In most global jurisdictions, the Know Your Customer (KYC) process is a foundational component of AML/CFT regulations. KYC requires banks and other financial services providers to establish and verify the identities of their customers in order to assess the money laundering risk that they present and understand their transactional behaviour. However, those same verification measures are also necessary when financial institutions deal with other businesses as part of a supply chain, stakeholder, beneficiary or similar relationship. In this context, that verification process is referred to as Know Your Business (KYB).
KYC laws have been a standard AML obligation around the world for decades and were introduced in the United States in 2001 with the USA Patriot Act in order to help detect and prevent terrorism financing activities. At the time, however, businesses that were regulated under the Patriot Act were not required to subject the businesses that they had relationships with to the same AML/CFT scrutiny. That disparity created a blindspot that criminals were able to exploit, using financial relationships between businesses to conceal their identities and launder money.
In 2016, the US’ Financial Crimes Enforcement Network (FINCEN) addressed the AML blindspot by introducing Know Your Business rules in its Customer Due Diligence Requirements for Financial Institutions (also known as the CDD Final Rule). Other global regulators introduced similar regulations: the EU’s 5th Anti Money Laundering Directive (5AMLD), for example, emphasized KYB processes, with the forthcoming 6AMLD set to increase the penalties and punishments for KYB noncompliance.
What Does Know Your Business (KYB) Mean?
Know Your Business has the same objective as KYC in the sense that it is a way for obligated entities to assess and understand the AML/CFT risk that new and existing business relationships pose. The KYB process should enable firms to examine the entities that they are dealing with and help them to determine whether they are authentic or are being used to conceal the identities of owners for illegitimate purposes.
Accordingly, KYB should focus on ultimate beneficial ownership (UBO) in order to reveal who is benefitting from their financial activities of suspect businesses. Criminals or other high-risk individuals may, for example. set up businesses in low regulation, offshore jurisdictions in order to deal anonymously with legitimate businesses in other parts of the world and avoid the scrutiny of standard AML/CFT measures. Similarly, firms must know whether a business, or its employees, are subject to international sanctions, have been exposed to political corruption, or have been the subject of news reports that could indicate they are involved in criminal activity.
Although specific regulations vary by jurisdiction, KYB regulations generally require firms to perform suitable due diligence, collecting and analysing a range of data and information on the businesses with which they have relationships. In order to establish beneficial ownership, KYB regulations may require identifying information such as:
- Company address
- Registration documents
- Licensing documentation
- Identities of directors and owners
Firms may refer to a range of official and private resources in order to conduct KYB checks. These include publicly available government registries and records and global corporate registries. In establishing the identities of individuals that are employed by or associated with businesses, it may be necessary to collect official materials such as passports, driving licenses, and bank statements, along with proofs of addresses and dates of birth.
KYB goes beyond the need to establish UBO and should be considered an ongoing AML process. This means that firms must conduct KYB throughout a business relationship, regularly checking businesses against sanctions lists, for political corruption exposure, and for any other indication that they might be involved in financial criminal activity.
In order to comply with FINCEN KYB regulations, and similar regulations imposed in jurisdictions around the world, firms must implement risk-based AML programs. In practice, that means that firms should assess the level of risk that their business relationships present and deploy a proportionate AML response, involving some or all of the following controls:
- Due diligence: Firms should perform suitable due diligence on the businesses with which they have relationships in order to establish and verify UBO. Where there is an increased AML risk, firms should perform enhanced due diligence, subjecting businesses to an increased degree of AML scrutiny.
- Transaction monitoring: Certain transactional behaviors may indicate that a business is involved in money laundering or terrorist financing activity. Unusual frequencies or volumes of transaction, transactions just under reporting thresholds, or transactions with high risk countries often represent money laundering red flags.
- Sanctions screening: Firms should screen businesses and their employees against international sanctions lists such as the OFAC sanctions list, the UN sanctions list, and the EU sanctions list.
- PEP screening: Businesses that are exposed to political corruption may present an increased level of money laundering risk. Accordingly, firms should screen businesses to establish their politically exposed person (PEP) status.
- Adverse media monitoring: Firms should monitor businesses for their involvement in adverse or negative news media stories that might indicate their involvement in criminal activity. The monitoring process should be ongoing and include traditional screen and print media and online sources.
The KYB process requires firms to collect, analyze, and manage vast amounts of data on the businesses that they have relationships with. Performing KYB checks manually involves significant time and labor costs and increases the potential for costly human error. To overcome that challenge, firms should seek to implement an automated KYB solution, integrating smart technology tools into their AML/CFT infrastructure to perform the necessary checks and processes faster and more efficiently than a human compliance employee ever could.
Beyond the speed and efficiency benefits of automation, smart technology AI and machine learning tools can help financial institutions spot patterns in their AML data, and react to suspicious changes in the behavior of businesses and their employees more accurately and effectively. Finally, by integrating smart technology into the KYB process, firms will be able to better adapt to changes in regulation (such as the upcoming 6AMLD) or in criminal methodologies, and continue to provide a high standard of KYB compliance in the future.