Individuals who have or had a prominent public position or a close relationship with someone in such a position are referred to as Politically Exposed Persons (PEPs). They are considered high-risk customers due to their potential involvement in financial crimes such as corruption and money laundering. However, it is important to note that not all PEPs engage in illegal activities.
Financial institutions are required to conduct a comprehensive risk assessment when working with PEPs, which involves identifying and monitoring any red flags. Even one indicator may suggest that the customer poses a higher risk of financial exploitation, making it necessary to carry out enhanced due diligence procedures and monitor their transactions closely.
When assessing customer risk levels, financial institutions should differentiate between domestic PEPs, who hold prominent public positions within their own country, and foreign PEPs, who hold similar positions in other countries, as the risks associated with these two categories may vary significantly. To automate the PEP identification process and reduce the risk of non-compliance, financial institutions can use AML compliance solutions like Sanction Scanner's PEP screening tool. By screening customers against global PEP lists and sanction lists, companies can quickly identify high-risk customers and perform the necessary risk assessments.
Risk Ratings For PEPs Based On FATF Red Flag Standards
Regulated firms have the responsibility to follow certain standards when onboarding and continuing to work with Politically Exposed Persons (PEPs) like screening and risk assessment. These standards include conducting continuous due diligence to match the client's PEP status, as well as monitoring and assessing their risk level. The Financial Action Task Force (FATF) is an intergovernmental agency that oversees and provides guidance on anti-money laundering and countering the financing of terrorism (AML/CFT) efforts.
In accordance with the FATF's guidelines, PEPs are classified into four different risk categories based on the level of potential risk they pose. These categories are:
- High-risk PEPs: These are individuals who hold prominent public positions, such as heads of state or government, senior politicians, senior executives of state-owned corporations, or high-ranking military officers.
- Medium-risk PEPs: This category includes individuals who hold lower-level public positions or are closely associated with high-risk PEPs, such as family members or business associates.
- Low-risk PEPs: This group includes individuals who no longer hold public positions but have done so in the past.
- Domestic PEPs: Domestic PEPs are individuals who hold prominent positions in their country of residence but not at the national level.
FATF PEP Red Flags
The Financial Action Task Force (FATF) has established various red flags for politically exposed persons to assist businesses in identifying potential illicit activity and maintaining AML compliance. If multiple red flags match the information obtained, it should generate concerns about illegal behavior and, in some cases, lead to exposure to money laundering. Besides, specific nations or regions may have their own indications of PEP-related suspicion that should also be considered.
1. Concealing Identity
PEPs are aware of their risky status and may attempt to conceal their identity. For instance, they may:
- Transfer legal ownership to a family member or a close associate.
- Conduct business through intermediaries.
- Use company vehicles without legitimate commercial motives to hide related industries and ownership.
2. Unethical Behavior
PEPs' conduct may sometimes expose them. For example, they may:
- Be uneasy or secretive about the source of their wealth and cash.
- Provide false, incomplete, or fraudulent information.
- Have inconsistent publicly available information.
- Be hesitant to explain why they are present in the country where the financial institution is located.
- Have been denied entry into the country.
- Regular money transfers between different countries.
- Have significant cash or wire transfers into or out of their accounts.
- Lack of specific or convincing justifications for business ties, account openings, or transactions.
- Have accounts or property in other countries, which is illegal in their own country.
3. Position in the Organization
The position of a PEP within an organization can also be cause for concern. For instance, they may have:
- Authority, access, and control over the company's money, policies, and activities.
- Capability to control mechanisms against money laundering or terrorist financing (ML/TF) on a formal or informal basis.
- Control over government or corporate accounts.
- Control or ownership of financial institutions.
4. The Market
The high-risk industries for PEPs vary depending on the location and country. Examples of high-risk industries include:
- Finance and banking.
- Defense and military.
- Companies that collaborate with government or state agencies.
- Extraction and mining.
- Provision of public goods.
5. Transactions Types
The transactions made by PEPs can also reveal a lot about them. For instance, they may:
- After a lengthy period of inactivity, the PEPs account displays significant activity in a short amount of time.
- Banking for the wealthy;
- Wire transactions that have no economic justification or are missing beneficiary information;
- Transactions or payments made anonymously from an unknown third party;
- Without a commercial reason, funds are frequently transferred from one account to another or across financial institutions.
- Significant financial movements, significant foreign money transfers, or wire transfers into and out of the account;
- Having and utilizing several bank accounts for no discernible purpose.
6. Goods and Services
The FATF identifies certain services and goods as riskier and more susceptible to being utilized by PEPs, such as:
- Businesses that cater to international customers;
- Trusts and suppliers of services;
- Accounts for correspondents and concentrations;
- Property investment;
- Dealers in high-end transportation vehicles such as sports cars, ships, helicopters, and aircraft.
- Dealers of precious metals, gemstones, and high-end items.
7. Indicators on the Ground
When conducting due diligence on a domestic PEP, financial institutions should also consider the geographic factors highlighted by FATF, including the risk associated with high-risk countries, corruption levels, single economy countries, and those that have not ratified relevant anti-corruption agreements.
- High-risk country, either foreign or local;
- A country where there is a serious danger of corruption;
- Countries having a single economy;
- A country that has not ratified a relevant anti-corruption agreement.