The fight against money laundering and terrorist financing requires a united front, with financial institutions and large corporations playing a critical role. One key weapon in this arsenal? Politically Exposed Persons (PEP) screening.
PEP screening identifies individuals with prominent public positions or close ties to them, who may be exposed to a higher risk of bribery, corruption, and other financial crimes due to their influence. For institutions subject to anti-money laundering (AML) regulations, screening PEPs is an essential part of a robust risk management strategy.
While there’s no universally accepted method for PEP screening, it remains an integral part of KYC and AML compliance regulations. Globally, an estimated $800 billion to $2 trillion is believed to be laundered annually.
What is a PEP?
PEP stands for Politically Exposed Person. These are individuals with significant political power, like government officials or their close associates. Due to their influence, they’re considered high-risk for corruption and money laundering.
Let’s consider an example. Imagine a bank considering a loan application from a local politician. Before approving it, they’d run a PEP screening. This checks the applicant against databases of PEPs and sanctioned individuals to identify any red flags.
Types of PEPs:
The FATF (Financial Action Task Force) outlines three most common and crucial for financial institutions to screen for:
· Domestic PEPs: These are individuals holding or who have held prominent public functions within their home country. This includes high-ranking government officials (ministers, heads of state), members of parliament, and senior military or judiciary officials.
· Foreign PEPs: This category focuses on prominent individuals from other countries. They hold or have held positions like heads of state or government, senior foreign government officials, or directors of state-owned corporations.
· International Organization PEPs: This group includes individuals who hold or have held prominent positions in international organizations like the United Nations, World Bank, or International Olympic Committee.
Additionally, family members and known close associates of PEPs can also be considered high-risk. Financial institutions may need to screen these individuals as well, depending on the specific circumstances and risk assessment.
Understanding PEP Screening
PEP screening involves the systematic assessment of clients and counterparties to identify whether they are politically exposed. This process typically occurs during customer due diligence (CDD) and ongoing monitoring procedures. Here’s an overview of how PEP screening works:
1. Identification: Financial institutions employ sophisticated tools and databases to identify individuals who meet the criteria of PEPs. These databases compile information on government officials, politicians, and their associates from various credible sources, including regulatory authorities, international organizations, and public records.
2. Risk Assessment: Once potential PEPs are identified, institutions assess the level of risk associated with the relationship. Factors such as the individual’s role, jurisdictional risk, and source of wealth are taken into account to determine the extent of due diligence required.
3. Enhanced Due Diligence (EDD): In cases where PEPs are identified, enhanced due diligence measures are applied. This may include obtaining additional information about the source of funds, scrutinizing transactions more closely, and conducting periodic reviews of the client relationship.
4. Ongoing Monitoring: PEP screening is not a one-time process; it requires continuous monitoring of client profiles to detect any changes in their PEP status or risk profile. Regular updates from PEP databases and adverse media monitoring help institutions stay abreast of any developments that may impact the risk associated with PEP relationships.
Is PEP Screening Mandated by Law and Who Needs to Screen for PEPs?
As stated earlier, though there are no universally prescribed regulations specifically for PEP screening, Anti-Money Laundering (AML) and Know Your Customer (KYC) compliance standards necessitate a risk-based approach toward assessing potential clients. Organizations are mandated to adopt “reasonable measures” to gauge the risk level posed by a client. This determination should be outlined within the organization’s internal policies to avert potential penalties for regulatory noncompliance.
Efforts aimed at mitigating the risks associated with PEPs should primarily focus on prevention. This entails not automatically declining business dealings with these individuals but instead employing a risk-based strategy. This strategy may involve conducting thorough customer due diligence (CDD) to gain a comprehensive understanding of the associated risks and to effectively lower them.
Any financial institution that is subject to AML regulations, including banks and credit unions, will need to screen for PEPs.
Why PEP Screening is Crucial in AML Compliance
· Risk Mitigation: Politically exposed persons (PEPs) are considered higher-risk customers due to their potential susceptibility to corruption, bribery, and money laundering. By screening for PEPs, financial institutions and regulated entities can identify and mitigate the elevated risks associated with these individuals and their close associates.
