Politically Exposed Persons: A crucial aspect of Client Due Diligence

Politically Exposed Person (PEP) has been defined by FATF as an individual who is or has been entrusted with a prominent function. To have a better understanding, FATF guidance on PEPs gave us a much wider interpretations on different types of PEPs such as Foreign PEPs as individuals who are or have been entrusted with prominent public functions by a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, important political party officials; Domestic PEPs as individuals who are or have been entrusted domestically with prominent public functions, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials; International organisation PEPs as persons who are or have been entrusted with a prominent function by an international organisation, refers to members of senior management or individuals who have been entrusted with equivalent functions, i.e. directors, deputy directors and members of the board or equivalent functions.

Stigmatizing PEPs as a high risk

The question is whether refusing to establish or continue a business relationship with a client simply because he is identified to be PEP is a good practice? The answer is an obvious NO and the same has been upheld by Financial Action task Force as well as “Refusing a business relationship with a PEP simply based on the determination that the client is a PEP is contrary to the letter and spirit of Recommendation 12”.

However, It is recognized by many global analyses and case studies that many PEPs are in positions that might be misused for the purpose of conducting money laundering (ML) and associated predicate offenses, such as corruption and bribery and terrorist financing (TF). Hence, FATF recommendations require nations to guarantee that financial institutions and designated institutions are properly regulated, and non-financial companies and professions (DNFBPs) has put in place safeguards to avoid the misappropriation of funds.

?Key factors to determine the risk level of PEPs

1)Jurisdiction

2)Nature of the PEPs position

3)Business Objectives

4)Adverse /Negative news about the PEPs

5)PEPs family and close Associates

To know if the PEP comes from a high or low risk country, whether the country falls under any sanctions, if there is any kind of instability or is there adequate checks and balances in the system is one main factor while dealing with politically exposed persons so as to determine their risk level. The influence level the PEP in question has or the nature of business goals such as what products or services does, they use/wish to use, whether the product /service comes under a medium-high risk category is yet another thing to determine. Reviewing /conducting a thorough adverse media check through some trusted sources will help in this process. Investigating into the Family and close associates of the PEPs can be a path to conduct risk scaling.

Reg Flag Behaviours

Ever wondered how PEPs facilitate fraudulent behaviours? Use of corporate vehicles without any specific /legal reasons, use of intermediaries are two methods highly followed. Now, how to keep a check on this and how to find out the same is a whole compliance level challenge every firms/service provider comes to face with.

Though the identification of red flags is being streamlined through multiple tools and products by institutions, few red flags associated with Politically Exposed Persons are:

1) unwillingness to share details about their source of wealth or source of funding

2) The information offered by PEPs is contradictory with publicly accessible trustworthy information

3) Making unwanted inquiries concerning the institution’s AML & PEP Policy and frameworks

4)Providing false, inaccurate /incomplete information

5)Moving of funds repeatedly to and from countries that too to which the person in question does not have any relation with.

6)PEPs who have been sanctioned by countries/global institutions.

7)PEPs from high-risk jurisdiction

PEP Reg Flags -Position

1) has substantial access to state assets, funds, policies, and procedures.

2) is in a position having control over licensing authorities

3) has formal or informal control over mechanisms set up to prevent and detect ML/TF

4) non-disclosure of all positions held

5) Partially owns /has control over any financial institutions or Designated Non-Financial Business or Professions either directly /indirectly

6)In a position as director/beneficial owners of a company which acts as the client of a financial institution /DNFBPs

PEP Red Flags-Product, service, Delivery channels, Transactions

1)Anonymous transactions

2)non-face-to- face business relationships /transactions

3)payments received from unknown /non-associated third parties

4)business that facilitates to high value foreign clients.

5)High end real estate dealers

6)Wire transfers

7)High risk products when used by PEPs

8)PEPs who are dealers in precious metals, stones, and other such luxurious goods.

9)Deals in luxurious transport vehicles

PEP Red Flags-Industrial sectors

When PEPSs has close connection with high-risk industries, the sector falls under high-risk category as well. Some examples of higher risk industries that are PEP red flags include:

1)Banking and Finance

2) Government procurement related business

3)Large infrastructure / big construction business

4) Health related sectors

5)Private institutions

6)Provision of public goods and utilities

?PEPs Red Flags-Geographical location

1)if the PEP is from a higher risk jurisdiction country

2)PEPs identified by credible sources as having a major risk of corruption

3PEPs from countries which has no adequate and efficient AML systems

4)PEPs from countries which has not yet ratified to the international global AML standards and Conventions.

PEP Screening

Customer onboarding is a time-consuming and difficult process for all financial institutions and especially for DNFBPs. According to the know your customer (KYC) requirements, enterprises must perform some checks during the customer onboarding process. The is facilitated by screening against the local list of the country and the United Nations Security Council Consolidates list. PEP screening is also carried out here.

So, what is PEP screening?

It is essentially the act of identifying and verifying an individual's existence on a list of Politically Exposed Persons (PEPs) to classify them as high-risk clients. Simply put, name screenings of individuals to know if they are a politically exposed person or not has also been carried out in this stage.

The main aim of PEP screening is to determine a client's ability to pose a threat or risk. This is done through few steps:

1)At the initial stage, all possible information from the client is collected.

2) The accuracy of the customer's information is verified by way of adverse checks through trusted online sources

3) Once the customer identification information has been confirmed, the level of risk associated with that customer is determined.

This allows every financial and DNFBP institutions to assess and determine the level of risk associated with each client.

Risk Based Approach and PEP screening

FATF has clearly said that a Risk-Based Approach to AML/CFT implies that governments, competent authorities, and financial institutions are required to identify, analyse, and comprehend the ML/TF risks to which they are exposed, and to implement AML/CFT measures commensurate with those risks to successfully mitigate them.

Since various PEPs have varying exposures, and each PEP category has distinct risk consequences, the senior management of every institution in question is required to make a formal decision as per the AML Policy documented prior to engaging with a PEP. Each PEP should be treated as a unique client, with his or her exposure carefully assessed. Following that, the compliance officer and risk management committee must assign the appropriate risk level as part of their overall risk-based strategy.

The components that can help in evaluating risk were identified in the Wolfsberg risk-based approach guidance, which has shed light on the methodology. Risk factor identification or indications that can allow the evaluation and measurement of the amount of risk can be described based on Wolfsberg's guidelines on a risk-based approach. The main categories listed were customer risk, products/services risk, geographical risk and industry risks.

The idea and method of RBA is very simple yet covers a wide compliance strategy.

?1) Identify the risk- identifying the risk factors associated.

?2) Assess the risk-determining the risk level

?3) Understanding the risk-mainly deals with calculating the impact of risks

?4) Mitigating the risk- devising a plan to mitigate the risk

Conclusion:

Quoting reference to ADGM AML Rulebook, the fact that a customer is a PEP does not automatically make them a high-risk customer: nevertheless, Enhanced CDD on PEPs is required. Every financial and DNFBPs should assess information associated with each PEP to determine what risk category is appropriate.?