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Defining the PEPs: Politically Exposed Persons (PEPs) are individuals who are, or have been, entrusted with prominent public functions, such as heads of state or government.1 A considerable number of jurisdictions expect financial institutions to treat a prominent public official's family and close associates as PEPs.2
DOMESTIC AND FOREIGN PEPS The existing PEP definition excludes domestic PEPs, family members beyond immediate family, and junior and middle-ranking PEPs. The core definitions too are restrictive (for example, including only immediate families and close associates) and these facts are likely to create loopholes.
In the international definitions relating to PEPs, the lack of clarity is confusing and, has frustrated implementation efforts. The lack of a clear definition may be used as an excuse for failing to take any action by a jurisdiction, regulatory authority, or a bank.
A consistent requirement does not exist on the issue of whether PEPs standards apply to foreign PEPs, or domestic PEPs, or both. The FATF 40+9 Recommendations apply the PEPs provisions to foreign PEPs only, although an interpretive note encourages countries to extend the requirement to domestic PEPs.3 The Third EU Directive, while not distinguishing between domestic and foreign PEPs in the definition, only requires EDD for foreign PEPs.4
Conversely, United Nations Convention Against Corruption, UNCAC does not distinguish between foreign and domestic PEPs which has the effect of requiring that State Parties mandate the application by financial institutions of EDD to both foreign and domestic PEPs.5 UNCAC has been signed by 140 States Parties, none of which have made a reservation to Article 52(1) - which means that all parties are obliged to enact measures for "enhanced scrutiny of accounts" for both domestic and foreign PEPs.
Despite international obligations under UNCAC, most legislators have made a political decision not to classify domestic office holders as PEPs. Still, banks in some jurisdictions are expected to consider, on a risk-sensitive basis, whether domestic PEPs customers pose a threat similar to that of their foreign counterparts.6
Whether the PEP is domestic or foreign the legal and reputational risks remain the same. PEPs controls are designed to draw attention to, and mitigate, the increased money laundering risk posed by this category of customers. While corruption is more prevalent in some countries than in others, domestic politicians are subject to the same pressures and perverse incentives as their foreign counterparts and should be treated accordingly. In some cases, the corrupt money may enter the financial system first through a bank in the victim country, and then through the correspondent relationships into the major banks in larger financial centers.
Many of the banks having corrupt PEPs as their clients do not distinguish between foreign and domestic PEPs. They think that a distinction makes little business sense and that it is easier to set up systems to include both domestic and foreign PEPs. It is easier to identify domestic PEPs. Institutions are also concerned about the reputational risk by banking a corrupt PEP, and that risk exists equally among domestic and foreign PEPs.
FAMILY MEMBERS AND ASSOCIATES Members of a corrupt PEP's family, or their associates, undertake transactions and apply for goods and services on behalf of a PEP. For that reason a PEP definition should include close associates and family members in addition to the prominent public official. This raises the issue of how to define these two categories.
Unfortunately, family and close associates are defined differently among the standards. UNCAC includes as close associates both persons and companies that are related to the individual entrusted with the prominent public function, whereas the FATF 40+9 Recommendations are silent on the issue.7 The Third EU Directive also provides clarification by adding joint beneficial ownership of legal entities or legal arrangements.8 Regarding family members, UNCAC and FATF do not limit the degree of relationship, while the Third EU directive focuses on immediate family members.9
WHO ELSE IS INCLUDED IN PEPS DEFINITION? A number of jurisdictions have attempted to provide direction to financial institutions and regulatory authorities on these definitions by setting out specific categories of positions. Banks also include additional categories in their definition of PEPs, going beyond the requirements under law or regulation. Senior decision makers from international and supra-national organisations, public associations, media, religious organisations, and public enterprises and undertakings were associated by some banks for this purpose.
The Wolfsberg Group has outlined a number of additional categories, including heads and other high-ranking officers holding senior positions in the armed forces, members of ruling Royal Families with governance responsibilities, senior executives of state-owned enterprises, and senior officials of major political parties.
Heads of supranational bodies (eg, UN, IMF, The World Bank), members of parliament, senior members of the diplomatic corps, members of boards of central banks may also be considered to fall within the definition but may be excluded on a risk-based approach.10
a- Have appropriate risk management systems to determine whether the customer is a politically exposed person.
b- Obtain senior management approval for establishing business relationships with such customers.
c- Take reasonable measures to establish the source of wealth and source of funds.
d- Conduct enhanced ongoing monitoring of the business relationship.
IDENTIFICATION OF PEPS The identification of PEPs requires effective Customer Due Diligence (CDD) processes, including the identification of beneficial owners. Building on this requirement, financial institutions have to place appropriate risk-management systems for determining whether a customer is PEP or not.
A bank should have risk management systems to identify if the customer is PEP, by asking necessary questions, performing a database check, referring to publicly available information, and so forth.
Banks are required to check whether a potential customer, existing customer, or beneficial owner, is PEP. This check is often made before the establishment of a business relationship; the account could not be opened until all relevant investigations, such as beneficial ownership and PEPs identification take place.
