October 4, 2023 Pierre Remy

Politically Exposed Persons (PEPs) and Compliance in Finance & Banking

Summary

Recent Scandals & PEP Definition: There's a rising trend of money laundering scandals implicating PEPs, individuals holding significant positions susceptible to corruption.
PEP Relevance & Challenges: Financial institutions classify PEPs as high-risk. Screening them is crucial for KYC and AML compliance but presents challenges like data updates and diverse global regulations.
Trust Stamp's Solution: Provides efficient PEP and Sanctions screening, ensuring accurate user onboarding while minimizing false positives.

Financial crimes involving politically exposed persons (PEPs) have become increasingly common. Notable banking incidents like the 1MDB Scandal, as well as cases involving politically exposed individuals (PEPs) such as Former US Representative William Jefferson, who faced charges related to fraud, money laundering, theft of public funds, and false statements, highlight the need for robust processes related to PEPs.

To ensure your organization's full compliance with financial crime regulations, you and your team must properly detect PEPs. Compliance with AML and KYC legislation requires identifying PEPs and screening all users against international sanctions lists. This is crucial for carrying out thorough customer due diligence procedures to prevent your bank from being used as a means to perpetrate financial crimes.

So, who is considered a politically exposed person, and why is it essential for your business to screen for them? Read on to learn more.

Who Is a Politically Exposed Person (PEP)?

A Politically Exposed Person (PEP) is an individual who holds prominent positions or influence in government, organizations, or institutions that make them susceptible to corruption, bribery, and other financial crimes.

Screening and checking PEPs is not just a regulatory requirement; it's a crucial step in preventing financial crimes. The funds associated with PEPs can be used for money laundering, terrorism financing, and other illicit activities, making their identification critical for financial institutions.

What is the Meaning of PEPs in Finance and Banking?

Politically Exposed Persons (PEPs) in the financial services space are categorized as high-risk customers owing to their elevated susceptibility to bribery and corruption. Consequently, financial institutions must implement heightened measures for evaluating and reducing the risks linked to PEPs. This typically involves conducting thorough due diligence on the customer and their immediate family members and vigilant transaction monitoring to detect any indicators of money laundering or illicit activities.

When assessing a new customer, a bank usually inquires about the individual's PEP status. If the response is affirmative, the bank proceeds with additional checks to mitigate the associated risks of engaging with a PEP. These precautions may include acquiring more comprehensive details regarding the source of the customer's wealth and conducting additional periodic account reviews to ensure it is used for legitimate purposes. These proactive measures enable banks to safeguard themselves against potential financial wrongdoing.

Examples of Politically Exposed Person

1. PEPs in Government Roles

Members of Parliament: Elected representatives are PEPs, as they can influence policy decisions and have access to public funds.
Heads of State and Executive Bodies: Presidents, prime ministers, and top officials fall into this category due to their immense power and resource access.
Diplomatic Roles: Ambassadors and high-ranking diplomats are also considered PEPs due to their close ties to the government.
Judiciary Bodies: Judges and magistrates play a crucial role in the justice system, making them potential PEPs.
State-Owned Enterprises: Individuals involved in state-owned businesses, which often handle significant public assets, can also be classified as PEPs.

2. PEPs in Organizations and Institutions

Central Financial Institutions: High-ranking officials in central banks and financial regulatory bodies are considered PEPs due to their influence on the financial sector.

Armed Forces: Top military officers hold significant power and can be PEPs.
International Sports Committees: Members of international sports committees can be classified as PEPs, significantly if their decisions impact large-scale sports events and investments.

3. Known Close Associates and Immediate Family Members as PEPs

Close Business Associates: Individuals closely associated with PEPs in business dealings, especially those who may be used as proxies for financial transactions, can be considered PEPs.
Sole Beneficial Ownership of Legal Entities: If a PEP has sole ownership of a legal entity, that entity can be treated as a PEP.
Immediate Family Members: Spouses, children, and other immediate family members of politically exposed persons are often included in the PEP category to prevent individuals from using their family connections to bypass regulations.

Each country may have different local PEP regulations to comply with when doing business in that region.

How Long Is An Individual Considered a PEP?

The length of time a person is classified as a PEP is not fixed and varies depending on the jurisdiction. Regulators advocate for a risk-based approach, considering factors such as the potential for informal influence wielded by the individual, the seniority of their former PEP role, and any continued connections to their current or past functions. It is advisable to review the guidelines provided by regulators in the regions where your operations are conducted.

Here are the recommendations from regulatory bodies in the United States (US), United Kingdom (UK), and the European Union (EU):

Financial Action Task Force (FATF) – Regarding Politically Exposed Persons (PEPs), FATF recommends a risk-based approach without predetermined time limits for classifying someone as a PEP. For more information, please refer to FATF recommendations 12 and 22 and the related FATF guidance.
Financial Conduct Authority (FCA) – Refer to paragraph 2.19 of FG 17/6 for the treatment of PEPs for anti-money laundering (AML). The FCA recommends subjecting individuals who were PEPs, even if they are no longer in public positions, to thorough scrutiny for a minimum of 12 months. However, some firms may continue these measures longer if they believe the risk is higher for that specific PEP.
EU Directive – According to Article 22 of Directive 2015/849 of the European Parliament and of the Council, organizations are required to assess the ongoing risk posed by a politically exposed person for at least 12 months after they have ceased to hold a prominent public function within a Member State, a third country, or an international organization. They must also implement suitable and risk-sensitive measures until the individual is determined to no longer present a specific risk associated with politically exposed persons.

How to Identify Politically Exposed Persons?

Politically Exposed Persons (PEPs) necessitate heightened due diligence measures during client onboarding and interactions with your organization. These measures encompass various steps, such as:

Securing approval for onboarding from senior management individuals well-versed in anti-financial-crime policies.
Conduct thorough identity verification through a "know your customer (KYC)" process.
Diligently investigate and establish the sources of funds associated with the PEP.
Ongoing vigilance in monitoring the financial activities and business relationships of the PEP.

Trust Stamp’s clients can screen and continuously monitor users for inclusion on international PEP and Sanctions lists as a part of their compliance program and identity verification flow.

What Are the Challenges To PEP Screening?

Politically Exposed Person (PEP) screening presents businesses with various challenges that can impact the effectiveness of their risk management efforts. These challenges include:

Keeping PEP Data Current: Frequent PEP list changes necessitate businesses to ensure their screening software remains up to date to detect emerging risks.
Resource-Intensive Compliance: A robust PEP screening program demands significant investments in resources, time, and finances.
Navigating Diverse Global Regulations: Varied global PEP regulations pose complexity for businesses in staying compliant and avoiding violations.

In addition to these overarching challenges, there are specific issues related to data quality and processing:

Data Quality Impact: Accurate PEP screening relies on high-quality data; poor data can trigger inaccuracies and false negatives, risking businesses significant fines.

Managing Data Volume: Enterprises with large customer bases and high transactions must efficiently process data to reduce false positives—a challenging task.
False Positives: Sanctions screening software generating invalid alerts leads to delays and extra costs, complicating PEP screening.

Addressing these challenges is crucial for businesses aiming to maintain effective PEP screening protocols and ensure compliance with evolving regulations while minimizing risks associated with politically exposed individuals.

Trust Stamp’s PEP and Sanctions Screening Solution

At Trust Stamp, we are committed to helping you onboard your customers safely and effectively. You can have a PEP and Sanctions screening built to minimize false positives while screening for all known aliases be run as a part of the identity verification process.

Other available safeguards include the ability to know when known problem biometrics return to your site or when the same face shows up as multiple identities.

For more information, contact one of our onboarding compliance experts.