Understanding the Five Types of Customer Due Diligence

Introduction to CDD, AML, and KYC

In the realm of customer identification and risk management, Customer Due Diligence (CDD), Anti-Money Laundering (AML), and Know Your Customer (KYC) are critical concepts. CDD focuses on assessing a customer's identity, AML aims to prevent money laundering, and KYC encompasses the overall process of understanding your customer. These concepts are vital for businesses in regulated industries to manage risks effectively and comply with legal requirements.

What is Customer Due Diligence (CDD)?

Customer Due Diligence (CDD) refers to verifying and authenticating a client’s identity and evaluating the potential risks they may pose in business relationships. CDD procedures are initiated before institutions provide client services and may be conducted periodically throughout the client’s relationship. The primary objective of CDD is to prevent financial crimes such as money laundering and identity theft.

Types of Customer Due Diligence

Financial institutions employ five types of CDD procedures based on initial client risk assessments:

1. Standard CDD

Standard CDD is applied to clients who present no significant risks based on initial assessments. It requires the collection of personally identifiable information about the client, beneficial owners, and any individuals authorized to act on behalf of the client. The required information includes:

- Full names

- Dates of birth

- Relationship to the client (for authorized persons)

- Business and home addresses

- Designation of the proposed business relationship

- Any data required by applicable regulations

Institutions can consult the guidelines set forth in Australia’s 2006 Anti-Money Laundering and Counter-Terrorism Financing Act for best practices in initial assessments and information verification.

2. Simplified CDD

Simplified CDD is generally applied to clients with established obligations to transparency and public disclosure, such as government entities, local authorities, and public service agencies. The AML/CFT Act Section 18(2) provides a list of qualified client types for reference. Simplified CDD requires institutions to:

- Confirm that the client meets the criteria for simplified CDD

- Identify the nature and purpose of the proposed business relationship

- Identify all authorized parties associated with the client entity

3. Enhanced CDD

Enhanced CDD is necessary for clients identified as high risk for financial crimes. Typical high-risk triggers include:

- Clients with trusts or other financial instruments containing personal assets

- Clients owning or controlling companies with nominee shareholders

- Politically exposed persons (PEPs)

- Non-residents in the country where the financial institution is headquartered, with citizenship or permanent residency in a country with minimal or ineffective anti-money laundering and anti-terrorism financing laws

For enhanced CDD, institutions should gather all information required by standard CDD procedures and provide a detailed exposition of the client’s sources of wealth and funds. Records must indicate that reasonable steps were taken to verify all claims regarding the sources of funds.

4. Delayed CDD

While financial institutions generally cannot commence work for clients before satisfying CDD requirements, exceptions exist for work essential to preventing the interruption of ongoing business operations. These exceptions apply only to low-risk clients. Delayed CDD requires:

- Completion of Know Your Customer (KYC) requirements

- Identity verification to be completed as soon as reasonably possible

- Immediate cessation of work and reporting of suspicious findings if the client does not meet verification requirements

5. Ongoing CDD

Ongoing CDD should be practised with all clients at intervals based on their risk status. For low-risk clients, CDD confirmation should occur annually. For medium to high-risk clients, the process should be conducted every six months. Additionally, CDD procedures should be applied whenever significant changes occur in the existing business relationship.

Understanding and implementing these CDD procedures are crucial for mitigating risks and ensuring compliance with regulatory requirements.

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By Anand Rajpurohit