The Importance of Enhanced Due Diligence for Politically Exposed Persons

Fines for financial institutions that effectively safeguard against money laundering are on the rise. While the Covid-19 pandemic paused some of these increases as businesses switched to hybrid and fully-remote frameworks, the evolution of a “new normal” that sees firms find their economic footing once again has led to an increased regulatory focus on money laundering efforts.

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One key area of interest is politically exposed persons (PEPs). These PEPs are often people in positions of power, their close associates, or even their family members. As a result of their situation, PEPs may have access to resources typically unavailable to ordinary citizens; abuse of these resources could lead to substantial money laundering volumes or lay the foundation for other financial crimes.

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To reduce this risk, financial institutions are well-served by carrying out enhanced due diligence (EDD) efforts to identify potential issues before they arise and ensure that PEP transactions are closely monitored. To take this a step further, businesses can leverage shared risk assessments to identify fraudsters before onboarding.

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But what exactly is EDD, and how does it work? How do companies identify PEPs, and what steps should they take to ensure they’re effectively managing these high-risk clients? 

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This piece will tackle the basics of EDD and PEPs, offer checklists and examples to help build out your due diligence efforts, and provide some best practice guidelines to reduce your total risk.

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Enhanced Due Diligence for PEPs: An Overview

Put simply, PEPs represent a higher than average risk for money laundering. While an ordinary commercial or enterprise client might have access to substantial amounts of money that could be laundered, financial firms can investigate their business history to determine their overall risk and make transaction decisions.

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When it comes to PEPs, meanwhile, it’s more difficult to gauge their overall risk. For example, some politicians may have limited history in power or large extended families with ties to organized crime. What’s more, PEPs are often exposed to additional risk sources such as bribes or “donations” from donors with criminal histories — histories that may be unknown even to PEPs themselves.

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EDD offers a more robust customer assessment framework to help determine the overall risk presented by PEPs and help companies make informed decisions about account openings, monetary transfers, and investment opportunities.

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What is Enhanced Due Diligence (EDD)?

EDD is a more in-depth form of customer due diligence (CDD), which is part of the CDD Rule of the Bank Secrecy Act (BSA) and falls under the broader purview of anti-money laundering (AML) efforts. The CDD rule is designed to “improve financial transparency and prevent criminals and terrorists from misusing companies to disguise their illicit activities and their ill-gotten gains.”

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The CDD rule requires companies to create policies and procedures capable of:

• Verifying the identity of customers
• Verifying the identity of beneficial owners of companies opening accounts
• Understanding the nature and purpose of customer relationships to develop risk profiles
• Conducting regular monitoring to help identify and report suspicious behavior

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EDD efforts leverage this framework and add additional levels of verification and confirmation to assess the risk presented by PEPs. Enhanced due diligence efforts typically address risk factors in three key areas:

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Customer Data

This data includes the current role of potential customers in political parties or their relationship to PEPs, along with any business activities — such as cash-intensive operations — that could increase money laundering risk.

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Geographic Location

Different countries pose different money laundering risks. For example, some may lack robust AML laws, while others may be at high risk of political corruption or may be blacklisted for terrorist financing.

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Banking Activity

If PEPs use high-revenue private banks with minimal transparency, there’s a natural increase in money laundering risk as your organization has limited insight into current transactions.

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The Enhanced Due Diligence Checklist

So what does an effective EDD program look like? 

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While there’s no standardized framework for developing and deploying EDD, standard components are worth including in any EDD program. Use our EDD checklist to get started.

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• Are you employing a risk-based approach? Establishing risk levels is key to effective EDD. However, unlike CDD, risk tolerance for PEP EDDs must be lower given the potentially high volume and value of illicit transactions. 

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• Have you obtained additional identifying information? The more information you can obtain from PEPs, the better. This includes personal and business data, information about their current political role, responsibilities, and connections to politically-connected companies or banks within their country.