· Regulatory Requirements: Many jurisdictions mandate PEP screening as part of broader AML and know your customer (KYC) obligations. Regulatory authorities expect institutions to implement measures to prevent money laundering and terrorist financing, and screening for PEPs is often a specific requirement outlined in AML regulations.
· Enhanced Due Diligence (EDD): PEP screening is a component of enhanced due diligence (EDD) procedures, which are triggered for higher-risk customers, including PEPs. Conducting thorough PEP screening allows institutions to gather additional information about these individuals, their sources of wealth, and their business activities, enabling more informed risk assessments.
· Reputational Risk Management: Engaging in financial transactions with PEPs without adequate scrutiny can expose institutions to reputational damage. By screening for PEPs and implementing appropriate risk management measures, institutions can protect their reputation and maintain trust with customers, regulators, and other stakeholders.
· Promoting Transparency: PEP screening enhances transparency within financial institutions by providing clarity regarding the individuals with whom they are conducting business. By identifying politically exposed persons (PEPs) and conducting thorough due diligence on their transactions, institutions promote transparency in their operations. This transparency not only helps prevent financial crime but also fosters trust among stakeholders, including customers, investors, and regulatory authorities.
Consequences of Neglecting PEP Screening
Neglecting PEP (Politically Exposed Persons) screening can lead to significant legal and reputational repercussions for businesses, especially those in the financial sector. Here are some examples and consequences of such neglect:
· Legal and Financial Penalties: Organizations that fail to perform adequate PEP screening may face substantial fines. For instance, in 2021, AmBank, a major Malaysian bank, agreed to pay $700 million to the Malaysian government for its role in the 1MDB scandal, which involved corrupt payments facilitated through PEPs. Additionally, the Financial Crimes Enforcement Network (FinCEN) imposed a $390 million fine on Capital One for violations related to inadequate AML (Anti-Money Laundering) programs and PEP screening failures (KYC Hub).
· Increased Risk of Financial Crime: Without proper PEP screening, organizations are at a higher risk of engaging in business relationships with individuals involved in money laundering, corruption, or terrorism financing. PEPs, due to their influential positions, are often targeted by entities looking to launder money or conduct other illicit activities.
· Reputational Damage: Associations with politically exposed persons involved in illegal activities can tarnish a company’s reputation severely. This can deter customers and potential business partners, impacting the business negatively in the long term.
· Regulatory Non-Compliance: Regulatory bodies worldwide require adherence to strict AML and KYC (Know Your Customer) protocols, including PEP screening. Failure to comply can result in sanctions and legal challenges, complicating operations and resulting in additional costs.
Conclusion
Failing to screen for PEPs (Politically Exposed Persons) is a gamble your institution can’t afford. It opens the door to financial losses, reputational damage, and regulatory fines. Prioritizing PEP screening protects you by identifying high-risk individuals linked to potential corruption and money laundering. This allows you to focus resources on deeper due diligence for PEPs, taking a proactive stance against financial crime before it happens.
Modern technology is a game-changer for PEP screening. Powerful databases offer comprehensive lists of PEPs from around the globe. These databases can also combine checks against sanction lists, giving you a complete picture. Automated screening minimizes errors and streamlines the process, making it more efficient. With a single international PEP list impractical, as highlighted by the World Bank, advanced screening tools are the most effective weapon. Choose a robust PEP screening solution and join the fight against financial crime — it’s a win for your business and the global financial system.
IDcentral’s Solution for PEP Screening
IDcentral assists in PEP screening by verifying customer names against a specialized PEP database as part of their AML screening processes. This screening helps identify individuals who hold or have held prominent public positions that may make them higher-risk customers for financial institutions. If a customer is identified as a PEP, additional due diligence measures are required during the customer onboarding process.
Furthermore, IDcentral integrates these PEP screenings with sanction screenings and continually updated negative media findings, providing a comprehensive compliance solution that includes customizable risk assessments tailored to specific business needs.
Originally published at https://www.idcentral.io/blog on April 24, 2024.
