A politically exposed person, as defined by financial regulations, is a person entrusted with a prominent public function. A PEP is perceived to be a potential risk for involvement in bribery and corruption by virtue of his or her position and the influence the person may hold. There is no globally accepted definition of PEP. In the 2003 Financial Action Task Force (FATF), an intergovernmental organisation founded in 1989 under G7 initiative to develop policies for combating money laundering, issued two specific recommendations regarding PEP management and risk mitigation. Following the 2003 FATF Money Laundering standard, most countries have defined their PEPs. For example, in the UK the Money Laundering Regulations define a PEP as an “an individual who is entrusted with prominent public functions, other than as a middle-ranking or more junior official.” Following different customer identification and verification procedures, firms classify PEPs as low, medium and high-risk, including the foreign PEPs. There is no agreed method for determining the time period that an individual should be treated as PEP after she or he ceased to be entrusted with the public function. In some countries the regulations impose a time period of at least 12-18 months. Some financial institutions adopt the approach ‘Once A PEP Always A PEP’ for very high-risk PEPs. In 2001 terrorist financing (TF) and other related threats to the integrity of the international financial system came under FATE’s mandate.
Definition of PEPs (FATF guidance paper)
‘Foreign PEPs: individuals who are or have been entrusted with prominent public functions by a foreign country, for example heads of state or of government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, important political party officials.
Domestic PEPs: individuals who are or have been entrusted domestically with prominent public functions, for example heads of state or government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, important political party officials.
International organisation PEPs: persons who are or have been entrusted with a prominent function by an international organisation refers to members of senior management or individuals who have been entrusted with equivalent functions, i.e., directors, deputy directors and members of the board or equivalent functions.
Family members are individuals who are related to a PEP either directly (consanguinity) or through marriage or similar (civil) forms of partnership.
Close associates are the individuals who are closely connected to a PEP, either socially or professionally.
In relation to politically exposed person, FATF recommended in 2003 that the financial institutions should have following measures in addition to performing normal due diligence:
Appropriate risk management systems to determine whether the customer is a politically exposed person.
Senior management approval for establishing business relationships with such customers. The objective of senior management approval is to ensure that more senior levels of management are aware of relationships with PEPs and there are adequate internal controls while undertaking business relationships with PEPs.
FATF guidance (recommendations 12 and 22) of 2013 on PEP is more comprehensive, elaborating the potential risks associated with PEPs and justifying additional anti-money laundering/counter-terrorist financing measures with respect to business relationships with PEPs. Generally, PEPs are influential and holds important positions which, FATF considers, can potentially be abused for the purpose of committing money laundering and related offences, including corruption, bribery and terrorist financing. FATF has suggested list of indicators/red flags that can be used or carefully considered to detect misuse of the financial system by PEPs.
Indicators/red flags
PEPs may attempt to shield their identity,
PEPs may feel uncomfortable to provide information about the sources of wealth or funds or may provide inconsistent information with their declared assets or published official salaries, or may be unable or reluctant to explain the reasons of doing business in the country of financial institution, or may move fund to or from countries where they do not have any business or other relationship, or have been denied visa.
PEP’s position or involvement in business and the way PEP presents his or her position are important risk factors to be taken into serious consideration. For example, PEP’s authority over or access to state assets, funds, policies, or operations; control over the regulatory approvals, including awarding licences and concessions; access to control or influence over government or corporate accounts; ownership or control over a financial institution either privately or ex officio, directorship or beneficial ownership of a legal entity that is a client of financial institution.
Industry/sector with which the PEP is involved is an important indicator. It means PEP’s connection with high-risk industries such as arms trade and defence industries, banking and finance, government procurement, construction, large infrastructure etc.
The purpose of business relationship and transaction are important factors while doing business with PEP. For example, suspicious transaction report (SRT) regarding a PEP, deposit or withdrawal of large amounts of cash, termination of business relationship by other financial institutions, substantial cash flow or wire transfers into or out of the account, use of multiple bank accounts for no apparent or other reasons etc.
Products, service, transaction of delivery channels which are of high risk as identified by FATF may be used by PEP. For example, private banking, anonymous transactions, non-face to face business relationships or transactions, and payment received from unknown or unassociated third parties. In addition, businesses that serve mainly the foreign clients, wire transfers that lack relevant or beneficiary information, correspondent accounts, dealers in precious metals, stones or luxurious goods, transport vehicles (sports cars, yachts, helicopters and planes) and high-end real estate dealers can also be used by PEP.
There are country specific red flags and indicators which mean the foreign or domestic PEP from a higher risk country identified by FATF for failure or strategic deficiencies in ensuring implementation of effective countermeasures by the financial institutions or DNFBPs (designated non-financial businesses and professions) to combat money laundering, terrorist financing, and financing of proliferation. Foreign or domestic PEPs from countries who have not signed or ratified the relevant anti-corruption conventions such as UNCAC (United Nations Convention against Corruption); or from the countries that are dependent on the export of illicit goods (e.g. drugs); or from countries with political system that are based on personal rule, autocratic regimes; or from the countries with poor and/or opaque governance and accountability; or from countries identified by credible sources as having high levels of organised crime.
