A Politically Exposed Person (PEP) is an individual with a history of holding a significant public position. In this blog, we’ll explore the legal risks associated with PEPs and discuss effective mitigation strategies. Stay tuned for insights into managing financial risks tied to individuals in politically exposed positions.
Understanding PEP risk
FATF standards mandate Customer Due Diligence (CDD) obligations for Politically Exposed Persons (PEPs), including Direct Family Members or Associates. PEPs, classified into Domestic, Foreign, and Heads of International Organizations, pose higher risks due to their influential roles, potentially misusing power for personal gain. Related Customers, connected to PEPs, are categorized based on familial or legal ties, presenting varying risks. Financial institution must apply special procedures but consider factors like the PEP’s control, authority, access to funds, governance, and corruption levels for effective risk assessment.
Mitigating Risk
Legal requirements
Distinct requirements apply to foreign PEPs versus domestic PEPs and Heads of international organizations (HIOs).
- For Foreign PEPs, FI must implement risk management systems, secure senior management approval, ascertain source of funds and wealth, and conduct enhanced monitoring.
- Domestic PEPs and HIOs necessitate measures for identification and specific actions for high-risk relationships. FI must assess life insurance beneficiaries for PEP or Related Customer status, informing senior management before policy payout. A thorough examination of the overall business relationship is required.
Identification of PEPs
Classifying Customers as PEPs:
Classifying Customers as PEPs requires adherence to legal definitions, encompassing roles like Heads of States, senior politicians, and judicial officials. Developing risk-based policies and procedures becomes crucial for identifying PEPs, their family members, or close associates. The determination involves assessing whether the individual holds or recently held a role with significant power or influence over decisions, policies, or fund disbursal for a government or international organization.
Classifying Customers as Related Customers:
Classifying Customers as Related Customers mandates FI to treat direct family members and close associates of PEPs similarly to PEPs themselves. This includes spouses, children, spouses of children, parents, and individuals with joint ownership or close business relationships with the PEP. These relationships serve as a mandatory minimum, not an exhaustive list. FI must adopt a risk-based approach, evaluating relationships for potential exploitation of illicit funds. Once a qualifying relationship is established, the FI must treat the customer as a PEP or as owned by a PEP. However, the status of a PEP cannot be transferred to their family members or close associates.
Time Limits of PEP Status:
To mitigate risks, periodically reassess PEP status based on factors like the customer’s previous role, corruption potential, informal influence, role linkage, relationships with other PEPs, nature of the business relationship, and overall risks associated with product and service usage.
PEP Screening:
PEPs or Related Customers classified during the CDD stage before initiating a business relationship. FI must implement effective risk management systems to identify foreign PEPs or Related Customers and take measures to identify domestic PEPs, HIOs, or Related Customers. While initial screening involves questioning customers, but relying solely on their assertion is inadequate. FI should supplement this with additional due diligence and remain vigilant for inconsistencies in customer profiles. Ongoing monitoring helps track changes in a customer’s status.
PEP Risk Rating:
FIs must conduct enhanced ongoing monitoring for relationships involving foreign PEPs and Related Customers. It is crucial to accurately risk-rate all PEP customers, customers with PEP beneficial owners, and those connected to PEPs. As already mentioned, factors for PEP risk rating include the nature of the PEP’s position and the anti-corruption controls in their jurisdiction. And for Related Customers, the risk is assessed based on the connected PEP’s risk and the nature of the relationship. When a customer has PEP status from multiple sources, FIs should use the higher risk rating.
Enhanced Due Diligence Requirements:
FIs must adhere to specific steps when dealing with foreign PEPs, Related Customers, domestic PEPs, HIOs, or Related Customers in high-risk business relationships:
- Obtain senior management approval before establishing or continuing a business relationship.
- Take reasonable measures to determine the source of funds and wealth for PEPs and Related Customers.
- Conduct enhanced ongoing monitoring for the relationship.
Transaction Monitoring
FIs are obligated to conduct continuous monitoring of all transactions. This ensures alignment with customer information, their business activities, and associated risks. The monitoring encompasses the source of funds when necessary. FIs can employ both manual and automated systems, including intelligence-led monitoring. Automated solutions such as Effiya Compliance suite effectively identify unusual patterns or behavior, especially for PEP customers, indicating potential suspicious activity or changes requiring a high-risk rating.
Suspicious Transaction Reporting:
Its mandatory for Fis to submit a suspicious transaction report (STR) or suspicious activity report (SAR) to the Regulatory body. This requirement arises when there are reasonable grounds to suspect that a transaction, attempted transaction, or funds, regardless of the amount, are linked to criminal activities.
Governance and Training:
The outlined preventive measures should be embedded within a comprehensive institutional AML/CFT program tailored to the risks faced by the FI. This program should encompass robust governance structures and be fortified by ongoing training initiatives. The AML/CFT training program is crucial to heighten employee awareness of the risks associated with PEPs as customers and empower staff to apply effective risk-based controls.
Conclusion
In conclusion, effective risk management of Politically Exposed Persons (PEPs) necessitates a comprehensive and globally aligned approach, adhering to standards like those set by the Financial Action Task Force (FATF). Financial Institutions should implement robust systems, conduct thorough due diligence, and apply enhanced monitoring. Processes such as classification, screening, and risk rating are crucial for proactive risk mitigation. Governance structures and ongoing training further strengthen FIs in combating money laundering and terrorist financing. Adherence to regulatory requirements is paramount for safeguarding operations and the broader financial system.