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KYC AML Guide: the Clock shows the average reeding time of the blog09 min Read

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KYC AML Guide: the Clock shows the average reeding time of the blogOctober 3, 2023

The Role of Sanctions in Due Diligence

The violations of EU, UK, US, and other nations' sanctions can result in serious enforcement actions, posing a significant threat to your business. The situation has become even more complicated now that the banks are also facing sanctions. While everyone strives to follow these sanction rules, many businesses find it difficult to navigate them. So, how should you go about ensuring compliance? Here comes the sanction due diligence. In this blog, we will look into sanction risk due diligence and its process.

M Abd'al Bari

Research Associate

What are Sanctions Risk Due Diligence?

Sanctions are measures that are imposed by governments or international organizations. These measures are intended to respond to specific undesirable behaviors or actions. Consider sanctions to be caution signs on the global trade highway, indicating that certain roads are closed.

This is about ensuring that you do not do business with a sanctioned individual or company – even if you don’t know because ignorance is not an excuse. It can be challenging to identify the owner or “beneficiary” of a company because ownership is frequently complex. Regulators, unfortunately, leave it up to each company to determine whether their operations violate the law. This is why due diligence is important.

Due diligence is critical to ensuring that you are not doing business with a sanctioned individual or company. It is important to undergo PEP Screening, AML watchlist, Sanction screening, and adverse media. Due diligence is even more important as part of a merger, acquisition, or joint venture because you don’t want to be held liable for wrongdoing that occurred before your involvement with your target company.

Sanction due diligence is also a way for you to determine whether your people and processes are adequate and appropriate for the risks you’ll be managing. These services should be diligent in assisting you in identifying the maintenance activities that will be required in the acquisition in the future, as well as discussing the current gaps and processes that could put you at risk again.

There are two sides to the risk:

  1. You are at risk if you violate the law and
  2.  You are at risk if you violate the contract because you agree in such a way that the other person is approved.

Doing the former exposes you to regulatory enforcement actions, while doing the latter exposes you to damage claims from your members or other stakeholders.

Also, a key challenge when doing a sanction review is the ability to access important data, such as complete client lists, and the right to speak with people involved in the process if they are unaware of the potential merger or acquisition.

Sanctions Due Diligence Process

Sanctions screening and due diligence can be performed in-house or by a third-party vendor. Companies should conduct sanctions screening and due diligence before entering into new transactions or acquiring a new client or customer, and while developing a policy of screening existing clients, customers, and counterparties at times determined by the company’s risk and exposure.

When conducting cross-border transactions, EDD and more regular screenings are critical, especially when dealing with high-risk jurisdictions.

Risk evaluation

It is best to conduct a thorough risk assessment for your business activities and the fintech sector. All factors such as geography, business partners, fintech service providers, and digital business models should be considered to identify areas where sanctions may apply. This evaluation will serve as the foundation for sanction due diligence, as it will cover both traditional businesses and fintech projects.

OFAC has identified key factors that companies should consider when developing their due diligence and screening program, including

  • a company’s size and sophistication;
  • products, services, and supply chains;
  • clients, customers, intermediaries, and counterparties; and
  • geographic locations.

Checking Your Counterparty

This means you must determine who you are dealing with. It is not sufficient to simply browse the various published lists, such as the SDN List, EU Consolidated List, and Consolidated List of Financial Sanctions Targets in the UK from OFSI. it is also important to consider indirect affiliation and ownership structures as it is an important aspect of sanctions compliance.

Finding Ownership and Control

The next step is to determine whether your counterpart is controlled or owned by a sanctioned person. Some businesses have their department with a designated person or group of people who do the right thing before and during contract execution. Others may seek the assistance of a lawyer specialized in sanctions.  it is critical to ensure that you have the necessary expertise – whether from internal or external resources – to carry out the required sanction due diligence before signing the contract and to ensure sanction compliance during the implementation process.

Who and What Needs to be Checked?

It is crucial to check your contractual counterparts and other parties involved in the transaction as a part of the due diligence process. The people who need to be checked are

  • Counterparties
  • Digital Infrastructure
  • Digital Assets
  • Asset Custodians and Managers
  • Transaction Senders and Receivers
  • Fintech Service Providers
  • Regulatory Authorities
  • Market Entry Point
  • Financial Gateways
  • Fintech Users and Customers
  • Financial Institutions and Banks

Termination Clause:

When your partner is sanctioned, you do not have the automatic right to terminate the contract. That is why it is critical for sanction due diligence to include a clause in the contract that gives you the right to terminate the contract if your partner agrees or if the contract’s performance is illegal.

Transaction Monitoring

To detect suspicious activity, implement continuous transaction monitoring tailored to fintech transactions. to detect patterns that could indicate potential sanctions violations do analyze digital financial transactions

EDD (Enhanced Due Diligence)

EDD measures should be used in fintech transactions, particularly for high-risk fintech entities or activities. For sanction due diligence there is a need to conduct thorough fintech-specific background checks, including verification of source of funds and additional documentation. also, there should be a special focus on fintech-specific risks, such as digital asset ownership and fintech service provider compliance.

Keep detailed records of your fintech due diligence activities, including transaction monitoring results, EDD processes, and risk assessments. These records serve as proof of your compliance commitment and can be extremely useful in sanction risk due diligence.

What to Do if a “Sanction Hit” is Detected?

Before taking any action, you should seek immediate advice from a specialized sanction consultancy. This is because different restrictions operate in different ways, and some transactions will be permitted while others will be prohibited. A general license that allows the performance of existing contracts for a set period may exist.

Why is it important in KYC AML?

Sanction due diligence is critical in KYC-AML processes. As it aids in:

  • It Identifies high-risk groups and financial criminals and compares customer data to a blacklist.
  • It helps to avoid serious penalties and ensure that all laws and regulations are followed.
  • It prevents illegal activities such as money laundering and terrorism financing.
  • It keeps its reputation by avoiding affiliation with illegal entities.

Conclusion

Incorporating sanctions in due diligence can help you not only reduce defensive risk but also approach new opportunities with greater confidence. Staying ahead of changes and regulatory restrictions with the right data can give you a competitive advantage in the future. Visit the KYC AML guide for better consultancy and services.

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M Abd'al Bari

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Muhammed Abd'al Bari is a certified Research Professional of KYC/AML Guide. Connect with Muhammed on LinkedIn