PEP COMPLIANCE OVERVIEW

What is a Politically Exposed Person, or PEP? And, more importantly, what does PEP compliance entail?

World-Check, the leading global PEP database solution, provides an overview of the PEP compliance challenge faced by banks, accounting firms, lawyers and other financial service providers, and also explores the nature and origins of PEP compliance legislation.

PEPs: An introduction

Perhaps somewhat unfairly, a series of events and financial scandals involving highly placed governmental officials and a number of former political dictators earned PEPs worldwide a bad reputation as being “risky” clients. Yet while dealing with this category of prospective clients certainly warrants Enhanced Due Diligence (EDD) and ongoing transactional scrutiny, it would be foolish to summarily dismiss PEPs as undesirable clients.

From the outset, a distinction must be drawn between “clean” PEPs and “dirty” PEPs. There is nothing wrong with dealing with PEPs, provided that the source of their income is transparent and able to withstand scrutiny. A “dirty” PEP is a problem; a “clean” PEP, on the other hand, can be an organisation’s most prized client. Key to mitigating your organisation’s “PEP risk” is the ability to distinguish between these two groups.

What is PEP risk?

Not every Third World governmental official is corrupt; nor does every single PEP pose a threat to your organisation’s reputation. PEPs are often influential and affluent individuals, the sort of clients private every private banker wants in his or her portfolio. Yet with this allure comes higher levels of risk.

From an institutional perspective, the risks associated with lacking PEP due diligence don’t stop at regulatory fines for non-compliance. Dealing with “dirty” PEPs – wittingly or unwittingly – carries the risk of severe reputational damage. To compound the PEP risk challenge, a Politically Exposed Person can become compromised at any given point – one illicit transaction is all it takes.

Institutions such as Riggs Bank or the Swiss financial houses indicted for their dealings with Augusta Pinochet, for example, serve as a warning against lacking PEP due diligence practices, and one that institutions disregard at their peril.

At the heart of the PEP issue lies risk; but to understand the need for PEP risk mitigation, its origins need to be examined.

Origins of PEP compliance

During the past couple of decades, several top financial institutions in the world learnt the value of PEP due diligence the hard way. Several Swiss banking houses suffered much public embarrassment relating to their dealings with Ferdinand Marcos, the Philippines’ infamous tenth president, and his family.

When it emerged that the dictator and his wife, the “Steel Butterfly”, had robbed the Philippine government of millions of dollars and deposited their loot in Swiss bank accounts, the resultant financial scandal and lingering bad publicity pointedly illustrated the need for knowing who your customers are, and to be aware of what they are doing financially. The scandal is generally credited as the birthing event of PEPs and PEP compliance legislation.

The term “Politically Exposed Person” has since been use in the Swiss banking community, and was originally created to define a category of high-profile clients that carries a measure of reputational risk. Within the financial services industry, PEP Due Diligence thus evolved from the need for an “early warning system” against reputational risk.

Over time, however, emerging Anti Money Laundering laws and PEP-specific legislation would make PEP Due Diligence a legal requirement for most regulated financial services providers.

But what are the qualifying criteria for being a Politically Exposed Person?

What exactly is a PEP?

According to the Financial Action Task Force (FATF), an inter-governmental regulatory body spearheading the implementation of global Anti Money Laundering (AML) and Anti Terrorist Financing (ATF) legislation, PEPs are past or current officeholders, or individuals who are or were formerly entrusted with high-level public functions in a foreign country. Examples of these positions of trust and power include senior politicians, heads of state or of government, senior judicial or military officials, important officials of political parties as well as senior executives of parastatals.

PEPs: More than just politicians!

In most cases, however, it is not the PEP that financial institutions should worry about, but rather their shadowy advisors, associates and frontmen. These individuals are at pains to conceal their true identity and constitute a reputational threat on account of whom they represent.

