How to navigate the increase in financial crime risks during a downturn | JD Supra


Financial crime flourishes in a downturn, and the mining & metals sector is not immune to it. The sector faces a number of industry-specific risks, and will need to react to the ensuing likely surge in enforcement activity.

Financial crime is an increasing challenge for businesses across all sectors, but with a looming recession, occurrences of corruption, bribery and fraud are likely to rise.

Anticorruption watchdog Transparency International has warned “corruption often thrives in times of crisis, particularly when institutions and oversight are weak, and public trust is low.” Meanwhile the UK’s National Crime Agency said in July 2020: “The business of corruption, it appears, is recession-proof,” adding: “As the global economy faces economic strife, further criminal activity is likely to be seen.”

A possible reason for this is because when businesses are dealing with increased financial pressures affecting profit margins and possibly ongoing viability, there are greater incentives—and in some cases active pressure—to engage in misconduct.

There may be increased temptation for individual employees to engage in improper conduct to meet certain targets, falsify reporting or market disclosures, or even exploit government subsidies or grants. Employees may also be more vulnerable to fraudulent schemes themselves.

The mining & metals sector is not immune to these risks, and faces a number of risks specific to the industry, should the expected downturn indeed give rise to increased financial crime.

Sector-specific risks

The mining & metals sector is already perceived as high-risk from a bribery and corruption perspective. It operates through highly complex supply chains, involving multiple third parties, across several often high-risk jurisdictions. Indeed, Transparency International’s latest Corruption Perceptions Index indicates that many producer countries are perceived to present considerable bribery and corruption risks for investors.

The sector relies heavily on close interactions with government officials, who hold a pivotal role throughout the entire life cycle of projects, and who approve the foreign direct investments that are critical to the industry. Managing these relationships is challenging at the best of times, and a global financial crisis is likely to exacerbate these difficulties.

The business of corruption, it appears, is recession-proof… As the global economy faces economic strife, further criminal activity is likely to be seen.

UK’s National Crime Agency, July 2020

For example, there could be increased pressure to make facilitation or “grease” payments to officials in certain parts of the world. Government officials may themselves experience increasing financial hardship and could therefore double down on requests for these types of payments which, until now, businesses have been making real progress in stamping out. Governments will likely suffer as a result of the global recession, and corporates may face increasing pressure to take this into account, which could present significant bribery and corruption risks.

All these risks are increased by the involvement of third parties in mining & metals projects, including agents and consultants liaising with governments on behalf of companies. The engagement of third parties throughout the entire supply chain exposes businesses to further bribery and corruption risks, for a number of reasons.

Complex supply chains already provide multiple friction points for wrongdoing, and increased competition and pressure to meet commercial objectives may incentivize bad behavior. Third parties may also face financial strain both professionally and personally, potentially making them more inclined to bend the rules in order to meet targets or secure certain contracts. Employees and other third parties will be under greater pressure to perform, which may in turn cause them to take greater risks.

At the same time, resources may be stretched and compliance functions not given sufficient attention, making it easier for misconduct to occur. As prices increase and costs begin to spiral, further pressure will be placed on profit margins, and compliance teams may suffer cutbacks. Certain key procedures such as due diligence carried out on third parties may therefore be neglected as a result.

Money may become harder to raise, further increasing the pressure already faced by the sector to secure sufficient investment. Mining & metals companies will be focused on securing investment, not just to survive the global recession, but also due to the climate crisis and the industry’s pivotal role in the decarbonization of the global economy.

Increased enforcement action

As well as leading to greater levels of financial crime being committed, recessions also tend to reveal ongoing crime that may have remained undetected during periods of growth. Volatile markets, commodity prices crashing, and disputes between parties brought about by financial distress create an environment in which ongoing fraud and other criminal behavior that was able to continue undisrupted during times of economic growth will finally come to light.

Enforcement agencies will also face pressure to be seen to be tackling the rise in financial crime. During periods of economic growth and prosperity prior to a recession, regulatory oversight may be more relaxed, but regulatory complacency allows harmful practices to flourish undetected.

Following the 2008 financial crisis, a swathe of white-collar crime was revealed, including market and benchmark manipulation, fraud and money laundering. There was an increase in prosecutions and calls for tighter regulation.

This wave of enforcement action continued for almost a decade, and companies accused of misconduct during turbulent economic times received greater public and media scrutiny, placing further pressure on enforcement agencies to investigate and prosecute any wrongdoing.

Reinforcing compliance frameworks

Fraud and other criminal behavior that was able to continue undisrupted during times of economic growth will finally come to light

Amid the increased risk of financial crime and regulatory scrutiny, a downturn can also give businesses an opportunity to re-evaluate their compliance frameworks, and ensure they are fit for the turbulent times ahead. Anticipation and prevention will be key to weathering the storm, and there are a number of ways in which companies can proactively enhance their compliance functions in order to better protect themselves.

Conducting regular risk assessments is a good starting point. They will help identify the risks faced by the business, and how these can be addressed.

The uncertainty of an economic downturn will mean that these risks may be in flux and change over time. Any changes to the company’s risk profile will need to be regularly communicated to the board, so that the organization’s commercial and legal objectives remain aligned. Staying on top of any changes to the organization’s risk profile will also mean that policies and procedures can be adapted as necessary, as and when new risks emerge.

Despite potential pressures on legal and compliance teams to cut costs and resources, maintaining a well-staffed compliance function should still be prioritized. Businesses will need to consider how best to allocate resources while ensuring that an adequate framework remains in place to monitor, review and enforce compliance across their entire operation.

Mining & metals sector participants will need to remain vigilant when engaging third parties or procuring services, and follow the necessary policies and internal processes. Some of these may need to be adapted for the economic climate.

For example, adequate due diligence must be carried out before entering into agreements with third parties to ensure that the organization does not increase its exposure to bribery and corruption by working with high-risk or disreputable service providers.

Particular attention will need to be paid to whether prospective third parties may be experiencing, or are likely to experience, financial distress, and whether this might incentivize them to engage in improper conduct in the business’s name or in any way that might involve the business.

Contractual protections in agreements with third parties would provide an additional layer of protection. These could include audit rights, signing a certificate of compliance, or a requirement to comply with the organization’s policies and procedures.

Once a relationship is established, all invoices and payments will still need to be closely scrutinized, and all interactions with third parties acting on behalf of the organization must be closely monitored.

Where local operations are applying for grants or subsidies, as well as bidding for public contracts, sufficient oversight of any interactions with government officials will be crucial, and compliance teams must ensure that the proper procedures for entering into these agreements are followed.

It is vital that all rules and internal procedures dealing with interactions and relationships with government bodies are clear and regularly communicated to all employees and any third parties who might act as intermediaries, so that they fully understand who to seek advice from if they come under pressure to engage in any conduct that might create liability for the business.

As well as clearly communicating policies and procedures, the importance of regular, relevant and engaging training for employees and third parties must not be underestimated. In particular, tailored sessions should be provided to those individuals whose roles expose them to greater risks of bribery and corruption, so they are better equipped to deal with risky situations as and when they arise.

Above all, businesses in the sector must take this opportunity to reinforce their compliance culture. The tone from the top must be clear—as well as pushing for growth, it must unequivocally convey that compliance remains a priority, and that any misconduct cannot be tolerated.

Despite the financial difficulties and hurdles a global downturn presents, the business’s duty to act ethically should not be compromised. While mining & metals sector participants focus on reaching their commercial objectives and remaining financially viable, the importance of communicating values and how to conduct business compliantly should not be forgotten.



Read More: How to navigate the increase in financial crime risks during a downturn | JD Supra

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