To make sure that a financial institution follows all financial crime compliance regulations, it is important to know who or what a politically exposed person (PEP) could be so that they can be found and enhanced due diligence (EDD) procedures can be carried out.
Even though PEP status doesn't predict criminal behavior, the risk it poses means that financial institutions have to take more AML/CFT precautions when starting a business relationship with a PEP and keep an eye on them to make sure they catch any changes in their risk profile. The purpose of PEP monitoring requirements is to prevent crime, so they shouldn't be seen as proof of criminal behavior.
In this guide, we'll break down everything you need to know about PEPs — from who they are and how to identify them, to their history and the importance of screening PEPs.
Who are politically exposed persons?
Politically exposed persons are individuals who are more likely to be exposed to and involved in financial crimes such as corruption, bribery, money laundering, and the financing of terrorism as a result of their political appointments or positions. PEPs pose a high risk to regulations because they often have access to large amounts of government money and may be able to get around anti-money laundering (AML) or counter-financing of terrorism (CFT) regulations. So, as part of their Know Your Customer (KYC) processes, businesses should screen their customers to see if they are PEPs and then change their compliance response accordingly.
PEP is often used to refer to elected officials and government workers, but it also includes military personnel, judges, and anyone else with a notable public or state-related job, as well as their friends and family.
Types of PEPs
Even though there isn't a clear global classification, the FATF puts PEPs into three main groups in its AML/CFT recommendations:
- Foreign PEPs: They can be political figures, government employees, or significant public personalities in other nations.
- Domestic PEPs: They may be public figures or politicians from the same nation as their bank or service provider.
- International PEPs: Not all PEPs are politicians or prominent figures. International PEPs are individuals who hold senior executive positions in international or state-owned organizations. This division is also known as "heads of international organizations" (HIO).
According to the FATF, the three PEP classifications are "not intended to cover middle-ranking or more junior individuals."
Building a list of PEPs that financial institutions can use could be helpful, but it is often hard to do so because the requirements for being a PEP are not well-defined and vary from country to country. The FATF publishes new AML/CFT recommendations on PEPs periodically, which makes it harder to make a "final" list of PEPs.
However, most countries base their descriptions of politically exposed persons on FATF recommendations, which essentially classify the following jobs and positions as PEPs:
- Government officials: These are current or previous officials who have been appointed to positions in the domestic or foreign governments. Heads of state or those working in the executive, legislative, administrative, military, or judicial sectors, both elected and unelected.
- Political party officials: Senior officials appointed to positions in major political parties at home or abroad fall under this category.
- Senior executives: This category of PEP includes top executives who work in government-owned commercial businesses or international organizations as directors or board members.
- Relatives and close associates: Relatives and Close Associates (RCA) of the people listed above may likewise be classified and regarded as politically exposed. This category includes spouses, parents, siblings, children, and spouses' parents and siblings, as well as direct family members or close social or professional contacts of a government or political official or senior executive.
The history of PEPs
In the 1990s, the Nigerian military dictator, Sani Abacha, stole billions of dollars from the Nigerian Central Bank and sent them to his accounts in the UK and Switzerland. This is when the term PEP was first used. After Abacha was removed from power, the new government tried to get the money back but had trouble. This led to the idea of a "Politically Exposed Person." Many cases were registered against people who indulged in money laundering and were classified as PEPs.
In October 2007, Vladimir Kuznetsov, a former Russian diplomat, was sentenced to four years and three months of imprisonment and ordered to pay a $73,000 fine for money laundering. Kuznetsov was the head of a United Nations budget committee when he used the money wrongly. He was also accused of helping a fellow UN employee take more than $300,000 in bribes from companies that wanted to do business with the UN.
In May 2008, Jim Hayes (Alaska mayor) and his wife were sentenced to 66 and 36 months in prison, respectively. They were found guilty of stealing government money meant for the Love Social Services Center (LSSC), a charity in Fairbanks that helps poor people. The couple was also convicted of money laundering for trying to conceal the diversion of funds and of filing false tax returns.
In March 2012, a regionally-operating British bank, i.e., Royal Bank of Scotland, was fined £8.75 million ($10.9 million) for failing to properly handle customers classified as PEPs and breaches of money-laundering rules after three years of systemic problems in handling the affairs of customers vulnerable to corruption because of their political links.
In November 2015, Barclays Bank was fined £72 million ($108 million) for failing to mitigate the risk that it may be used to aid financial crime. Because the individuals involved were politically exposed persons, Barclays should have conducted enhanced due diligence and monitoring.
In June 2016, Canara Bank's UK division was fined £896,100 ($1.2 million) in the UK for anti-money laundering violations. For persistent anti-money laundering (AML) breaches, Britain's market regulator barred the bank from receiving new deposits for around five months.
Why are PEP checks important?
With growing scrutiny from local and international financial regulators, financial institutions must protect themselves against all types of fraud and financial crimes. Individuals who meet the PEP definition should be categorised based on their level of risk and screened. To mitigate their risks and liabilities, financial institutions must apply some PEP AML measures.
The Financial Action Task Force (FATF) has made a set of rules to keep businesses and financial systems from being used for illegal purposes. Every government needs to have strict anti-money laundering (AML) compliance systems in place, and if they aren't followed, there should be consequences. According to anti-money laundering regulations, financial institutions must take all reasonable precautions to ensure that they do not intentionally or unknowingly assist in the concealment or transfer of the proceeds of corruption by political figures, their families, and associates.
Ongoing Customer Due Diligence (CDD) is part of the compliance process. This means that a company must use ongoing screening processes to keep an eye on business transactions and entities. The Reserve Bank of India (RBI) urged banks and financial institutions regulated by the RBI to carry out appropriate AML/KYC measures in its circular dated July 1, 2008. "Before accepting the PEP as a customer, banks should check the person's identification and inquire about the source of funds."
Sanctions checks are necessary to assess the risk of people, businesses, and countries. PEP screening, Adverse Media screening, and Watch List screening are among the sanction checks.
As part of the necessary AML regulations put in place by governments, sanction checks are undertaken so that financial institutions may identify individuals. This ensures that they do not engage with people who aren't allowed to work in certain industries or do certain things. There are numerous elections held at various levels around the world. With new people being elected, the PEP database needs to be updated often, so an entity needs to take care of this task.
While the election commissions of various governments can offer data on newly elected officials and the government can supply information on other kinds of PEPs, it is difficult to obtain information on political party officials who change. Manual periodic evaluations can be hard for many institutions because the business and political interests of PEPs change over time. An annual review of the status of a PEP may not be possible for some businesses or may not be enough for high-risk PEPs. However, the risk can be controlled more effectively with a real-time automated solution that scans for major changes to a PEP's account or file on a regular basis.
Despite the common belief that PEPs are more likely to commit crimes, there is no real evidence to support this claim. PEP status does not predict criminal behavior, but it does pose a higher risk.
What does this mean for financial institutions? Financial regulators require businesses to include PEP screening techniques in their anti-money laundering programs. Businesses should be aware of the PEP regulations that apply in their jurisdiction in order to implement AML/CFT procedures that are compliant with money laundering regulations.
With this in mind, a good compliance program should include an ongoing real-time transaction monitoring system, an effective customer risk score, accurate KYC and ID verification, and regular sanctions screening checks, all of which Flagright provides.
Contact us here to schedule a free demo of how we help financial institutions meet all its compliance obligations.