One very important tool that should be part of your operational AML compliance toolkit is about dealing with PEPs. Subsequentially to any form of customer due diligence, you will most likely have to deal with this group of customers. The first thing you might wonder is, what in the world is a PEP.
What is a PEP?
Let’s clean this up a little bit and embed this in the customer due diligence. A PEP is nothing more than an individual. An individual that has been entrusted with a prominent public function or political role.
Money Laundering involving PEPs
Why should this be of money laundering concern? The positions that these individuals hold can be abused for the purpose of laundering illicit funds or other predicate offences such as corruption or bribery. Generally speaking, it is true that having PEPs as customers or doing business dealings with PEPs represent a higher money laundering risk for organizations. Examples in which politicians or their associate abuse their positions for money laundering purposes are manifold. You have to look no further than at the Panama Papers, this is quite a rich resource for such examples. Over 140 politicians from 50 countries have been implicated in the Panama Papers.
Now the FATF has long recognized the circumstance that PEPs might have roles and functions can be abused for the purpose of money laundering. They addressed this with two of their recommendations. The first of these PEP-related recommendations is number 12. This basically covers the effective implementation of customer due diligence requirements and is mainly directed at financial institutions. It is recommended, that financial institutions should be required to identify PEPs in their customer base and apply enhanced due diligence on them.
Qualifying as a PEP is one of the drivers for a customer to require enhanced due diligence. These customers will automatically be treated as high risk customers.
Now if you consider that many countries comprehensively follow the FATF recommendations and oblige the banks by law, we take it as a working hypothesis that this recommendations applies. The circumstance that banks have to apply enhanced due diligence on PEPs means that it is more effort for them to have PEPs as customers. The enhanced due diligence measures that have to applied to PEPs contain basically a handful of elements.
Identifying Politically Exposed Persons
The first of these elements cannot really be counted, because it is the requirement to identify PEPs. How do you do this? There are many different databases in place that list persons with current or previous political roles or other prominent functions. In practice though, there is something interesting going on. Because especially banks really want to avoid any regulatory fines, they sometimes tend to overcomply with regulatory requirements. For some banks, the PEP status of an individual never expires. So, let’s say one of their customers was a member of a country’s parliament 20 years ago. Some countries still treat them as PEPs, having to apply enhanced customer due diligence on them.
Defining the Scope of the PEP Definition
And then there is something else that is quite interesting to note. Some countries are extending the regulatory scope of PEPs to their close associates and immediate family members. With regards to associates this means that anyone who has a close business relationship with a PEP, is also a PEP. The next consecutive question is, what is a close business relationship? This can also differ depending on the prudent regulators’ expectation and also from bank to bank. For some it is when a person has joint beneficial ownership of legal entities or legal arrangements with a PEP. For other it is when a person as the sole beneficial ownership of a legal entity which is known to have been set up for the benefit de facto of the PEP.
The PEP definition can also be including immediate family members who, in turn, are also considered PEPs. This includes parents and children of PEPs, spouses or partner, siblings, and other.
It’s easy to see how the list of potential PEPs is huge and continually in flux as people move into new roles, family members change, regulations and recommendations from the FATF get updated on a local level, and the international landscape continually alters.
Determining who is a PEP and who isn’t is really a science in itself.
Once a PEP is identified enhanced due diligence measures need to be applied. These are basically the other three elements of what to do with PEPs according to the FATF.
Operational actions when dealing with PEPs
The actions that need to be taken are to obtain senior management approval for establishing or continuing such business relationships; to take reasonable measures to establish the source of wealth and source of funds; and to conduct enhanced ongoing monitoring of the business relationship.
PEPs’ Risk Return Profile
Ultimately, this all narrows down to risk and return. PEPs potentially impose a higher risk of money laundering. The FATF, governments, and regulators are therefore requiring businesses, especially banks, to be stricter with them. So they are, on the one hand, at an increased risk through violating regulatory requirements, reputational damages, and legal liabilities as we have also discussed. And on the other hand, they have a much higher internal effort to take care of the enhanced due diligence requirements, which brings down their cost-income ratio with these type of customers.
By the way, the other FATF recommendations that we mentioned earlier, is regarding non-financial businesses and professions and more or less says that in specific situations these guys should apply this main PEP recommendation as well.
Now you know what’s the buzz regarding PEPs about and what you have to do to make dealing with PEPs part of your operational AML toolkit.