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Uncovering PEPs in Fight Against Financial Crime

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By Rachel Woolley, Global Director of Crime at Fenergo.

Non-compliance is a costly business. Throughout 2020, financial institutions (FIs) around the globe have received $10.6 billion in enforcement actions for financial crime violations, including breaches of anti-money laundering (AML) and know your customer (KYC) regulations— up 27% from last year. With the pandemic leading to an acceleration of fraudulent activity, FIs are being urged by regulators to be ever more vigilant, particularly when it comes to adequately identifying a politically exposed person (PEP), a crucial component of KYC and AML compliance.

PEPs can trigger money laundering and corruption concerns, and therefore require an additional level of scrutiny. However, PEP management can pose many difficulties, not least relating to the accurate categorization of an individual as a PEP due to jurisdictional variances in definitions. Despite an evolution of these definitions in recent years, PEPs remain a challenge to identify.

Making headlines

Recent news highlighting financial oversight linked to PEPs have negatively impacted FIs’ reputations, with hefty fines imposed as a result of inadequate policies, processes, procedures, systems and governance. Notable examples from 2020 include the Luanda Leaks, which exposed how Africa’s richest woman exploited family ties (among other things) for two decades to build an empire. The billionaire daughter of Angola’s former president bought large stakes in banks and used them to route millions of dollars received in payments from Chinese and European contractors on construction projects in Angola.

Of course, one of the most infamous financial crime stories in recent years was the 1Malaysia Development Berhad (1MDB) scandal, which implicated Goldman Sachs in a massive corruption scheme. Off the back of the high-profile scandal, Malaysian regulators issued two of the highest value enforcement actions in 2020—a settlement with Goldman that included a US$2.5 billion penalty and the guaranteed return of US$1.4 billion in assets. Several other regulators around the world issued fines to the leading investment bank bringing the total enforcement action value to $6.8 billion. Separately, in July 2020 Deutsche Bank was fined $150 million for failing to adequately monitor its relationship with Jeffery Epstein. Though not strictly speaking politically exposed, Epstein’s relationship with high-profile political individuals would certainly meet the threshold of “known close associate”, requiring increased scrutiny by financial institutions.

So, what (or rather “who”) is a PEP, and why should FIs be vigilant when assessing the risk of doing business with one? How can they mitigate exposures to sanctions and PEP risk, and the potentially devastating cost of non-compliance?

The problematic PEP definition

The definition of a PEP varies slightly from jurisdiction to jurisdiction but is generally accepted to include individuals that hold a “prominent public function”, including presidents, prime ministers, and other senior politicians. The definition also extends to members of royal families, senior executives of state-owned entities, and heads of international organizations such as the United Nations, World Health Organisation, International Monetary Fund and the World Bank. Most jurisdictions consider individuals with the ability to direct and control government funds, or the ability to influence decisions, to be politically exposed, and thus could be susceptible to external influence, bribery, or corruption.

It is important to note that identifying an individual as a PEP is not a suggestion of previous or future criminal behavior. However, it is necessary for FIs to adequately identify individuals that not only hold prominent public functions, but also those who are considered to be closely connected to senior politicians, like family members and business associates, i.e., “known close associates”.

The purpose of identifying a PEP is to ensure the appropriate level of due diligence is applied in accordance with a risk-based approach. This is due to the public nature of the function or office held by politically exposed individuals, which naturally increases their exposure to corruption, bribery or money laundering. In determining the acceptability of higher-risk accounts, a bank should be able to obtain sufficient information to evaluate whether an individual is or is not a PEP – whether domestic or foreign.

However, there is a significant problem with the very definition of a PEP globally. In the US, it is at odds with EU standards and FATF guidance, as the US only defines foreign PEPs. In the EU, the definition of PEP was extended under the 4th AML Directive, which was enacted in 2015, to include all national/domestic PEPs and categorise them as high risk. In the US, it’s also not a regulatory requirement that would demand obliged entities to apply specific measures—which again, differs vastly from the EU approach. This disjointed approach highlights the need for regulators to strengthen cross-border collaboration and offer a single framework reflecting both foreign and domestic PEPs.

Mitigating exposures to sanctions and PEP risk

FIs should be vigilant when assessing the risk of doing business with PEPs. Extra care must be taken when determining whether an individual is a PEP, and whether their financial activity requires additional scrutiny. FIs have an obligation to identify the source of wealth as well as source of funds that belong to PEPs, which will give a sense of the kind of activity an FI could expect from that PEP throughout their relationship with the financial institution. And of course, institutions will have to keep a close eye throughout the relationship to identify any behaviour that may give rise to suspicious activity, including transactions that may be related to bribery, corruption, or money laundering.

Yet many FIs struggle to untangle complex entity hierarchy structures during onboarding due to manual, paper-based processes and operational silos. But with digital onboarding solutions incorporating graph data visualization software, financial institutions can visually map structures of companies and identify ultimate beneficial owners (UBOs), controllers and other individuals that have an interest in an entity.

This technology also helps FIs to manage PEPs and high-risk individuals more efficiently, enabling the collection of enhanced due diligence information and documentation in line with regulatory requirements.

Digitising customer verification

It has never been more important for FIs to enhance and digitalise client due diligence measures in order to identify stakeholders or UBOs who are considered to be politically exposed. Even though being a PEP is not a crime, it is critical for FIs to be alert to potential criminal financial activity when doing business with one. Knowing how to identify a PEP, or identify individuals that have close associations with one, is a crucial element of financial crime prevention and automation is key to its timely success.

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