PEPs: Mitigating Risks for Businesses in a Complex Regulatory Landscape

Those who hold more power are more likely to abuse it.  Because of their position in society, they are prone to engage in corruption or money laundering. As a result, the international community is paying more attention to politically exposed persons (PEPs).

These are people who significantly impact their nations or international organisations. Financial institutions are obliged to check such individuals to prevent illegal transactions.

In this article, we'll look at the role and possible implications of PEP clients for businesses. 

Who Is Considered a Politically Exposed Person?

The term PEP comes from the financial regulation area. It denotes a category of persons who hold a high position in the country's political system or executive power.

Due to their role and influence, these people may be involved in corruption and bribery. Thus, financial monitoring authorities pay special attention to their financial activity.

Determining whether a person is politically exposed can be challenging. 

First of all, there are no clear criteria for how long PEPs hold their status. In other words, there are no clear timelines during which a person is considered politically exposed after the end of their term.

The second complication is a lack of universal definition between jurisdictions, which is especially challenging for companies operating in many countries.

PEP meaning in the UK

There is no single definition of a PEP in the world. Most often, countries are guided by the terminology of the Financial Action Task Force (FATF), which defines PEP as “an individual who is or has been entrusted with a prominent function.”

Based on this broad description, each country interprets this concept differently. For example, in the UK, the term is enshrined in Article 35 (12) of The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017).

This law describes in detail under what conditions a person should be classified as a PEP. These persons hold the highest positions in the state and international organisations. Here are some examples:

• State leaders.
• Ministers and Deputy Ministers.
• Members of Parliament.
• High-ranking figures in the banking system and defence ministries.
• Senior judiciary officials.
• Ambassadors and heads of international organisations.

In addition, family members and close associates of such individuals also belong to the category.

Types of Politically Exposed Persons

FATF classifies PEPs into several categories, depending on where they hold/have held significant positions:

• Foreign PEPs are influential citizens from other countries,
• Domestic PEPs refer to people in power within their own country,
• International organisation PEPs are key figures within international organisations.

Family members and close associates are also considered PEPs, as they are closely connected to the individual in question either through family or personal/professional relationships.

Risk levels

Not all PEPs pose the same threat of financial crimes. We can categorise them as high or low risk.

Here are some indicators to look at:

1. The country of origin. For lower risk, PEPs should operate in a country with strong institutions, low corruption, and transparent disclosure requirements. Also, politically exposed foreign persons (PEFPs) are usually considered riskier than domestic PEPs.
2. The position that the person holds. The more power an official has, the greater the potential for unlawful activities. A public figure with no direct executive power, such as an opposition MP, would be considered low risk as opposed to the head of the state.
3. The period after post-resignation. The UK typically considers a lapse in PEP status of at least 12 months to be less risky. 
4. Consistency of income and lifestyle. If a person’s wealth largely extends the funds they officially earn, it may be a sign of corruption.

Use FCA guidance to find more risk factors. 

The Law on PEPs

The Financial Action Task Force is a global organisation that establishes and oversees guidelines to prevent ML/FT crimes. 

Over 200 jurisdictions around the globe adhere to FATF recommendations and integrate them into domestic legislation. 

On the EU level, the main legal acts on PEPs are represented by AML Directives.

In the UK, the main law governing the matter is The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

According to the document, regulated financial organisations should check clients under the PEP category, and take extra effort in the form of enhanced due diligence for high-risk individuals. This means companies should analyse any suspicious activity and ask for additional information.

Companies in the UK are obligated to report any suspicious activity found during client verifications to the National Crime Agency. 

The Financial Conduct Authority (FCA) is a state regulator in the financial area, which, among other things, provides guidance on issues concerning PEPs. 

FATF rates the UK as compliant with its recommendations on politically exposed persons. 

PEP in AML

Governments and the financial sector devote a special role to PEPs in money laundering efforts. Verification of clients is essential for preventing illicit activities, and operations with sanctioned regimes and corrupted political figures. 

In light of the scale of the problem, countries are tightening regulations and enforcing higher fines for violations. 

Last year, worldwide penalties imposed on companies for not adequately preventing ML crimes increased by over 50%. 

Trading and banking industries were among the most affected, with a volume of fines of $6 billion and $2 billion respectively.

Thus, failing to meet the requirement is very costly for firms. It may have other negative implications, such as reputational damage and loss of reputable customers.

As of now, the protocol for UK firms in terms of AML/PEP compliance consists of three steps. 

1. When verifying a client as politically exposed, an employee must obtain approval from higher-ranking executives for proceeding with the business partnership. 
2. They also need to implement sufficient measures to identify the origin of wealth and funds. 
3. Lastly, the organisation has a responsibility to constantly oversee such business relationships.

There are several important notes for firms dealing with PEP clients. They need to remember that the status in itself does not indicate that person committed any crimes. It only indicates the need for closer inspections.

In addition, companies need to follow a risk-based approach when dealing with their new persons. This is a pillar principle in financial monitoring, which suggests that each case is unique and should be approached differently. The greater are anticipated risks, the more thorough check is needed.

For some clients, it may be reasonable to lose monitoring efforts once they resign from office. For others, the "once a PEP - always a PEP” principle is more applicable. Some individuals would be considered safe to work with after initial verification, while others would require enhanced due diligence.

How Can LIGA UNITED Help?

LIGA UNITED is a solution which combines multiple information streams to verify the credibility of companies.

Here are some details that you can find within a seconds to be sure about your clients:

• Company dossier with key registration information,
• Information on beneficiaries and officers,
• The history of the company changes,
• Presence in sanction lists and toxic trace,
• Trade activity and latest financial performance,
• Negative media mentions,
• Graphic tool for searching business links, even if they are hidden under the long chain of intermediaries,

With our analytical solution, you can make informed decisions when working with new companies and easily monitor any updates. Book your demo today to test all the features.

Final Thoughts

Working with individuals taking high posts requires special attention from businesses. Governments worldwide are tightening regulations and increasing penalties to reduce ML crimes. 

Many companies struggle with this task since there are no uniform definitions across jurisdictions, nor is there a "universal recipe" for handling such categories of customers.

IT solutions streamline the process, as you can run checks in minutes and automatically track updates.