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• How will you monitor ongoing transactions? Effective EDD includes both up-front assessment and ongoing transactions evaluation to determine any change in risk level. In practice, this means creating a framework that lays out regular assessment timelines and in-depth record keeping.

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• What steps will you take to create a culture of compliance? Employee training is critical to ensure staff are all following EDD procedures. It’s also worth investing in robust identity verification solutions to streamline this process and provide staff time to follow up on critical details. 

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What is a Politically Exposed Person (PEP)?

According to the Financial Action Task Force (FATF), a politically exposed person “is an individual who is or has been entrusted with a prominent function.” 

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Because of their prominent public role, they’re naturally more susceptible to potential money laundering or other criminal efforts — even if they have no intention of engaging in this type of activity. 

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This is partly because criminals may use processes such as legitimate donations to launder money, possibly because close friends and family of the PEP may use their connection with the person to conduct illegal activity without the knowledge of the PEP themselves.

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There are four broad categories of PEPs:

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PEPs in government - These include current and former government members, such as those in legislative roles, serving on executive or judiciary bodies, or who manage state-owned businesses.

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PEPs in business or industry - These PEPs include high-ranking members of central bank authorities, the armed forces, and internationally-recognized bodies, such as global sporting organizations.

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PEPs as close associates - Close associates include those who have business relationships with PEPs, such as joint ownership of a company or who run a business set up for the sole benefit of the PEP.

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Family members - Family members include spouses, parents, children, siblings, uncles, aunts, and in-laws. In effect, anyone who might have regular access to a PEP and their resources. 

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Politically Exposed Persons Examples

Still not sure exactly how qualifies as a PEP? Consider these examples.

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First is a current member of a country’s leading political party. They neatly fit the definition of a PEP because they have a high public profile and access to resources that could potentially be used for money laundering or other illicit activities.

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Next is a former government member who now serves on the board of a private company. While the company itself may not pose a risk, if the person still has strong ties to current members of government, they may be considered a PEP by extension.

Immediate family members are also considered PEPs, but this risk additionally extends to indirect family members who may have access to the PEP themselves. For example, the brother-in-law of a current member of Congress would be considered a PEP given their proximity to power and potential resources. 

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Why Do You Need to Pinpoint PEPs?

Pinpointing PEPs is critical to reducing total risk. Given the broad nature of potential PEPs, businesses often discover that the risk extends far beyond a member of industry or government to a host of current and former associates in addition to immediate and more extended family members.

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While this increased risk doesn’t mean PEP transaction requests should be refused out of hand, it does require EDD to ensure that businesses have made every effort to identify possible routes of compromise or criminal activity. By pinpointing PEPs, conducting EDD, and ensuring that all findings are documented, financial firms can protect themselves from non-compliance fines or sanctions.

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PEP Screening Best Practices

PEP screening best practices focus on reducing risk by increasing the amount of data businesses have available to make decisions regarding new accounts, large transactions, and possible investments.

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First up? Obtaining as much information as possible about PEPs. This includes their full name, date of birth, country of residence, and any roles that could be considered politically exposed, along with the date they left any posts of influence.

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Next, firms must assess the broader network of PEPs extending from the initial PEP themselves — such as associates and family members — and obtain as much information as possible about these individuals and their financial histories.

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Finally, it’s important to regularly consult available PEP lists and lists of countries with the highest money laundering rates and FATF blacklists and greylists. Worth noting? These lists are not comprehensive and may not be current. While they’re a good starting point, companies must use multiple avenues of identity and transaction evaluation to determine the overall risk presented by PEPs.

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Final Thoughts: Why EDD is Critical for PEPs

EDD is critical for PEPs as a way to comply with AML and BSA regulations while reducing total risk. By creating and deploying a robust EDD framework, firms can assess new accounts and transaction requests with confidence and can ensure that even in the event of unexpected criminal activity, they’ve met compliance and regulatory obligations.

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Given the continually changing nature of the political landscape, however, companies need to create EDD and PEP screening programs that provide avenues for the regular reassessment of individuals, their resources, and their connections to politically exposed persons in order to be continuously protected.

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