kyc

The idea of understanding your client(s) should be a commonplace practice for most companies and other work systems. It will help enhance your reliability and strengthen your prominence within your respective field. There’s a specific name for this kind of concept and it is called ‘KYC.’ While it is an overall unpopular phrase in the public consciousness, it actually plays an incredibly significant role in all industries that are business-oriented.

What does it mean?

KYC stands for ‘Know Your Client’ and it is a standard form that is recognized throughout the investment industry. It guarantees that investment advisors know detailed information regarding their client’s risk tolerance, knowledge in investments, and financial position.

Before we continue, here is a brief explanation of what exactly ‘risk tolerance’ is. Risk tolerance is typically defined as the general degree of ‘variability’ (the extent to which data sets diverge from the average value) in investment returns that an investor is willing to endure. Basically, it is a very important element when it comes to investing.

What KYC rules do is that they protect both the clients and the investment. The clients are protected by way of having their investment advisor understand which of the investments is the right fit for their personal situations. Likewise, the investment advisors are protected by knowing what they are permitted to include in the client’s portfolio and also what they cannot include.

In July of 2012, two rules were implemented that collectively cover this specific topic:

  1. Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer)
  2. FINRA Rule 2111 (Suitability)

These rules were put in place as a means to protect the broker-dealer, as well as the customer. This way, brokers and firms can deal with clients in a fair manner.

kyc

KYC Rule 2090

The Know Your Customer Rule 2090 states that each and every broker-dealer should utilize an acceptable amount of effort when opening and maintaining accounts. It is a requirement to understand the crucial facts of each customer and also keep records of them. In addition, they will need to identify each individual who has the authority to act on behalf of the customer.

Moreover, the KYC rule is a vital component at the beginning of a customer-broker relationship because it will establish the essential facts of each customer preceding the declaration of any recommendations. Those “essential facts” are unequivocally needed in order to effectively service the customer’s account and to also be aware of any particular handling instructions for said account.

On top of that, the broker-dealer needs to be acquainted with each person who has the authority to act on behalf of the customer, and additionally, the broker-dealer will have to adhere to all of the laws, regulations, and rules built into the securities industry.

Rule 2111

From here, we can transition into further explaining the aforementioned ‘suitability rule.’ As it is found in the FINRA Rules of Fair Practices, Rule 2111 goes alongside the conventional KYC rule and covers the subject pertaining to making recommendations. The suitability rule notes that a broker-dealer must have valid footing when making a proposition that is suitable for a customer derived from the client’s needs and situation finance-wise.

This huge responsibility basically means that the broker-dealer has conducted a complete review of the ongoing facts and profile of the customer, which includes the customer’s other securities before ultimately making a purchase, a sale, or an exchange of security.

Customer Profiles

When it comes to the establishment of a customer’s profile, investment advisors and firms are wholly responsible for knowing about and understanding each customer’s financial situation by researching and gathering information about the client, such as their age, other investments, tax status, financial wants, past experiences in investments, investment time horizon, needs pertaining to liquidity, and the previously discussed risk tolerance.

The SEC (U.S. Securities and Exchange Commission) states that a new customer must provide detailed financial information that includes their name, date of birth, address, their status of employment, annual income, net worth, and any investment objectives and identification numbers before setting up and opening an account.

How the procedures go

A good number of financial institutions will begin their KYC practices by simply collecting basic data about their customers while also (ideally) using electronic identity verification. Pieces of this information can be very beneficial when determining whether or not an individual is involved in a financial crime.

As soon as this basic information is collected, banks will compare it to lists of individuals that are widely known for being involved with corruption, on a list of sanctions, suspected of playing a part in a crime, or at high risk of partaking in bribery or money laundering. Financial institutions will additionally look into lists of Politically Exposed Persons (PEPs).

From this point, the bank then measures how much of a risk their client is and how likely they are to become involved in illegal activities. Once this calculation has been made, the bank can make a theoretical framework of what that client’s account should eventually look like in the near future. Once the expected trajectory of the account has been established, the bank can then frequently monitor the client’s account activity and ensure that nothing appears to be out of the ordinary.

Conducting this process for one person additionally enables financial institutions to compare that particular client’s profile to those belonging to their peers. If a bank has two clients that have similar occupations and backgrounds, and they are also known for connecting in their respective fields, it is to be expected that their accounts will end up resembling each other.

Conclusion

In recent years, the KYC form has not only received a lot of support from banks and companies, but it has also become common practice for credit companies and banking institutions. While it is a lesser known term outside of this industry, it holds a great amount of importance for those who utilize it.

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