Politicians and other high-profile public officials are especially vulnerable to criminal behavior since they wield significant power and have access to a wealth of resources. Therefore, screening for politically exposed persons (PEPs) helps financial institutions identify and manage the risks related to doing business with PEPs.
But while all PEPs are susceptible to illicit activity and money laundering, not all PEPs are equal: some PEPs may be considered higher risk than others and may warrant additional scrutiny. Recognizing this, governments and financial institutions take care to make a distinction between PEPs — specifically between foreign and domestic PEPs.
Further, although some countries may publish PEP lists, the Financial Action Task Force (FATF) warns against relying on them, as “[lists of actual names] are quickly outdated, difficult to manage, costly to maintain, and do not contain family members or close associates.” In general, these lists — whether they contain actual names or simply the position titles — also depend on the publishing country’s interpretation of a PEP, which may vary and may not appropriately or consistently capture a financial institution’s risk level.
Financial institutions must, therefore, understand the difference between these two types of PEPs and the associated AML/CFT risks, as this will impact screening and business decisions.
While there is no official, universally agreed-upon definition of what constitutes a foreign PEP, most countries align their definition to the one laid out by FATF, which classifies foreign PEPs as “individuals who are or have been entrusted with prominent public functions by a foreign country.” These individuals, according to FATF, include:
- Heads of state and/or government;
- Senior politicians;
- Senior officials of the government, judiciary or military;
- Senior executives of state-owned corporations; and
- Important political party officials.
In general, doing business with foreign PEPs, as opposed to domestic PEPs, is considered to carry a higher risk, and thus requires greater scrutiny. This is due to the fact that the financial institution is less likely to have a profound understanding of the various nuances of the foreign country’s political landscape and, therefore, of the PEP’s exposure to or ability to exploit possible corruption.
It’s also important to note that financial institutions in certain markets, such as large urban centers that see a lot of global commerce — New York, Washington, D.C., London, Hong Kong, and so on — may deal with quite a few foreign PEPs. Other smaller or more regional institutions may seldom come across a foreign PEP, if at all.
Nevertheless, regardless of their usual clientele, all financial institutions must carefully consider why a foreign PEP may want to do business outside their home jurisdiction and take reasonable steps to determine their source of wealth and funds during onboarding. This may include, pending legal and privacy concerns, verifying the information gathered during the customer due diligence process with FIs in the PEP’s local region.
Domestic PEPs, on the other hand, are those persons who, as FATF defines, “are or have been entrusted domestically with prominent public functions.” Unsurprisingly, the same public functions that are included within the foreign PEP definition are included here as well. The difference is only a matter of which country has appointed or elected the individual to his or her post.
It’s worth noting that, as the Association of Certified Anti-Money Laundering Specialists (ACAMS) points out, there is a “second tier” of domestic PEPs — that is, those at the state (or provincial) level — that should also receive additional scrutiny. The same applies to “local political leaders and law enforcement,” which, according to ACAMS, present “the biggest challenge.”
Finally, while domestic PEPs are generally considered less risky when compared with foreign PEPs, financial institutions will likely come across more domestic PEPs in the course of doing business than foreign ones simply due to geographic proximity. Furthermore, it may be more difficult to discern initial red flags, given that it is natural for domestic PEPs to want to do business in their home jurisdiction.
To determine the risk level each PEP poses, financial institutions must apply a risk-based approach that weighs not just whether a PEP is foreign or domestic but rather takes a holistic view of the PEP. Just a few of the additional factors to consider include:
- The PEP’s jurisdiction: Does it generally experience low or high levels of corruption? How politically stable is it and does it have strong checks and balances?
- The nature of the PEP’s position: Access and influence levels vary from PEP to PEP and position to position. A mayor doesn’t have the same level of exposure as a president. Where do the PEP’s access and influence fall on the spectrum?
- The PEP’s business objectives: What products or services does the PEP wish to use? Are they high-risk or low-risk?
- The PEP’s spending behavior: Does the PEP’s spending behavior align with the salary and sources of wealth associated with their position?
- Adverse or negative news about the PEP: Does performing an adverse media check on the PEP surface any kind of unfavorable news related to criminal behavior? Make sure to review a range of trusted news sources. The search should be global in scope but also include articles in the PEP’s local region.
- A PEP’s relatives and close associates (RCAs): Who does the PEP associate with personally and professionally? Sometimes the PEP may not turn up any major red flags, but a relative or close associate does.
Financial institutions must carefully consider each PEP vis-à-vis the institution’s AML/CFT risk management approach. This includes proactively monitoring the business relationship even post-onboarding and perhaps applying more rigorous rules for certain transaction patterns. It’s, therefore, critical that these institutions implement screening processes that provide the most up-to-date information possible at all times. This requires the use of flexible, automated screening tools that are updated daily and can help financial institutions apply their approach consistently across their business.