Fraud, reporting delays and problems for passive funds

The week on, April 4–10, 2020

7 days montage 09042020

Covid-19 frazzles AI fraud systems

Seismic changes in customer behaviour see machine learning solutions throw out false positives

EU banks seek FRTB delay, citing ‘strain’ of virus

Firms want leeway to fight market mayhem, minus burden of new reporting rules

Index delays leave passive bond funds in purgatory

Moves to postpone index rebalancings could backfire as rating agencies press ahead with downgrades

COMMENTARY: The wave of fraud

Disasters of all kinds loosen the ties of society – and while this can lead to impressive outpourings of volunteer help, it can also open up opportunities for wrongdoing. (For all the memories of the Blitz Spirit in the UK, for example, crime in the UK soared 57% during the Second World War.)

The same is true of financial disaster, and the coronavirus pandemic is a financial and economic disaster as well as a human tragedy. A wave of financial crime, in particular fraud, has not yet shown up in the tables of op risk loss data, but it will. Motive and opportunity drive crime, and both have expanded as a result of the pandemic.

The systems intended to stop internal and external fraud have improved dramatically since the 2008 financial crisis, with artificial intelligence and machine learning technology now in widespread use. But the data on which these systems were trained has now, suddenly, become obsolete, compliance managers warn.

With every major economy in freefall, and billions of people under movement restrictions, spending patterns have changed beyond recognition. The massive involvement of the state in supporting business – through schemes such as the employee furlough plan in the UK – will change the shape of the economy still further. Fraud detection schemes will be swamped with waves of false positives resulting from “unusual account activity”. This creates a unique opportunity for frauds to proceed with very low chance of detection.

The motive for fraud is sometimes simple greed, but often it is the result of financial pressure – hard times increase a criminal’s need for money; turbulent markets can make it difficult for the trader to meet targets without cheating. For these reasons, previous crises have seen spikes in fraud initiation, but with the average internal fraud lasting 30 months from initiation to detection, the cost of pandemic fraud will probably only become apparent in 2022 at the earliest.

And those both inside and outside financial institutions whose job it is to stop fraud will have their own problems to deal with – they will have to wrestle with the difficulties of remote working, and will be deprived of many of the surveillance tools which covered offices and trading floors.

As the crisis continues, financial institutions may also find employee morale falling. The emergency spirit of the first few weeks of lockdown will fade, and bitterness may start to rise as bonus freezes, pay cuts and even redundancies are announced. Disgruntled employees will have a strong motive to take all they can carry on their way out, and little loyalty left to dissuade them from doing so.

Just as seriously, poor morale, uncertainty and frustration are likely to increase the rate of operational errors. In the months ahead, management at all levels will have any basic skills of leadership they possess severely tested.


Fixed income exchange-traded funds witnessed huge outflows in March as the coronavirus crisis raged, with those carrying European high-yield debt suffering the most, data from the European Securities and Markets Authority (Esma) shows. From February 19 to March 23, cumulative outflows from EU high-yield bond ETFs totalled 36% of net asset values. Outflows from US high-yield ETFs equalled 15% of NAV, and from EU and US corporate investment-grade funds 11% and 5%, respectively



“The post-2008 reform agenda focused on making prudential regulation more restrictive, reversing the ‘laissez faire’ tendency of the pre-crisis years. This time, the response of global regulators and supervisors is the exact opposite. In the US, the federal regulatory agencies have encouraged banks to use their capital and liquidity buffers; they signalled they would welcome their depletion in particular if the added margins were used to maintain or extend credit to households and businesses” – Ignazio Angeloni, former ECB board member

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