In the financial world, PEP screening is a term that is gaining more importance by the day. The reason is simple: PEPs, or politically exposed persons, pose a significant risk for financial institutions. The possibility of corruption and money laundering through such individuals necessitates a thorough screening process. In this blog, we will dive deeper into the world of PEPs and explore the need for PEP screening.
PEP (politically exposed persons) screening is a crucial process that helps prevent financial institutions (FI) from becoming involved with illicit financial activities. PEPs are individuals with significant political influence, such as government officials or their family members. These individuals are considered high-risk due to the potential for corruption and money laundering.
To understand PEP screening, let’s consider an example. Suppose a bank receives an application for a loan from an individual who is a member of parliament in their country. Before granting the loan, the bank would conduct PEP screening to ensure that the individual is not involved in any illegal activities or has any connections to organized crime.
Corruption is the biggest issue facing society today. According to estimates by the World Economic Forum, the cost of corruption worldwide crossed at least $2.0 trillion, which is approximately 5 percent of the global Gross Domestic Product (GDP). Furthermore, businesses and individuals pay more than $1 trillion in bribes every year, as reported by the World Bank. Consequently, tackling corruption is vital for economic growth and development.
Therefore, PEP screening is not only important for mitigating risk but is also required by law in many countries. For instance, Section 312 of the USA Patriot Act specifies enhanced due diligence procedures that include increased monitoring of the financial activities and dealings of senior foreign political figures (SFPF), a subset of PEP.
In the financial industry, politically exposed persons are foreign individuals and their associates who hold or have held a prominent public position. Conducting business with corrupt PEPs can result in serious damage to a financial institution’s reputation, leading to negative consequences for the business.
Additionally, if a financial institution or its employees were aware or should have been aware of funds originating from corruption or serious crimes, criminal charges may be filed, even if they chose to ignore the situation.
A globally agreed definition to identify a Politically Exposed Person (PEP) does not exist; however, the Financial Action Task Force (FATF) defines PEP as “the types of prominent public functions that an individual may be or may have been entrusted with by a foreign or domestic government.”
The Financial Action Task Force (FATF) provides the following definitions to help identify PEPs:
1: Foreign PEPs refer to heads of state or government, high-level politicians, top-tier government officials, judges or military personnel, and senior executives of state-owned companies, as well as key officials of political parties in a foreign country.
Domestic PEPs, similar to foreign PEPs, are persons who have held or are currently entrusted with significant public functions within their own country.
2: International organization PEPs are individuals who have occupied or are currently in a high-level position within an international organization. This includes directors, deputy directors, board members, and those in equivalent roles.
3: Family members of PEPs are persons who are directly related to a PEP through blood (consanguinity), marriage, or similar forms of partnership. Last, close associates are people who have a close personal or professional connection with a PEP.
Although there is consensus on the mentioned definitions, it’s important to consider some regional variations. Depending on the jurisdiction, regulatory requirements and due diligence recommendations may differ. FATF simplifies the process to a certain extent through its guidance and recommendations on the matter.
However, most recommend guidance from the legal team and/or the Financial Intelligence Unit (FIU) of the country in question to confirm the obligations related to politically exposed persons.
Across the world, differences in information and practices have made manual screening a challenging task. A proposal published by Harvard suggests that the current system for identifying PEPs is both ineffective and inaccurate.
Without reliable data sources or an official list, most financial institutions must depend on self-identification, commercial vendors, and internal checks.
Some countries do publish PEP position lists. For instance, the online directory of world leaders and cabinet members of foreign governments is updated weekly by the Central Intelligence Agency (CIA). However, some countries do not publish official lists at all or do not update them often. Although open-source lists are available for free, their completeness and reliability can also vary greatly.
A PEP (Politically Exposed Person) may still be considered a PEP even after leaving office, depending on the procedures in place. Financial institutions, for instance, may view PEPs as high-risk for up to 18 months after leaving office and act accordingly.
According to FATF Recommendation 12, a PEP is someone who has had a significant public role in the past but may no longer hold that role. The recommendation leaves room for an open-ended approach, suggesting that someone who was once a PEP could always be considered one.
Now that we understand the basics of PEP screening, let us look at PEP best practices, the repercussions of not undertaking a PEP screening, and some real-world scenarios.
PEP screening is a crucial component when it comes to abiding by both Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations. To safeguard themselves against potential risks, financial institutions must implement the PEP screening process. Here are some measures financial institutions can undertake:
When dealing with Politically Exposed Persons (PEPs), a one-size-fits-all approach is ineffective, and instead, PEPs should be assessed along a risk spectrum that considers their position and level of authority.
A risk-based approach should be adopted during the PEP screening process to identify individuals requiring additional due diligence measures, especially foreign PEPs who may present a higher level of risk. Compliance officers can effectively gauge the risk of doing business with a specific person by using this approach.
Financial institutions should apply due diligence procedures based on the level of risk involved while conducting a risk assessment. This may include documenting the duration of an individual’s political exposure, title, and country.
Additionally, firms should document the intended purpose and nature of the relationship or account, the source of initial funds (if applicable), and their account activity. Customer wealth and sources of funds should also be understood and documented, with independent and reliable sources used to verify this information if needed.
Senior management approvals of PEP relationships with individuals who have thorough cognizance of a financial crime risk and their responsibility within the FI’s AML control environment are crucial. Furthermore, the PEP screening process should include consistent monitoring of the relationship.
Due diligence processes should ensure appropriate levels of risk assessment for customers, and ongoing due diligence should be applied to the entire customer base. Best practices include having a process to declassify PEPs into a lower-risk level when appropriate.
Ensuring that employees and managers receive regular AML training and communicate policies and procedures related to PEPs is crucial. Technological solutions can help streamline the process, but compliance officers are still necessary. Therefore, preventing financial crimes requires the abilities of employees as well as the technology used in PEP screening.
Neglecting PEP screening can have serious consequences, both in terms of legal and reputational risks.
Here are three recent examples of companies facing fines for neglecting PEP screening:
These examples demonstrate the importance of robust PEP screening and the potential consequences of neglecting this crucial compliance process. Companies need to be vigilant in identifying and assessing PEP risks in their customer base and have effective safeguards in place to mitigate these risks.
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