Compliance with financial crime regulations is crucial for every company. As part of this compliance, it’s essential to understand the definition of Politically Exposed Persons (PEPs) to identify them and conduct additional due diligence as required by PEP KYC & Anti-Money Laundering (AML) laws.
What is a Politically Exposed Person?
A politically exposed person is an individual who holds a prominent public function, such as a government official, high-ranking military officer, or senior executive in a major state-owned enterprise. A PEP generally presents a higher risk for potential involvement in bribery or corruption through their position and influence. Close business partners or family members of PEPs are often considered connected PEPs as they could pose an AML risk as well.
Politically Exposed Person levels
PEP levels refer to the categorization of Politically Exposed Persons (PEPs) based on the level of risk they pose in terms of potential involvement in bribery or corruption through their position and influence. PEPs can be broadly classified into four levels:
- Level 1: Prominent figures representing an international body.
- Level 2: Individuals holding a position at the national level.
- Level 3: officials holding a position at the state level.
- Level 4: civil servants holding a position at the local level.
Financial institutions are required to screen for PEPs and implement adequate AML measures based on these four levels to reduce their risks and liabilities.
Why is it important to screen for PEPs?
All individuals meeting the definition of a PEP should be classified according to their risk level and screened before commencing a business relationship. Financial institutions must implement adequate PEP AML measures to reduce AML risks and liabilities.
Increased scrutiny from local and international financial regulatory authorities makes it crucial for financial institutions to protect themselves from fraud and financial crimes. Fines imposed by bodies like the Financial Action Task Force (FATF) and Financial Crimes Enforcement Network (FinCEN) for non-compliance with AML laws and regulations have reached millions of dollars, providing a strong motivation for businesses to screen for PEPs. That’s why many financial institutions often assume the “once a PEP, always a PEP” approach (ongoing PEP status), even when clients abandon their governmental or civic positions.
How to conduct PEP due diligence?
PEP due diligence is conducted based on the level of risk that each Politically Exposed Person (PEP) presents. Level 1 PEPs include those representing international bodies, while level 2 PEPs are individuals holding a position at the national level. Level 3 PEPs are officials holding a position at the state level, and level 4 PEPs are civil servants holding a position at the local level. The risk level associated with each PEP determines the extent of the due diligence required, with higher-risk PEPs requiring more thorough due diligence.
It’s important to note that the specific due diligence steps and risk assessment may vary based on the jurisdiction and regulatory requirements. Financial institutions must develop risk-based policies and procedures for the PEP due diligence process to comply with AML laws and regulations.
Generally speaking, PEP due diligence should incorporate the following aspects:
- Employ a Risk-Based Approach: The risk-based strategy provides a complete picture of a company’s high-risk customers and those situations that warrant high-risk status.
- Obtain Additional Identifying Information: Provide a questionnaire to high-risk clients tailored to the risk-based policies to gain in-depth customer knowledge and the risk they may pose.
- Analyze the Source of Funds: Under the EU’s Fourth Money Laundering Directive (MLD4), legal organizations are expected to hold up-to-date Ultimate Beneficial Owner (UBO) records in a register open to authorities and other persons of genuine interest.
- Ongoing Transactions Monitoring: Obtain transaction details, such as history, purpose, and nature, and analyze information, such as the duration of the transaction and the parties involved.
- Adverse Media Check: To build a complete customer KYC profile of your client and their reputation, you must thoroughly review related press articles and analyze relevant information. The overwhelmingly negative results strongly indicate that they are too risky for business. Businesses should take the following due diligence step if the results are positive.
- Draft Your Report for Further Review: Compile your due diligence report for internal and future regulatory reviews before onboarding.
- Develop an Ongoing Risk-Based Monitoring Strategy: Continuous high-risk client monitoring is time-consuming and requires a lot of effort, so using a risk-based monitoring strategy is optimal.
To sum up, understanding the definition of a PEP and the importance of conducting due diligence on them is critical for financial institutions to comply with AML laws and regulations. With increased scrutiny from regulatory authorities, financial institutions must implement adequate measures to reduce their risks and liabilities. By following a risk-based approach and conducting thorough due diligence, businesses can protect themselves from financial crimes and potential fines.
ComplyCube provides comprehensive AML compliance solutions, including PEP screening, to help businesses mitigate risks and ensure compliance. Contact us to learn more about our services and how we can help you safeguard your business against financial crimes.