Enhanced Due Diligence Measures

Posted in Know Your Customer (KYC) on March 29, 2024
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Enhanced due diligence (or EDD) is a CDD method that entails a deeper look into the customer’s risk. It’s made to deal with high-risk potential consumers and low-probability transactions. This article elaborates on ‘Enhanced Due Diligence Measures’.

Customers from high-risk jurisdictions offer a higher risk to the organization, which is difficult to detect via regular due diligence.

The standard Customer Due Diligence process is an organization’s critical due diligence procedure for identifying and verifying its customers’ identities, including the beneficial owner if applicable. Enhanced due diligence processes are applied to all consumers in the high-risk category, regardless of country. All financial institutions must comply with this industry and AML regulatory obligation.  

When a client is thought to be at a higher risk of financial crime, such as PEPs, EDD is performed. Organizations must use a risk-based methodology to evaluate whether a consumer is a greater risk or not, according to the Financial Action Task Force regulation. 

When are EDD measures applied?

EDD measures imply enhanced inspection, stricter transaction thresholds, frequent reviews, bad news checks, and extra identification and verification processes, among other measures.

EDD measures are applied by the organization when it is dealing with:

  • sanctioned countries;
  • Politically Exposed Persons (PEPs);
  • Correspondent banking accounts;
  • Customer located in high-risk jurisdictions, and;
  • Charitable organizations.

For example, if an organization is into the money lending business and an individual/entity wants to apply for a short-term loan, the organization will first do the standard due diligence on customer and post verification. The screening will be performed by the customer, such as negative news screening. Sometimes, if an entity or individual does a fraud, it reflects on the daily newspaper, and even sometimes it shows up on Google also through blogs, articles, compliant forums, newspaper sites, and so on. Therefore, it helps to ascertain the risk associated with new customers.

EDD measures include:

  • obtaining additional information on the customer (for example, occupation, the volume of assets), and updating more regularly the identification data of customer and beneficial owner; 
  • obtaining additional information on the intended nature of the business relationship; 
  • obtaining information on the source of funds or source of wealth of the customer; 
  • obtaining information on the reasons for intended or performed transactions; 
  • obtaining the approval of senior management to commence or continue the business relationship; 
  • conducting enhanced monitoring of the business relationship by increasing the number and timing of controls applied and selecting patterns of transactions that need further examination.

EDD will vary to match the circumstances but in general consists of the following principles: 

  • adequate measures should be taken to establish the legitimacy of the source of funds and source of wealth to be used in a higher-risk business relationship; 
  • additional information should also be obtained on the nature of the expected relationship and the frequency and level of expected transactions/activity; 
  • significant adverse information about the customer or the customer’s beneficial owners or controllers should be adequately examined, including where there is information to question the beneficial owner’s integrity; 
  • the authority for signing off new customers should be graduated according to risk; higher-risk customers should always be escalated to senior management level and possibly also referred to compliance or the AML team for a ‘four-eyes test’. 

The monitoring requirements should also be determined based on the risk assessment, with higher-risk customer/product combinations being subjected to more frequent checks and/or a higher level of scrutiny.

Enhanced Due Diligence Measures

FATF Recommendations for EDD

FATF Recommendations 12, 13, and 19 require that EDD should be undertaken where the customer is a politically exposed person (PEP); or is connected to a higher-risk country and for a correspondent banking or similar relationship. The Interpretive Note to Recommendation 12 adds the following circumstances as being those that might give rise to higher-risk relationships. 

The business relationship may be conducted in unusual circumstances (such as significant unexplained geographic distance between the financial institution and the customer). These include:

  • non-resident customers;
  • legal persons or arrangements that are personal asset-holding vehicles;
  • companies that have nominee shareholders or shares in bearer form;
  • cash-intensive businesses;
  • the ownership structure of the company appears unusual or excessively complex given the nature of the company’s business;
  • customers linked to higher-risk jurisdictions;
  • customers who take higher-risk products or services. 

It can be expected that regional and/or domestic legislation or regulations will add to these higher-risk categories. For example, the 4MLD currently requires EDD to be applied where the customer has not been physically present for identification purposes. The risk is increased if the company or other entity operates within a higher-risk business area for money laundering or terrorist financing purposes or has dealings with higher-risk jurisdictions.

Higher-risk individuals

Other higher-risk customers who will require more extensive due diligence are also likely to include the following individuals and entities: high-net-worth individuals seeking a wealth-management or private banking relationship; an individual whose source of funds (or, where applicable, source of wealth) is unclear or who requires complex structures to be established, and privately-owned companies and other entities, such as trusts. 

These are generally assessed as higher risk than quoted companies because they are exposed to a lower level of external scrutiny than companies that are publicly owned. The risk is increased if the company or other entity operates within a higher-risk business area for money laundering or terrorist financing purposes or has dealings with higher-risk jurisdictions. For such relationships, the identities of the beneficial owners and controllers must also be verified in addition to verifying the identity of the corporate entity. Beneficial owners may also be executive directors or the settlors of trusts. 

Final Thoughts

EDD is a Customer Due Diligence method that necessitate a deeper look into the customer’s risks. EDD is implemented for customers from high-risk jurisdictions because they offer a higher risk to the organization, which is very difficult to detect using a regular due diligence.