Check & Prevention: To address these risks FATF recommends member countries to ensure that their financial institutions and DNFBPs implement measures to prevent the misuse of the financial system and non-financial businesses and professions by PEPs. Designated non-financial businesses and professions are lawyers, notaries, independent legal professionals, real estate agents, tax advisors, insurance firms trusts, company service providers etc., who have occupational risks in ML/TF operations.
These are preventive requirements. It is to be noted that PEP should not be stigmatised as being involved with criminal activity. Refusing business relationship with a client being PEP is contrary to the spirit of preventative measures recommended by FATF for dealing with a person who is PEP. The aim of requirement of preventive measures is to fight against money laundering and the accompanied offences including corruption and terrorist financing.
Pursuant to the FATF recommendation, member countries are required to implement measures for the financial institutions to ensure appropriate risk management systems in place to determine whether the client or beneficial owner is a PEP or related or connected to a foreign PEP. FATF first issued mandatory requirements of preventive measures to fight against ML in June 2003 covering foreign PEPs, their family members, and close associates. In February 2012, FATF expanded the mandatory requirements to cover domestic PEPs and PEPs of international organisations, in line with definition of PEPs as defined by Article 52 of the UNCAC. Article 52 of the UNCAC defines PEPs as “individuals who are, or have been, entrusted with prominent public functions and their family members and close associates”, and includes both domestic and foreign PEPs. The main aim of the obligations in Article 52 of UNCAC is to fight corruption, which is endorsed by the FATF. However, it is important to note that the aim of the 2012 FATF requirements extends more broadly to the fight against money laundering.
Whether a customer or beneficial owner is a PEP depends upon the effective implementation of customer due diligence (CDD) measures, including the identification, verification, and on-going due diligence requirements. Usually, banks and financial institutions do the CDD checks which include verifying a customer’s name, address, date of birth and photo ID and screening them to ensure they are not on prohibited lists. Effective application of risk-based approach is central which means that banks and financial institutions identify, assess, and understand the money laundering and terrorist financing risk to which they are exposed, and take appropriate mitigation measures in accordance with the level of risk. This approach allows the banks and financial institutions to decide the most effective way to mitigate the money laundering / terrorist financing risks they have identified.
Many countries have established rules for identifying Politically Exposed Persons as part of AML regulations. In Europe it is mandatory that financial institutions must assess and identify whether potential clients are PEPs and apply appropriate extra due diligence if any PEP is identified. It is to be noted that being a PEP does not imply the person has been involved in illegal activity, but extra caution must be taken when dealing with the person and transactions. This extra care includes obtaining more information about the sources of the customer’s wealth, as well as conducting periodic reviews of the account to ensure it is being used in a legitimate manner.
Financial institutions must implement specific measures in order to prevent the misuse of the financial system institutions and DNFBPs as well as set up detection mechanisms against potential abuse. Side by side, FATF recommends additional measures for high-risk business relationships with domestic and international PEPs. Additional measures include assessment of the nature of business relationship and its country of origin. The corruption perception index of Transparency International is used to assess the risk associated with a business relationship with a PEP and PEP-related entity.
As recommended by FATF, effective customer due diligence (CDD) should be conducted to identify if the beneficial owner of an entity is a PEP, or if an individual can be labelled as PEP. This implies adequate due diligence processes, using reliable documents to confirm his/her identity, to determine the ownership structure of a company, and screening against specific PEP databases. If the transaction is considered as high risk, enhanced due diligence (EDD) should be performed to assess the different parameters surrounding the transaction. FATF suggests that failing to comply to CDD measures, financial institutions should not open the account, commence business relations or perform the transaction; or should terminate the business relationship; and consider making a suspicious transactions report in relation to the customer.
The FATF recommendations require that family members and close associates of PEPs should be determined to be PEPs because of the potential for abuse of the relationship for the purpose of moving the proceeds of crime, or facilitating their placement and disguise, as well as for terrorist financing purposes. Consistent with the risk-based approach outlined above, the period for which family members and close associates of PEPs who are no longer entrusted with a prominent public function should be treated as PEP is directly related to the assessment of risk for the PEP.
Conclusion: Basically, FATF recommendations require the member countries to make sure adequate measures are in place to identify the clients who are politically exposed persons and take extra care while dealing business with them considering their position and influence over the financial system, regulatory bodies, policy and legal framework which they or their family members or associates can misuse for money laundering, bribery and even terrorist financing. Here the main spirit is to fight corruption which was highlighted by UNCAC as obligation for member states to comply with for the smooth functioning of global financial system.
Md Ashadul Islam is Former Senior Secretary, Financial Institutions Division, Ministry of Finance. ashadislam@hotmail.com