PEP concealment is used to gain access to the banking system, and can involve individuals, shell companies or other legal entities. As such, existing PEP definitions also include the family members, associates and anyone else who may benefit financially from their relationship with the primary PEP.

The Wolfsberg Group, an association of 12 leading international banks, broadened this definition to include individuals whose current or past official position can attract publicity beyond the borders of their home country, or whose financial actions or circumstances may be the subject of increased public scrutiny.

In short, a PEP is someone who’s previous or current public position situates them in close proximity to state coffers or related ‘cookie jar” opportunities.

What is a “sleeper PEP”?

During the period 2005 to 2007 alone, more than 310 elections and by-elections took place around the world – that’s an average of nearly 10 elections per month. (Source: ElectionGuide.org). This means that one or more of your existing clients may be elected to public office, and hence become politically exposed, without your financial institution knowing it!

These undetected PEPs in your client base are referred to as “sleeper PEPs”. Such existing clients pose a significant threat to your institution’s reputation, as no Enhanced Due Diligence has been done to assess whether they are involved in corrupt or fraudulent transactional activities.

The unfortunate reality is that pleading ignorance about your relationships with such tainted PEPs will not save your institution from bad publicity and lasting reputation damage – especially if it were to emerge that these clients were involved in corruption or terrorism financing, for example.

As such, routine and ongoing PEP risk screening is not only considered best practice, but is also a legal requirement. Find out more about PEP requirements for banks and other financial service providers.

Yet in practice, full compliance with every letter of PEP legislation has not come without major operational challenges. In the post-9/11 era, the proliferation of regulatory compliance laws, combined with the need to screen hundreds of thousands of users and accounts on a routine basis, has created a substantial administrative burden for banks, asset management houses, trust companies and related institutions.

The sheer magnitude of the due diligence challenge has subsequently led to the adoption of a so-called risk-based approach* to regulatory compliance, meaning that Enhance Due Diligence and ongoing scrutiny is required for heightened-risk client categories, and PEPs in particular.

*Low-risk persons or entities, once identified and confirmed as such, do not require additional or heightened scrutiny. Find out more about the risk-based approach to KYC.

What is the risk-based compliance approach?

Broadly speaking, the risk-based approach is a “lean solution” entailing the identification of a set of high-risk categories, and matching individuals and entities against these during the preliminary stages of due diligence. Should a person fall into one or more of the specified risk categories, advanced due diligence, also referred to as Enhanced Due Diligence (EDD), is then required.

Many operational PEP definitions are informed by the FATF PEP definition, yet the recent trend has seen also certain national and regional definitions becoming broader in their interpretation of what a Politically Exposed Person is. World-Check's PEP White Paper seeks to contribute to the refinement of the PEP definition, and will provide financial institutions for dealing with PEPs – especially in jurisdictions where politics and big business are closely related.

World-Check: A comprehensive PEP compliance solution

Featuring a database of tens of thousands of Politically Exposed Persons, robust data mining capabilities and the ability to bulk-filter entire client bases routinely, World-Check enables banks and other financial service providers to meet their PEP compliance obligations with ease and on an ongoing basis.

Significantly, it is not just the sheer number of profiles in our PEP database that counts, but also the system’s ability to identify and critically assess PEP risk.

About the World-Check PEP database

More than 70% of the Egmont Financial Intelligence Units (FIUs) have access to World-Check’s PEP risk intelligence. World-Check emphasises quality, rather than quantity, and sets out to aid organisations in identifying and mitigating actual PEP risk, rather than merely “ticking the boxes” and confirming the position of a Politically Exposed Person. Thousands of new profiles are added to the World-Check PEP database each month, whilst older ones are constantly updated as new public source data becomes available.

Widely recognised as industry pioneer and thought leader in the field of PEP due diligence and risk mitigation, World-Check CEO David Leppan is frequently called upon to address top-level industry conferences as a keynote speaker on PEP-related issues and challenges.

Find out more about this PEP intelligence solution, or contact World-Check with additional queries.