professionals with useful tools, real-life case studies, and regulatory insights to enhance their AML systems. Enroll today to ensure your firm meets supervisory expectations and stays ahead of financial crime risks.
References
- EU AML Directives – eur-lex.europa.eu
- FATF Recommendations – fatf-gafi.org
- CySEC AML Guidance – cysec.gov.cy
- ICPAC AML Directives – icpac.org.cy
- Central Bank of Cyprus AML – centralbank.cy
- Cyprus Bar Association AML – cba.org.cy
- MONEYVAL Evaluations – moneyval.coe.int