Article Preview – ‘Sigma Ratings: Adapting the Credit Rating Agency Model for the Anti-Money Laundering World’

In today’s post we will preview an article by this author that is due to be published soon in the Journal of Money Laundering Control. The article is available in its pre-published format here. In this post we will review the underlying premise of the article, and present the target of the article which is a new venture in the anti-money laundering arena – Sigma Ratings.

The article aims to introduce the new venture to the literature and examine its potential against the backdrop of the anti-money laundering (AML) arena, and also against the experiences of its model-sharing cousins, the credit rating agencies. For clarity, Sigma Ratings is essentially a mixture of the two worlds and seeks to bring the credit rating model into the AML arena, with the hope being that the agency will enable the world to ‘transact with confidence’. To achieve this aim, the article presents a number of different contexts. The first context presented is that of the AML world and some of the competing theoretical pressures that underpin it. This is followed by an analysis of the banking arena and its importance to the concept of AML, before the article concludes by introducing Sigma Ratings and then discussing some of its potential strengths and weaknesses.

Money laundering is contextualised genealogically at first. We see that the concept of money laundering is a long-existing one, but efforts to formally combat it emanated from the 1980s and the spread of drugs around the global system. The links between money laundering and organised crime are analysed closely, because as one scholar notes, ‘money laundering has become instrumental in both the success and collapse of organised crime’. This is emphasised by the statistical notion that estimates suggest that the money laundering industry is the world’s third-largest industry behind oil and agriculture, which demonstrates the societal importance of affecting this particular sector. In attempting to understand the theoretical underpinnings of money laundering, we see that there are a number of competing pressures that influence the development of AML efforts, including political, economic, and legal-based concerns. In utilising the systems theory lens, it is discussed that these competing pressures produce inefficiencies that are systemic to the AML effort – the reasoning for this is, potentially, that the systemic nature of AML is not properly considered by those who can affect the regime, and the result is that many initiatives tend to focus on the symptom rather than the cause.

This concept is examined from within the context of banking. We start by seeing that banking is widely recognised as being one of the crucial ‘pinch-points’ for money laundering and, thus, the global AML effort. However, the dynamics of banking in general, and in ‘correspondent banking’ in particular, are advanced to show that there are a massive number of pressures on the banking system when AML is considered. It is suggested by scholars that banks were ‘unwillingly recruited’ into the AML regime and that this is based on a number of aspects. Those aspects are discussed in the article and range from the increased cost of participating in the regime, particularly when placed against the lack of opportunity to derive profit from the expense. It is discussed that there have been attempts to correct this imbalance, most notably with the invention of ‘Financial Inclusion’ (FI), which aims to open previously untapped markets to the banks as a sort of quid-pro-quo for their AML efforts. FI includes categories such as low-income individuals, rural sectors, or undocumented groups, but a large amount of the focus is in developing countries. However, the aims of tempting banks into FI as some sort of reward for increased AML compliance have not come to fruition, with it being suggested that there exists a massive fear of dealing with entities from other jurisdictions when their practices are not fully vetted – this is the issue with ‘correspondent banking’ and is one of the main issues that underlies some of the headline-grabbing stories of massive banking penalties for AML failures for institutions such as HSBC and BNP Paribas.

It is within this gap that Sigma Ratings, potentially, is best suited. The article introduces Sigma Ratings to the literature and some of the declarations form the new company are assessed. The agency declares that they are different to the recognised ‘Big Three’ rating agencies in that Sigma rate entity-level ‘non-credit’ risks such as financial crime compliance and governance. Sigma is championing its usage of ‘deep domain expertise and cutting-edge computer science’ in order to generate a number of risk scores for companies around the world. One of the founders of the company – Stuart Jones – describes the company as the world’s first ‘business integrity rating agency’, which is particularly apt and contextualises the new offering nicely. The agency’s internal processes are discussed and we see that they have a simple rating system akin to that of the rating agencies – these simplistic rating scales are one of the key selling points in the rating arena – and a prescribed system for coming to a rating decision. The article goes on to discuss that, because of the agency’s adoption of the infamous ‘issuer-pays’ remuneration model, there exists a potential conflict of interest, but the article advances the notion that this may not be as prevalent as in the credit rating industry because regulators may be one of the key users of Sigma’s ratings, more so than in the credit rating industry. However, there still exists the potential of rating inflation, and this is something the article focuses upon and warns against. We see that Barclays have been involved in the funding of this new addition, and that this is not surprising given the potential importance to the banking industry via the concept of ‘signalling’ – the ability to convey to external bodies like investors but, more importantly, regulators, will be a key selling point to Sigma Ratings and the products that it develops.

The article concludes with a positive sentiment in that the new offering is particularly welcome and, if it continues to develop, will be of great benefit to the AML system. There are potential issues if the agency grows, but these can be off-set (or, maybe they will not be). Nevertheless, the agency is a welcome addition to the field of AML and will hopefully inject useful information into a system that needs clarity and, in a lot of cases, some simplicity. The ability to ‘signal’ to a number of entities should make the banking process, especially where money laundering and the fight against it is concerned, much more efficient and, therefore, potentially more systemically positive than it currently is. There is a widespread understanding that more is needed from the global AML effort and this offering that Sigma represents may be a positive addition on that regard.

Keyword – Sigma Ratings, Money Laundering, AML, Banking, @finregmatters