How Banks Can Do PEP Risk Management Amidst a Changing Regulatory Landscape?

Why is Politically Exposed Persons (PEP) Screening Important?

Proximity to power makes Politically Exposed Persons vulnerable to committing corruption, tax evasion, and misappropriation; hence they are more likely to be involved in money laundering to conceal proceeds from these crimes. For obliged sectors, PEP screening is a critical step in AML Compliance since  PEPs pose a higher money laundering risk because of their ability to influence government decisions and get involved in illicit activities such as embezzlement of public funds. PEP RCA screening is also crucial which implies that obliged sectors should screen customers to check if they are PEP’s relatives or close associates as relation to influential figures is also a significant AML risk indicator.  During their political and administrative careers, PEPs may attempt to transfer illegal funds to their names and acquire illegal wealth. PEP compliance solutions and PEP risk management strategies are important for regulatory reasons and financial crime prevention.

Challenges in Politically Exposed Persons (PEP)  Checks

The practical challenges of accurately identifying and managing PEP risks highlight the operational complexity of organizations.

A universally accepted definition of PEP is necessary for identification efforts. Although international organizations such as the FATF provide guidance, the implementation of these guidelines can vary significantly from jurisdiction to jurisdiction. This variation can lead to inconsistencies in the PEP identification, especially for global financial institutions operating in multiple countries. Additionally, the threshold for classifying an individual as a PEP varies from jurisdiction to jurisdiction, further complicating compliance efforts.

Dynamic Nature of PEP Status

The main challenge in PEP screening is the dynamic nature of their status. An individual may not be a PEP when they engage with a financial institution, but may later gain a distinguished public position resulting in a change in their profile. In contrast, the PEP may relinquish its official status, but the risk associated with its previous role and influence may remain. This fluidity requires continuous AML monitoring and re-evaluation of customer profiles, which requires significant resources and complex systems to track status changes effectively.

Data Quality of AML Monitoring Systems

Access to accurate and up-to-date information is another significant barrier to confirming an individual’s PEP status. Although commercial databases and PEP lists are available, they are not always comprehensive or up-to-date. The quality of the AML data varies, and in some cases, information about lesser-known or newly identified PEPs may be missing. This limitation is particularly acute in countries with less transparent governance structures, where information about government officials and their staff may not be available or easily verifiable.

False Positives in AML Risk Management Solutions

Attempts to identify PEPs can be complex due to the simple reason that one person can share a name with millions of others and while PEPs may have distinct positions, their names may not always be distinct. One challenge in the way of efficient name screening is a large number of false positives as many common users could be mislabeled as PEP based on partial or misleading information or incompetency of name-matching algorithms. Addressing these false positives requires additional investigation and enhanced due diligence, diverting resources from other compliance activities. This challenge highlights the importance of using effective screening processes and analytical tools to accurately distinguish between true and false matches.

The Role and Challenges of AML Compliance Vendors in PEP Risk Management

The primary responsibility of the vendor is to develop technology, fetch real-time, accurate data, and help companies identify and prevent financial crime and other risks. This includes extensive oversight, testing, and accountability to regulators, customers, and third parties. From a vendor perspective, the biggest challenge is creating a flexible and configurable PEP compliance solution for companies to adapt to a risk-based approach. A key challenge is to understand the risks expected by clients when assessing client risks, prioritizing alerts for transaction monitoring, or initiating enhanced due diligence processes.

From a client perspective, the use of the latest technologies requires continuous monitoring. Also, the ability to demonstrate to regulators that processes are free from bias, including unconscious bias. If the system fails, it takes a lot of resources and engineering support to ensure stable and efficient operation. Customers often overlook the security risks associated with these technologies as they focus on managing various risks such as fraud, corruption, high-risk users, and sanctions evasion. Clients need to step back from time to time, assess their skills, and identify areas for improvement. Working with a professional AML compliance vendor is more effective than handling everything on your own.

Effective PEP Risk Management Strategies

Alia Mehmood, Regulatory Affairs Practice Lead, at ComplyAdvantage, provides insights into how AML compliance vendors can tackle the PEP risk management strategies in the KYC AML guide webinar “Mitigating False Positives: Significance of Data Quality in AML Compliance”.

From Alia’s perspective, the key challenges faced by vendors include

• Organizations need to understand that the threat posed by politically exposed persons (PEPs) is not limited to individuals. This applies to their relatives, close associates, and people connected to them involved in bribery, corruption, or illegal activity.
• Consider the country where the PEP is based. What is their role, power, and influence both internally and externally?
• Organizations face challenges when their verification processes aren’t linked to enhanced due diligence. They should maintain a PEP register to keep track of the PEP population within their firm.
• It’s also essential to consider the different jurisdictional requirements for PEP risk management.
• Organizations should understand the global approach and policies, with specific provisions for different jurisdictions. They need to assess the risk level of a PEP, whether domestic or foreign, and consider the jurisdiction’s impact on the company’s risk factor. For example, they can use country risk factor methodologies or risk scores from the World Bank or Transparency International.

In the webinar, Alia said that

“Firms now take whatever PEP inherent assessment they are doing and look into splitting that between domestic and foreign PEPs and also consider the jurisdiction of that PEP”

• AML-compliant solutions vendors can tackle PEP checks by having configurations in place to handle transliteration errors, various naming conventions, and non-Latin names, such as Arabic by providing them as a standard feature to reduce false positives for our customers. This screening isn’t just for sanctions, but also for politically exposed persons (PEPs) and adverse media. Clients may want to focus on specific adverse media categories rather than screening everything.
• Another challenge in assessing PEP risk levels is a diverse approach to how long a PEP should be considered a high-risk entity. While Once a PEP always has wider support, many jurisdictions mandate that a PEP doesn’t remain a high-risk entity exit from politics, or relinquish the public role.

A key issue in PEP screening is the need for additional risk parameters. A person’s PEP status alone does not indicate high risk. When assessing high-risk clients, particularly those with PEP status, enhanced due diligence is crucial to determine if there is any association with criminal activities. Adverse media screening is an essential part of this process. Therefore, PEP screening software needs to incorporate an adverse media tool to ensure comprehensive evaluations.

However, there are many challenges in adverse media screening as well. Charlie Patterson, Group Head of Risk Revolut Business shared his opinion on how adverse media screening affects banking decisions as

“Media is becoming less unbiased, and stories can be inflated. Misinformation is shared, so decisions cannot be solely based on adverse media screening. It is not always accurate and can harm reputations. If we are looking at adverse media screening, it needs to be paired with other information. We need to request information from customers or businesses, look into our databases, and conduct extra transaction monitoring”.

This highlights the importance of combining PEP and adverse media screening with other risk assessment methods to ensure comprehensive and accurate decision-making.

Bottom Line

In conclusion, effective PEP risk management strategies require collaboration between AML compliance vendors and clients. Vendors must develop advanced, unbiased technologies that can handle the complexity of PEP screening, and AML monitoring systems and provide robust support starting from the real-time data. Clients need to implement these tools effectively, ensuring compliance and continuously assessing their risk management strategies. Given the challenges of identifying and managing risks associated with PEPs and their associates, a collaborative approach ensures both parties can stay ahead of evolving threats and maintain secure operations.