To understand the money laundering risks they face, financial firms need a robust and scalable approach to PEP identification and due diligence, says Refinitiv’s Michael Meadon.
The World Economic Forum estimates the global cost of corruption at USD 2.6 trillion, or 5 percent of global GDP. Adding to this, more than USD 1 trillion is paid in bribes by businesses and individuals each year, according to the World Bank.
“Corruption begets more corruption and fosters a corrosive culture of impunity,” UN Secretary-General António Guterres said in December 2018, revealing these alarming estimates and calling for transparency and international cooperation against corruption.
The United Nations Convention against Corruption (UNCAC), which entered into force in December 2005, is the only legally binding international anti-corruption treaty, and one of the primary tools available to the global community for combatting corruption.
Under Article 52 the UNCAC, jurisdictions must require financial institutions to conduct enhanced scrutiny of accounts sought or maintained by or on behalf of “individuals who are, or have been, entrusted with prominent public functions and their family members and close associates.”
Indeed, in February 2012, the Financial Action Task Force (FATF) adopted this as its definition of politically exposed persons (PEPs). “The main aim of the obligations in Article 52 of UNCAC is to fight corruption, which the FATF endorses,” it says in its PEPs guidance.
The guidance requires financial institutions to identify PEPs and assess the risk of those business relationships, in recognition that many PEPs are in positions that can potentially be abused for corruption, embezzlement, and related predicate offences of money laundering.
While the requirement to conduct due diligence on PEPs is a long standing one – the FATF first introduced mandatory requirements relating to PEPs in June 2003 – recent high profile corruption cases have brought the issue firmly back into the limelight.
Into the limelight
Last month, Malaysia’s High Court convicted and sentenced former Prime Minister Najib Razak to 12 years in jail and a fine of MYR 210 million (USD 49 million) in his first corruption trial involving state-owned wealth fund 1MDB. Najib was found guilty of criminal breach of trust, money laundering and abuse of power. While a stay of execution was granted pending appeal, he faces dozens of other charges in four additional trials linked to 1MDB.
“We have come a long way in the last quarter of a century,” says Michael Meadon, Proposition Sales Director, Risk for Asia Pacific at Refinitiv. “As recently as 1996 the OECD had to issue a recommendation to disallow the tax deductibility of bribes for foreign officials – then a not uncommon practise. Then we had the UNCAC, and now all these years later we’re starting to see senior politicians – potentially at least – going to jail.”
“While partial and uneven to be sure, this is just one illustration of how far norms and expectations have come – all the way from explicit state facilitation of foreign bribery, to looking the other way, and then to condemnation and enforcement.”
Elsewhere, Angola’s Supreme Court has just convicted the son of former president Jose Eduardo dos Santos for fraud, sentencing him to five years’ imprisonment for stealing USD 500 million from the national sovereign wealth fund. Other high profile corruption trials still ongoing are those of South Africa’s former president Jacob Zuma and Israel’s current prime minister Benjamin Netanyahu.
One former president that has already spent time in jail is Brazil’s Luiz Inácio Lula da Silva, who was convicted on charges of money laundering and corruption in July 2017. After a failed appeal, he was jailed in April 2018, and released less than two years later on procedural ruling that will allow him to exhaust all his appeals. He served 580 days of what was supposed to be a 12 year sentence.
Meanwhile in China, a major crackdown on corruption has been underway since 2012. It was recently reported that over 18,500 people were prosecuted in 2019 for crimes related to corruption, representing a 90 percent increase year-on-year. Over the year, a total of 25,000 trials involving corruption, malfeasance and bribery were concluded, resulting in 29,000 convictions.
A rising focus on PEPs
In line with the heightened focus on corruption and bribery at the government level, Asia Pacific regulators have likewise been cracking down on failures by financial firms to comply with rules around PEP identification and monitoring – in recognition of the risks business relationships with such individuals can entail.
In July this year, MAS (Monetary Authority of Singapore) revoked the capital markets services licence of Apical Asset Management for breaching AML/CFT requirements. Among its deficiencies, the firm failed to conduct enhanced monitoring of a fund related to a PEP for a “significant length of time”, the regulator had said.
In the same month, MAS also penalised a trust and corporate services provider SGD 1.1 million for AML/CFT breaches. This included failures to inquire into the background and purpose of unusually large transactions undertaken by PEPs. The firm also did not file suspicious transaction reports for the transactions.
In New Zealand, the FMA (Financial Markets Authority) issued a rare public warning for contraventions of AML/CFT laws by an online brokerage, including for its failure to conduct PEP checks. In one instance were a PEP was identified, there was no record of senior management approval for continuing the business relationship.
A Hong Kong brokerage was also penalised by the SFC (Securities and Futures Commission) earlier this year for failures relating to PEP identification, among other AML/CFT breaches. The firm was said to have not put in place adequate and effective screening procedures for the identification of PEPs.
More is better
According to Meadon, financial firms need to have an institutional risk-based approach and they need to intimately understand the money laundering risks they face, given the products that they have, the clients they have, and the geographies and political and legal arenas in which they operate.
In particular, he recommends a robust and scalable approach to PEP identification and due diligence, encompassing three critical components. First, firms need to allow for customers to self-identify as a PEP in their standard KYC processes. While this may be prone to both false positives and false negatives, it forms just one in a series of controls.
Second, financial firms need to have a robust screening programme that is able to run all customer names against a database of known PEPs, on a daily basis. This also involves additional processes to identify true matches, add that customer to an internal PEP register, conduct enhanced due diligence and monitoring, and obtain senior management approval for the relationship per FATF’s guidelines.
Finally, though less common, Meadon suggests the use of transaction monitoring systems to identify previously unknown PEPs based on the account activity of existing PEPs. “You can discover PEPs through transaction monitoring that you otherwise would never be able to detect, including family members, financial advisers and other business associates,” he said.
Given the highly specific and complex nature of their operations and the current environment, Meadon says most banks are already ramping up their PEPs controls, taking the approach that “more is better, even if it drives up the cost of compliance.”
To learn more about how to mitigate the money laundering risks of PEPs, register for this webinar.