Politically Exposed Person (PEP): Meaning, risks & compliance

What is a Politically Exposed Person? Is "Politically Exposed Person" the same as PEP? What are the best practices and ways to manage the risks associated with PEPs?

For Designated Non-Financial Businesses and Professions (DNFBPs) and fintech firms operating in the modern financial landscape, understanding and managing PEPs is not merely a regulatory obligation. It is a critical component of robust anti-money laundering (AML) and anti-corruption strategies.

This article delves deep into the concept of PEPs, exploring their definition, the heightened risks they pose, and the essential compliance frameworks financial institutions must navigate to mitigate these challenges.

Understanding Politically Exposed Persons (PEPs)

The presence of Politically Exposed Persons within an institution’s client base significantly elevates its exposure to financial crime risks, particularly money laundering and corruption. Proper identification and management are non-negotiable.

What is a Politically Exposed Person?

A politically exposed person (PEP) refers to an individual who holds or has held a prominent public function.

This classification implies that, due to their position and influence, they inherently carry a higher risk of being involved in bribery or corruption.

The politically exposed person definition is broadly outlined by international bodies like the Financial Action Task Force (FATF). It typically includes:

• Heads of State or Government, such as presidents, prime ministers, or monarchs.

• Senior Politicians, including cabinet ministers and members of parliament or similar legislative bodies.

• Senior Government Officials, encompassing high-ranking civil servants, ambassadors, military officers, and senior judiciary members.

• Senior Executives of State-Owned Corporations, specifically leaders of entities where the state has significant ownership.

• Important Party Officials, individuals holding key positions in political parties.

• Senior Management of International Organisations, such as directors, deputies, and board members.

  
  

A crucial distinction exists between domestic and foreign PEPs:

• Foreign PEPs are those individuals holding prominent public functions in a country other than the one where the financial institution is located.

• Domestic PEPs hold such functions within the same country. While foreign PEPs have historically been seen as higher risk, many jurisdictions now apply similar stringent controls to both categories.

Characteristics of PEPs

PEPs are defined not just by their direct roles, but also by characteristics that extend their influence and potential risk. Common traits include:

• Access to public funds and assets: Their positions often grant them control or influence over significant public resources.

• Decision-making power: They hold positions that allow them to shape policies, award contracts, or influence financial flows.

• Global mobility: Many PEPs frequently engage in cross-border activities, further complicating due diligence.

The significance of family and close associates in PEP classification cannot be overstated.

A person's status as a PEP can extend to their immediate family members (spouses, children, parents) and known close associates (individuals closely linked socially or professionally).

This is because criminals often use these relationships to obscure the true beneficial owner of illicit funds.

Identifying these connections is vital for comprehensive risk assessment.

Politically Exposed Person examples

• A sitting Minister of Finance (foreign PEP).

• The Chief Executive Officer of a state-owned national oil company (domestic PEP).

• An Ambassador representing a country in another nation (foreign PEP).

• A judge on the Supreme Court (domestic PEP).

• The spouse of a Head of State (close associate of a foreign PEP).

• A close business partner of a high-ranking military official (a close associate of a domestic PEP).

What are the risks associated with Politically Exposed Persons?

The classification of an individual as a PEP automatically flags them for heightened risk, not because they are inherently corrupt, but due to their vulnerability to corruption and their potential for facilitating illicit financial flows through their positions.

The global scale of this challenge is vast. The United Nations Office on Drugs and Crime (UNODC) estimates that the amount of money laundered globally each year is between 2% and 5% of global GDP, or 800 billion to 2 trillion US dollars.

A significant portion of this often involves funds moved by or on behalf of PEPs.

Money laundering and corruption risks

PEPs are frequently linked to money laundering and corruption risks due to the opportunities their public positions present. They might:

• Abuse their power for personal gain through bribery or embezzlement.

• Misappropriate public funds through fraudulent schemes.

• Leverage their influence to facilitate illegal transactions for others.

Case studies highlighting risks posed by PEPs frequently appear in global headlines, from major bribery scandals involving state contracts to embezzlement of national resources by high-ranking officials.

These cases underscore the role of PEPs in facilitating illicit financial flows, often moving funds across borders to conceal their origin and ownership.

This makes their transactions a prime target for scrutiny by AML professionals. Fines for AML compliance failures worldwide continue to climb, reaching billions of dollars annually, with many directly or indirectly linked to inadequate PEP controls.

Regulatory challenges

Addressing the risks associated with PEPs involves navigating complex global regulatory frameworks.

The Financial Action Task Force (FATF) plays a pivotal role in setting international standards and FATF Recommendations that guide national regulatory authorities. These recommendations mandate that financial institutions apply Enhanced Due Diligence (EDD) to PEPs.