Once PEP has been identified, senior management decides whether to continue the business relationship, and if so, apply Enhanced Due Diligence (EDD) measures in line with national legal and regulatory requirements.
IDENTIFICATION TOOLS Some of the processes that can be used to help identify PEPs include the following:
---- Customer due diligence.
---- Transaction monitoring and ongoing monitoring.
---- Business knowledge.
---- Group compliance.
---- Commercial PEP database
---- Asset and income declaration filing lists.
---- Media and journals.
---- The Internet and search engines.
RISKS ASSOCIATED WITH PEPS PEPs are one of the high-risk categories of customers, particularly with regard to Money Laundering (ML). Business relationships with PEPs may represent high risks for FIs and DNFBPs as a result of assuming positions through which they might become vulnerable to, get involved in, or misuse their power and influence for, personal gain or the gain of family members or close associates. They might also or misuse or appropriate public funds. Such individuals might also use their families or close associates to conceal funds or assets resulting form the abuse of their official positions. In addition, they may also use their power and influence to access or control legal entities for similar purposes;
The failure to apply CDD may expose them to significant reputational, legal or operational risks. Persons with political and public positions are therefore considered to belong to a ML high-risk category of customers.
If PEP becomes involved in a criminal activity, this traditional discretion often becomes an obstacle to detecting or investigating such crimes. Diplomatic immunity may also constitute a further obstacle in certain cases relating to these persons, given that this immunity may enable them to easily bring their funds out of their country of origin. In addition, PEPs often resort to other parties (such as associates, friends, family members or intermediaries) to execute financial operations on their behalf. This adds to the level of risk related to then in connection with ML/TF.
VARIABLES AFFECTING THE RISK LEVEL:
---- Politically exposed person's nationality
---- Person's position, authority and powers
---- Business relationships volume and complexity
---- Types of products or services offered
---- Foreign parties dealt with
CHALLENGES CONFRONTING APPLICATION OF ENHANCED CDD MEASURES The difficulty to apply enhanced CDD measures on PEPs undoubtedly increases the level of risks related to them. Reviewing the PEPs definition, it includes that business relationships with family members or close associates of PEPs involve reputational risks similar to those of PEPs themselves. Thus, the financial institutions and Designated Non-Financial Business and Professions (DNFBPs) face serious difficulties in identifying family members or close associates of PEPs correctly.
In addition, the difficulty increases when certain alterations occur as per the current (existing) customer's status, for example when he/she becomes PEP after promotion, elections, or marriage. Therefore, the failure to apply enhanced CDD measures may result from the financial institutions' and DNFBPS' failure to know PEP's family members, relatives, partners or changes that occur to his/her occupational or social status. It might also result from the customer failing to submit important/valuable information or giving insufficient/misleading/wrong information or details.
RISK MANAGEMENT AND MITIGATION The application of enhanced CDD measures when dealing with PEPs does not mean ceasing the establishment or entry into business relationships with these persons, as they are not criminals, terrorists, money launderers or drug traffickers. No legislation in any FATF or FSRBs countries prevents dealings with them. However, it is necessary for financial institutions and DNFBPs to realise the risks connected to them and deal therewith in an appropriate manner.
THE RISKS RELATED TO PEPS MAY BE MITIGATED THROUGH THE FOLLOWING:
1) To get more information about these persons and their family members and associates, and adopt enhanced CDD measures to identify them and monitor their transactions in a scrutinised appropriate manner. The enhanced CDD measures applied to identify them may include the following:
---- Identify the customer and the beneficial owner.
---- Know the customer's country of residence.
---- Review resources (such as available lists of names) to determine whether the customer is a PEP.
---- Obtain information directly from the customer concerning the possibility of him becoming PEP.
---- Know the objective of opening the account and the volume and nature of the activity expected for the account.
---- Obtain information on the occupation and the other income sources.
---- Know the source of wealth and funds.
---- Obtain information about the direct family members or associates who have the power to conduct transactions on the account.
2) Apply the "Know Your Customer" program, by setting the appropriate procedures and verifying their efficiency.
3) Bank and FIs compliance departments should be responsible for the assessment of compliance with policies and procedures relating to the identification and verification of customers and beneficial owners. In general, those controls may include:
---- Identify PEPs and accept dealing with them under the same procedures applied on new customers.
---- Enhanced CDD measures should be applied on anyone who has become PEP.
---- Verify the application of the CDD measures, risk assessment, and to apply proper controls.
---- Application of KYC procedures and on the manner how they should deal with PEPs and all relevant procedures. The training should also include new and old employees in all departments, focusing on the methods of verifying the customer's identity by the staffs who directly deal with the customers.
DEALING WITH PEPS
1. Laws, regulations, or other enforceable means are required to include a specific definition for PEPs. This definition should be in agreement with the one stated in the glossary annexed to the FATF 40 Recommendations.
---- Identifying categories regarded as family members: to comprise for example the direct family members including the spouses, children, parents, siblings, and may be also extended to include the in-laws.
