Politically exposed persons (PEP)

What you need to know about this special group of people in terms of KYC

For business relationships to work, it is important that there is a solid base of trust right from the beginning, so that financial institutions, authorities and companies know who they are dealing with when it comes to potential new customers. The Know Your Customer process (KYC process for short) lays the foundations for this.

If this check reveals that the person is politically exposed, particular care must be taken during the identification verification.

This article is about how companies in Germany and Europe can recognize a “politically exposed person” (PEP) and which measures are effective for fulfilling their duty of care.

Who or what is a politically exposed person (PEP)?

In Germany, the Money Laundering Act (GwG, in Europe the AMLD) defines exactly who is to be classified as a politically exposed person (PEP). According to § 1 para. 12 GwG, a PEP is any natural person who exercises or has exercised a high-ranking important public office at international, European or national level. In the case of a former politically exposed person, the obligated parties must take into account the risk for at least twelve months after leaving public office. It also includes persons who hold or have held a comparably politically significant public office below the national level.

The section contains further information on who is to be classified as a politically exposed person in Europe – and also names very specific functions and groups of people, which, however, are not listed exhaustively here:

• Ministers, heads of state, heads of government and members of the European Commission
• Members of parliament
• Members of the governing bodies of political parties
• Members of supreme courts and constitutional courts
• Members of the governing bodies of courts of auditors or central banks
• Ambassadors
• Members of the administrative, management and supervisory bodies of state-owned enterprises.

In order to prevent possible financing of terrorism or other dangers – and to be able to protect their own company and the state from the consequences of money laundering, politically exposed persons are subject to comprehensive scrutiny in accordance with the GwG.

Increased risk with politically exposed persons

The enhanced due diligence for politically exposed persons is based on the assumption that, due to their special social role, they are more likely to be the target of corruption attempts.

Extended due diligence for the PEP environment

In Europe, the extended due diligence does not only apply to a politically exposed person themselves: family members or persons personally close to this PEP may also be subject to the so-called Enhanced Due Diligence (EDD). In Germany, the Money Laundering Act (Geldwäschegesetz, or GwG) stipulates that the risk of the effects of possible money laundering or corruption cases may also apply to family members of politically exposed persons.

Accordingly, the law also specifically names who is classified as a family member:

• Spouse
• Registered partner
• A child and their spouse or registered partner
• each parent.

Last but not least, this group of persons is supplemented by other persons close to a PEP. This term includes natural persons such as business partners who have an economic connection with the politically exposed person, see Section 1 (14) GWG. The connection through economic ownership is mentioned here as an example.

Risks of working with politically exposed persons

When working with or doing business with politically exposed persons (PEPs), four risk categories are distinguished:

1. Risk of bribery of PEPs

Politically exposed persons in public office have, among other things, the task of deciding on the awarding of high-priced contracts. Thus, there may be an increased risk of bribery attempts by companies or individuals seeking to improve their chances in this way.

2. Risk of money laundering by PEPs

In addition to the risk of bribery, there is also a risk that politically exposed persons could be misused to launder ill-gotten gains. This would be possible, for example, through straw companies, international transfers or support from family members.

3. Risk of PEPs financing terrorism

Due to their special position, there is an increased risk for PEPs of being approached by terrorist organizations and – even if unknowingly – exploited by them for terrorist financing.

4. Risk of corruption by PEP

Politically exposed persons are exposed to a higher risk of corruption due to their special position. If a PEP is associated with corruption, this not only has a negative impact on the PEP concerned: the reputation of people and companies that could be associated with the incident is also usually negatively affected in the long term.

Due diligence in identifying a PEP

In the fight against economic and financial crime, due diligence is an important factor. The requirements for fulfilling the increased due diligence are set out in Section 15 of the German Money Laundering Act (GwG).

A distinction is made between standard due diligence (SDD) and enhanced due diligence (EDD). EDD is the so-called increased duty of care. Among other things, it applies when the respective potential customer or business partner is a politically exposed person – and thus poses an increased security risk.

Objectives of the enhanced duty of care (EDD)

The aim of Enhanced Due Diligence (EDD) is to minimize the risk of the following serious threats, to which politically exposed persons and their environment are particularly exposed:

• Financial fraud
• Money laundering
• Terrorism financing

In addition, the enhanced due diligence should help to ensure the security of the financial system as a whole.

Correct risk classification of a PEP

With the appropriate measures in place, companies in Europe are able to identify politically exposed persons during an initial due diligence check and then initiate the appropriate measures based on the correct risk classification. This classification is based on the following assumptions:

High risk:

heads of state, members of parliament and other prominent representatives of organizations, companies or state institutions at national and international level require thorough due diligence.

Normal risk:

Ambassadors, heads of financial institutions and religious leaders, for example, belong in this category because they can exert a great deal of influence and therefore require strict scrutiny.

Low risk:

Mayors or regional politicians who have few international connections or authority require attention despite the low risk.

The risk of politically exposed persons to be assessed in the due diligence process thus decreases from “high” to “low”. Depending on the classification of a PEP into one of the levels, financial institutions, authorities and companies must take appropriate anti-money laundering measures (AML measures for short) to reduce the risks as much as possible.

PEP risk by country

Another factor in assessing the risk probability associated with politically exposed persons is the country in which (or from which) a PEP is economically active. For example, if they operate in countries with less strictly regulated economic systems for combating money laundering and terrorist financing, the risk increases. There are corresponding lists for this as well.

Recognizing politically exposed persons

As part of anti-money laundering (AML), European companies are obliged to implement targeted measures to detect PEPs.

Even in the case of long-standing, functioning business relationships, it is not enough to assume that you know your business partner and therefore do not need to conduct a thorough check. In some cases, it is even necessary to check a PEP’s other business relationships, such as their customers and suppliers.

As soon as a new business relationship is established, the customer’s identity must be verified and due diligence must be carried out on the basis of this data.

To fulfill their due diligence obligations, financial institutions, insurance companies and other companies in Europe use software solutions to compare their customer data with entries in sanction or PEP lists – both nationally and internationally. There are innovative technical solutions for this that can be seamlessly integrated into existing systems – for example, from WebID.

Consequences of incomplete PEP control

If a company does not carry out a complete PEP check, it is not only its reputation that is at stake. It can also incur heavy fines under the Money Laundering Act (GwG). The amount of the fine is regulated in § 56 Abs.3 GwG and, depending on the severity of the violation, can in some cases even be up to five million euros or double the value of the economic advantage gained from the violation.

About WebID

WebID’s technologically advanced, automated identification solutions, such as TrueID or AccountID, are AML-compliant and help to quickly and efficiently identify customers as part of the KYC process – i.e. in Germany, one of the most strictly regulated markets.

 

WebID relies on AI-powered analysis and machine learning for thorough identity verification – and these solutions can be seamlessly implemented into systems that are already active. Optionally, through our technology partners, they can be expanded to include a background check with PEP lists, which quickly identifies politically exposed persons and subjects them to an extended due diligence check.

WebID’s consulting and solution expertise in the German and European economic area is now also in demand internationally. For example, we recently advised a Fortune 500 technology provider so that this company is enabled to select the appropriate identification procedure – and we will also implement this in the system landscape.