Local bodies like the Financial Crimes Enforcement Network (FinCEN) in the USA, the Financial Conduct Authority (FCA) in the UK and the Office of the Superintendent of Financial Institutions (OSFI) in Canada, alongside international organisations such as the United Nations Office on Drugs and Crime (UNODC), World Bank and International Monetary Fund (IMF), all contribute to shaping the global response to PEP related risks.

The implications of non-compliance for financial institutions are severe, ranging from hefty fines and reputational damage to imprisonment for individuals and loss of operating licences. These consequences highlight the critical need for robust AML obligations and comprehensive AML compliance programs.

Compliance best practices for financial institutions

Given the inherent risks, robust AML obligations are paramount for financial institutions dealing with PEPs.

Due Diligence requirements

The cornerstone of managing PEP risk is Enhanced Due Diligence (EDD) for PEPs. This goes beyond standard KYC procedures and involves:

• Obtaining senior management approval for establishing business relationships with PEPs.

• Taking reasonable measures to establish the source of wealth and the source of funds.

• Conducting ongoing monitoring of the business relationship.

Effective KYC procedures for identifying PEPs are the first line of defence. This involves accurate politically exposed person screening at onboarding, leveraging reliable politically exposed person list databases, and continuously updating these checks.

Manual processes for this can be incredibly time-consuming and error-prone, a key reason why global RegTech spend is projected to reach over $200 billion by 2028, reflecting a critical shift towards automated solutions.

Read also: The types of AML checks

Developing a robust compliance program

A comprehensive AML compliance program is vital, with key components, namely:

• Risk based approach: Categorising PEPs based on their risk profile; for example, country of origin, position, or source of wealth.

• Training and awareness: Regular training for all staff on PEP related risks, red flags, and reporting procedures.

• Ongoing monitoring: Implementing ongoing monitoring of PEP transactions to detect unusual patterns or high risk activities.

• Record keeping: Meticulous record keeping of PEP transactions and due diligence activities.

• Suspicious Activity Reports (SARs): Prompt and accurate filing of SARs when suspicious activity is identified.

FAQs

Who are considered politically exposed persons in the Philippines?

In the Philippines, the Anti Money Laundering Act (AMLA) and its Implementing Rules and Regulations define PEPs to include individuals who are or have been entrusted with prominent public functions by the Philippines, a foreign country, or an international organisation, as well as their immediate family members and close associates.

This generally covers heads of state, senior government officials, judicial or military officials, and senior executives of state-owned corporations.

Who are considered politically exposed persons in Singapore?

Singapore's Monetary Authority of Singapore (MAS) specifies in its AML/CFT notices that PEPs include individuals entrusted with prominent public functions, their family members, and close associates.

This covers a similar scope to FATF definitions, encompassing high-ranking government officials, judicial or military figures, and senior executives of state-owned enterprises, both domestic and foreign.

Who are considered politically exposed persons in the UAE?

The UAE's AML/CFT framework, aligned with FATF standards, defines PEPs broadly as individuals who are or have been entrusted with prominent public functions in a foreign country, in the UAE, or by an international organisation. This includes their family members and close associates. Financial institutions in the UAE are mandated to apply EDD to these individuals.

Is PEP a red flag?

Yes, being a PEP is inherently considered a red flag, indicating a heightened risk of corruption or money laundering. It does not mean the individual is involved in illicit activities, but it mandates enhanced scrutiny and due diligence from financial institutions.

Is once a PEP always a PEP?

Not necessarily "always", but the risk status often persists for a significant period after an individual leaves a prominent public function.

The FATF recommends a risk-based approach for former PEPs, considering factors like the level of influence held, the duration of their function, and the risks associated with the country or function.

Many jurisdictions mandate continued monitoring for a specified number of years after a person ceases to be a PEP.

How do I check my PEP status?

Individuals cannot directly "check their PEP status" through a single global database.

PEP status is determined by financial institutions based on their internal risk assessments and information gathered from public databases, commercial PEP screening tools, and due diligence checks.

If you are applying for financial services, the institution will likely conduct a PEP screening as part of its KYC process.

Conclusion

The complexities surrounding Politically Exposed Persons present a significant challenge for financial institutions globally. The broader impact on financial systems of unchecked PEP-related risks can lead to financial instability, erosion of public trust, and damage to a country's reputation.

Combatting financial crime effectively requires a multi-faceted approach where the role of transparency in combating financial crime is paramount.

For DNFBPs and fintechs, this means embracing cutting-edge technology and adopting a proactive stance. Robust PEP screening solutions and automated ongoing monitoring are no longer luxuries but necessities.

The necessity of vigilance in dealing with PEPs cannot be overstated.

By understanding the definitions, risks, and regulatory expectations, and by implementing sophisticated software tools for tracking and monitoring PEPs, financial institutions can move beyond basic compliance.

They can safeguard their operations, protect their reputation, and contribute to the integrity of the global financial system.

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