---- Identifying close associates: to include close co-workers who are widely known and/or personal advisors, particularly financial consultants or persons representing the PEP in the financial operations.
---- If one of the family members, or close associates is involved in the management or supervision of or presidency of a legal person, this legal person should be subject to the same enhanced CDD measures applied on the PEP without being classified as such.
---- Factors may include the official responsibilities of the post, the position title, the level of power and authority associated with the position, and whether the person has the financial authority allowing him access and control over government funds or assets.
---- Some other factors are worth consideration such as the nature of the position, the powers and the authorities associated with the position (mainly the financial ones), the period during which the person remained in this position, his reputation and other elements. In general, removing a name from a PEP list should be subject to a suitable level of senior management reviewing and approval, it should also be documented.
2. Expanding the definition to include local PEPs is considered.
3. PEP category's definition is not extended to include medium and junior levels but rather concentrate on senior PEPs.
4. FIs and DNFBPs should ordinarily apply internal procedures on ways to deal with those lists and benefit from them in an efficient way to identify PEPs, such as:
---- Internal database containing the names of the PEPs.
---- Screening the names of the customers against the database to identify the status of PEP.
5. Supervisory authorities for FIs and DNFBPs may carry out the following:
---- Set the bases for the supervisory practices that govern the KYC programs and apply their procedures.
---- Observe the compliance of FIs and DNFBPs with the requirements of dealing with PEPs and draw the appropriate systems to manage the risks related thereto.
---- Identify the financial institutions and DNFBPs that do not set these systems, oblige them to take quick steps to comply, and conduct intensive follow-up in this respect.
---- Pay more attention to the application of set procedures by FIs and DNFBPs via their on-site inspection visits.
6. Countries should sign, ratify and fully implement the 2003 United Nations Convention against corruption.
7. Competent authorities should provide lists of examples of the major transactions that could be executed by PEPs to FIs and DNFBPs to identify unusual transactions or such operations that may involve money laundering or terrorist financing. These lists may comprise the following for instance:
---- The PEP requests the execution of an operation through another institution or company that does not usually deal with foreigners.
---- The PEP requests that the operation be kept secret, eg by requesting it be registered in the name of another person or company.
---- The PEP executes several operations through more than one geographic area to conceal the nature, source or ownership of the funds.
---- Significant or frequent transfers of funds.
---- The PEP repeatedly reduces the balance of his account to the minimum.
FURTHER READINGS
1. Financial Action Task Force (FATF) 40 Recommendations on AML.
2. Interpretative notes to the 40 recommendations.
3. AML/CFT Methodology 2004.
4. FATF typologies reports.
---- Money laundering typologies report 2001-2002
---- Money laundering typologies report 2003-2004
5. Customer Due Diligence for Banks, Basle Committee, October 2001.
6. General Guide to Account Opening and Customer Identification, Basel Committee, February 2003.
7. Wolfsberg AML Principles frequently asked questions with regard to Politically Exposed Persons.
8. Politically Exposed Persons (PEPs): Good practice/FSA.
9. Bank Secrecy Act Anti-Money Laundering Examination Manual, "Politically Exposed Persons- Overview"/Federal Financial Institutions Examination Council Bank Secrecy Act/Anti-Money Laundering InfoBase.
10. "PEPs Moving Forward", a discussion paper, David Leppan, CEO and founder of World-Check.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)
1. FATF Glossary; Article 52(1), UNCAC.
2. FATF Glossary; Article 52(1), UNCAC
3. UNCAC, Article 52(1); FATF 40 Recommendations, Recommendation 6 and Interpretative Note to Recommendation 6.
4. Third EU Directive 2005/60/EC, Article 13(4).
5. UNCAC, Article 52(1).
6. One country imposes requirements for domestic PEPs only. Mutual evaluation reports from jurisdictions with laws, regulations or guidance addressing foreign and domestic PEPs at the time of their most recent mutual evaluation report include Antigua & Barbuda, Argentina, the Bahamas, the British Virgin Islands, Bulgaria, Cape Verde, the Cayman Islands, Dominica, the Gambia, Grenada, Haiti, Indonesia, Malawi, Mauritius, Mexico, Montenegro, Pakistan, the Philippines, Qatar, Sierra Leone, South Africa, Thailand, United Arab Emirates, and the Virgin Islands. Brazil, although not included in the sample group, also imposes requirements for both foreign and domestic PEPs.
7. United Nations General Assembly Fifty-eighth session, "Report of the Ad Hoc Committee for the Negotiation of a Convention against Corruption on the work of its first to seventh sessions: Interpretative notes to the official records (travaux préparatoires) of the negotiations of the United Nations Convention against Corruption (United Nations, New York, October 7, 2003) A/58/422/Add.1, para 50.
8. Dir 2006/70/EC, Article 2(3).
9. Which may not be sufficient in cultures and jurisdictions in which the extended family maintains very close ties. UNCAC does not list categories of PEPs, however FATF does.
10. "Wolfsberg Frequently Asked Questions on Politically Exposed Persons," May 2008.

Copyright Business Recorder, 2012

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