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PEP and Sanction Checks Explained - Customer Due Diligence 101
Despite increasingly strict regulations, upwards of 2 trillion USD are laundered worldwide – every year. As an essential part of Customer Due Diligence (CDD), PEP and sanction checks help protect banks and other financial institutions from engaging with high-risk individuals and entities, ultimately helping prevent money laundering and terrorist financing.
Therefore, PEP and sanction screening must be performed as part of the Know Your Customer (KYC) or Know Your Business (KYB) protocol. In this article, we’re going to look at both PEP and sanction checks, discuss how they are performed, the challenges that can occur when performing them and how banks can utilise software to remain compliant.
What is a PEP and why are they important?
A Politically Exposed Person or PEP is an individual that currently or has in the past held a prominent public position. For example, the head of state, a member of parliament, a city mayor, and so on.
The reason this is important is because such positions typically offer the individual a certain amount of influence and access to public funds. Therefore, said individuals are at a higher risk of money laundering and similar financial crimes. Furthermore, since they are public figures and parts of their personal information are available to the public, there’s a higher risk of someone impersonating them in order to commit fraud.
For these reasons, even people related to a PEP, or individuals with close business relationships with one, will typically get flagged by Anti-Money Laundering (AML) systems. Such individuals are classified as Relatives and Close Associates, or RCAs for short.
But Politically Exposed Persons aren’t automatically barred from working with banks and other financial institutions. Instead, their status only necessitates that they go through Enhanced Due Diligence (EDD). Whether or not the financial institution in question then decides to do business with them depends on the amount of risk said person or entity would carry.
How is PEP screening performed?
A PEP screening can be performed in two ways. Firstly, some banks may use third-parties that have their own curated PEP lists in order to screen new customers. Alternatively, the bank or financial institution can manually look through relevant, public databases.
For example, if onboarding a person in the UK, the bank can see whether their name is on the parliament list of lords and MPs, the list of ministers, and other similar databases.
PEP screening can also include additional data sources such as trusted news publications or the internet. Generally, utilising multiple data sources is advised so that the data is more accurate, the Due Diligence process more robust, and the chance of non-compliance lower.
For this reason, most third-party PEP list providers will pull information from many different sources across different countries. This then leads to a more global outlook, which is essential for financial institutions that operate across multiple jurisdictions.
It’s also important to note that geographical differences do exist in terms of how PEPs are handled. For example, in Switzerland, domestic PEPs are typically treated with a lot less scrutiny than foreign PEPs, while in other jurisdictions such differences might not be as evident or present. For example, in the US, the Bank Secrecy Act (BSA) doesn’t differentiate between foreign and domestic PEPs.
Furthermore, how PEPs are approached is also subject to change. For example, in the UK, an amendment to their AML framework has made it so that domestic PEPs are automatically considered lower risk than foreign or overseas PEPs, which wasn’t the case prior to 2024.
What is sanctions screening?
Sanctions screening is fundamentally similar to PEP screening in that a person’s name is compared to a list of sanctioned individuals and entities. However, unlike PEP lists, sanctions lists are more regularly available, with organisations such as the United Nations, OFAC, FATF and others providing publicly available sanctions lists.
However, just like with PEP lists, banks and other financial institutions can opt for third party providers that consolidate different sanctions lists into one place.
Another key difference is that since sanctions lists are typically created by larger governing bodies or organisations, they tend to be a lot more detailed than third-party PEP lists. That is to say that they often include key identifiable data, such as passport numbers, addresses, place and date of birth, etc.
Difficulties with performing PEP and sanction checks
Imagine being tasked with building a robust safety net for your bank or business. On the surface, PEP and sanction checks might appear to be straightforward compliance steps.
But as you dive deeper, you quickly realise that these processes are far from simple. What makes them so challenging? It’s the small yet crucial obstacles that often go unnoticed.
Fuzzy matches
Firstly, fuzzy matches. This term relates to the practice of being capable of adapting to outliers. For example, if a person’s name has two accepted spellings, they might provide their name under one spelling and then be on a PEP or sanctions list under the other spelling.
The same principle applies to typos, cultural and language differences, and even aliases. Typically, sanctions lists are less likely to run into this issue, as they provide a lot more identifiable information and even the spelling of the individual’s name in the source language. However, this isn’t always the case.
Regulation changes
Furthermore, it’s important to note that neither PEP nor sanctions lists are set in stone – as we’ve seen in the example of how the UK changed the risk profile for foreign PEPs. And since these changes can happen on the level of a single jurisdiction, financial institutions that operate in multiple countries have to keep tabs on many different methodologies and regulations.
Therefore, these lists must be updated somewhat frequently in order to remain accurate.
And while the Financial Action Task Force (FATF) offers global recommendations on how these processes should be handled, even the methodology can change over time.
Inconsistent data quality
Lastly, the quality of data can differ. In terms of PEP screenings, news and online searches might not provide enough information to properly identify the person.
For example, if a person’s name does appear on a PEP list but doesn’t include any other information other than their name, the bank can’t confirm whether that’s the person opening an account. And sanctions lists don’t always have all of the needed data either.
Another issue is the fact that sanction lists may differ between organisations. This is why it’s important to take many different sources into account and judge fringe cases on an individual basis.
How software performs PEP and sanctions checks
Automated Customer Due Diligence software can be seen as vital for PEP and sanctions checks for a few main reasons. Primarily, as we’ve established, both PEP and sanction checks require a large number of different data sources in order to enhance accuracy.
And while a person can manually go through the different lists and check whether a new client is on any of them, the process is likely going to be quite slow. Not to mention that human error is an important consideration here as well. Slow, possibly inaccurate processes make for a worse customer experience, and therefore aren’t something banks should aim for.
Additionally, not having to manually check every client means that employees get to spend more of their time on different tasks. Therefore, their day-to-day life can benefit from this software as well.
Lastly, in terms of AML/CFT compliance, software is quite helpful. Not only can it handle much larger data sets but it can also be automated to create proper audit trails. That means that proving proper Due Diligence controls are in place is also going to be easier.
Who can benefit from PEP and sanction check software?
Banks and other financial institutions that have to perform a large number of PEP and sanction checks are going to be the ideal audience for automated screening software.
The most obvious example of this is a huge retail bank that onboards hundreds or thousands of people every week.
However, another important thing to keep in mind is what happens when a PEP or a sanctioned individual/entity is flagged – Enhanced Due Diligence. EDD necessitates an even more robust overview of the client as well as frequent monitoring of transactions.
In this context, automated software as a whole becomes a lot more valuable. This remains true even for smaller institutions in the case that they typically deal with high-risk clients. For example, private banks or wealth managers working with ultra-high-net-worth individuals.
Conclusion
In conclusion, PEP and sanction checks are an essential part of Customer Due Diligence and help financial institutions minimise risk. Additionally, both screenings are very important for compliance as they influence whether a given client should go through Enhanced Due Diligence.
They are relatively simple processes, only requiring lists of data to which clients can be compared. However, due to the amount of data needed, utilising automated software will be the right choice for many.
Therefore, if you’re looking for expert guidance on streamlining your compliance processes without sacrificing neither speed nor accuracy, get in touch. Together, we can craft a tailored strategy to help your business stay ahead in the ever-evolving regulatory landscape.
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worldwide trust Atfinity to drive their digital transformation.
Book your demo today and see why leading financial institutions worldwide trust Atfinity to drive their digital transformation.