It’s pretty challenging for financial institutions to identify Politically Exposed Persons while onboarding new clients quickly. The reasons are many, including the varied definitions of PEPs, inaccurate or limited data access, and insufficient data about their relatives and close associates (RCAs). However, despite all the challenges organizations must face to identify them, failure to do so can result in high penalties or sanctions from international regulatory bodies.
So, what happens if a company does not comply with the compliance program? Well, Non-compliance in identifying the PEPs and RCA can cause significant financial setbacks for companies.
One such example is Barley Bank, which did not take the PEP due diligence process seriously and let one suspicious transaction be held under its umbrella. Due to not complying with the PEP due diligence process, the bank has to pay 72 million dollars in fines. That’s why identifying PEPs and their relatives and close associates (RCAs) is essential for financial institutions to ensure integrity and prevent corruption and other financial crimes. Here, we will explore the PEP due diligence process, its importance, and best practices for organizations’ effective implementation.
How can organizations Identify the PEPs?
PEPs are often defined as individuals who hold or have held higher-ranked government positions in the past. However, the definition isn’t just limited to them. EU AMLD also defines the relatives and close associates of PEPs as PEPs, so screening against their close associates is also compulsory for the organization. The bodies also categorize them into three different types: domestic PEPs, foreign PEPs, and International PEPs.
Example of PEPs
- Head of State (President or Prime minister)
- Higher Ranked Military Officers (ex. Chief)
- Senior Judiciary Members
- Head of International organizations (UN, UNSC, etc)
What makes them so suspicious? Before answering the question, we would like you to know that not every PEP is a criminal. However, their influence and authority make them high-risk entities susceptible to criminal activities such as corruption, bribery, money laundering, and even terror financing.
4 Mandatory steps of the PEPs Due Diligence process
- Identification
The first and foremost part of PEP due diligence is knowing the customer’s identification. As we have already said, identifying the PEPs is quite a complicated process because there is no single definition of PEPs.
Therefore, identification should be done using advanced and reliable tools that comply with AML regulations. It is recommended that the financial institution consider the Relatives and close associates of PEPs as part of PEPs.
- Verification
You identified the PEPs? That’s good. The next step you need to work on is verifying your client’s position in public office. You should ask questions. For instance, Are they higher-ranked officers, military generals, or judiciary members? Financial institutions must keep themselves updated about the PEPs’ personal information as they often hide their identities. Therefore, the verification must be done by cross-referencing information with reliable sources and using advanced technologies like AI-driven verification systems to ensure accuracy and efficiency.
- Risk Assessment
This is the most critical part of the PEP due diligence process because, at this stage, a bank’s compliance team must assess the level of risk every PEP can pose to your organization and the overall financial system. What’s the best way to determine the risk level? Identify their position and their influential power within their area and beyond the boundaries. It will help your organisation to check how powerful the entity is.
- Monitoring
Many regulatory bodies update the sanctions lists, so financial institutions must conduct continuous monitoring to detect and prevent any suspicious activity from being performed by your PEP client. The best way to achieve this is to implement robust monitoring systems that prompt red flags when any activity meets the suspicious activity.
What FATF guidelines say about PEP risk level
For financial institutions, the FATF has several guidelines on PEPs red alert. The following are some of the red flags that could indicate that the PEP is planning criminal activity.
- Hiding their ownership
Introducing some of their close family members, spouses, or children as the owners of property and assets means something dirty cooking in Pep’s mind.
- Background history
Check if the person has been involved in criminal activity in the past. Criminal activities include exploiting public assets, corruption, and money laundering.
- Reluctancy in providing detailed information.
Individuals who refuse to provide detailed information about themselves and their source of income and wealth are more likely to be at high risk.
- Source of income
What sources is the individual getting the income from? If you see someone involved in a high-risk industry like gaming, cryptocurrency, real estate, or privatization, consider it a red flag.
Organizations Required to Conduct PEP Screening
Ideally, every organization needs to screen against PEPs, but financial institutions, particularly banks and credit unions, must conduct thorough screenings of their new clients. After completing the screening process, the compliance team must adopt a risk-based approach, where if they find anyone on the list of PEPs, they consider them a threat to their organization. What if the organization does not assign a risk score to each PEP? Organizations may face hefty fines or penalties, and these regulatory bodies often fined more than 1 million dollars.
