Table of contents
What is a Politically Exposed Person (PEP)?
A Politically Exposed Person (PEP) is someone who, through their position or influence, is more susceptible to being involved in bribery, money laundering or corruption. This is usually someone who has been entrusted with a prominent public function in a government or international organization. Close business associates and family members are also considered PEPs. PEPs represent a higher risk for financial institutions and Designated Non-Financial Businesses and Professions (DNFBPs) because they are more likely to become involved in financial crimes like money laundering.
The Financial Action Task Force (FATF) first defined the term PEP in 2003 as “individuals who are or have been entrusted domestically with prominent public functions, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, important political party officials.”
This understanding of Politically Exposed Persons is in line with the view of the United Nations Convention Against Corruption (UNCAC) on persons with prominent public functions, defined in its article 52, defined as “individuals who are, or have been, entrusted with prominent public functions and their family members and close associates.”
The PEP terminology is used to qualify a person that might present a higher risk and be exposed to potential acts of bribery or corruption, given the power and influence he or she may exercise. This particularly applies to senior politicians with influence over legislative processes, or individuals having a deciding power in procurement processes.
What is a PEP in relation to AML / CFT compliance?
In the context of Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) compliance, PEPs present a higher risk of being involved in corruption and Money Laundering activities. The term PEP is defined in Article 4, 28°, of the Anti-Money Laundering Law as a natural person who is or who has been entrusted with prominent public functions.
What is the meaning of PEPs in finance and banking?
In the context of financial services, PEPs are considered to be high-risk customers due to their heightened susceptibility to bribery and corruption. As a result, financial institutions are required to take enhanced measures to assess and mitigate the risks posed by PEPs. This typically includes conducting due diligence on the customer and their family members, as well as monitoring transactions for signs of money laundering or other illicit activity.
When assessing a new customer, banks will typically inquire as to whether the individual is a PEP. If the answer is yes, the bank will then proceed to carry out additional checks in order to mitigate the risks associated with doing business with a PEP. These measures may include obtaining more information about the source of the customer's wealth, as well as conducting periodic reviews of the account to ensure it is being used in a legitimate manner. By taking these precautions, banks can help to protect themselves against potential financial crimes.
Learn more about how to perform AML Screening & Monitoring against PEP and global sanction lists.
What are the three types of Politically Exposed Persons?
The Financial Action Task Force (FATF) further details three types of PEP that might pose a business risk:
- Domestic PEP: as defined above, it encompasses a broad spectrum of people occupying public functions within a specific country;
- Foreign PEP: defines individuals with prominent public positions in a foreign country. The main difference is therefore the country which has entrusted the individual with the designated function;
- International organization PEP: designates individuals who have been entrusted with a prominent function by an international organization (directors, deputy directors, members of a board, etc.).
While the type of positions concerned by those definitions may be quite large, it mostly targets Heads of state, senior politicians, top ranking members of the military apparatus or judicial system, as well as top executives from state-owned companies (SOE).
When screening individuals, their family members may also be mentioned as “related PEP” depending on their degree of familiarity with the PEP. It is also possible to identify close associates to a PEP, in case they are connected either socially or professionally.
The Politically Exposed Person (PEP) regulations
As part of AML regulations, many countries have established rules for identifying Politically Exposed Persons (PEP). In Europe, this is mandated as part of the Anti-Money Laundering Directive (AMLD). In particular, PEP regulation was strengthened significantly as part of the fifth directive (5AMLD), implemented in 2020.
A PEP presents a higher risk for money laundering activities or terrorist financing. As such, financial institutions must identify whether potential clients are PEPs and apply appropriate extra due diligence if so. Being a PEP does not imply that the person has been involved in illegal activity, but extra care must be taken when checking the person and transactions.
What are the implications of having business ties with a Politically Exposed Person?
As part of Anti Money Laundering (AML) programs, companies must implement screening mechanisms against individuals they are working with, to prevent corruption and risks of conflict of interest. Indeed, most the countries have set up within their AML legislations the obligation for screening PEPs to prevent the associated risks. Financial institutions and designated non-financial businesses and professions (DNFBPs) are the most affected entities by these obligations.
They must implement specific measures in order to prevent the misuse of the financial system and non-financial businesses and professions by PEPs, as well as setup detection mechanisms against potential abuse. In the 2003 FATF 40 Recommendations, the institution Financial Action Task Force (FATF) issued two specific recommendations regarding PEP management and risk prevention. In its June 2013 Guidance dedicated to recommendations 12 and 22, FATF highlighted that in the frame of high-risk business relationships with domestic or international PEPs, “institutions should take additional measures consistent with those applicable to foreign PEPs.”
Therefore, the nature of the business relationship is one of the factors to be assessed, in addition to its country of origin. Different criteria can also be taken into account to assess the factor of risk and thus mitigating it. As an example, the Corruption Perception Index (CPI), provided every year by the NGO Transparency International is one way to put into perspective the risk associated to a business relationship with a PEP or PEP-related entity.
The FATF has developed a collection of red flags that should alert DNFBPs suspecting potential abuses:
- PEPs attempting to shield their identity: whether it is through shell companies or intermediaries;
- Abnormal and erratic behaviors: such as his inability to provide valid information, inquiring about AML policies, or moving funds between different countries;
- PEP’s position or involvement in businesses: has regulatory controls over licenses, business approval, or has substantial authority over public funds;
- PEP’s involvement in high-risk industry: construction, defense and arms trade, mining, banking and finance, public procurement, etc.;
- Transaction types: substantial transfers in and out of the PEP’s account, often withdraws or deposit cash, mix of personal and corporate assets;
- Country-related risks: PEP’s originates from a country where corruption is a known phenomenon, or countries which are not signatories of UNCAC.
Who is classified as a Politically Exposed Person (PEP)?
Anyone who presents a higher risk for potential involvement in bribery and corruption by virtue of their position is considered a PEP. Anyone currently or formerly holding such a position could be a PEP.
This includes, but is not limited to, the following:
- Heads of state.
- Government officials. This includes MPs, senior ministers, and those in senior military or judicial positions.
- Senior roles in state-owned enterprises.
- Diplomatic roles, including ambassadors, consuls, or charge d'affaires.
- Certain roles within central financial institutions, including Court of Auditors and board members.
- Relatives of any of the above PEPs. This will include parents, children, partners, uncles/aunts, and in-law relations.
- Close business associates of PEPs. This includes anyone with a close business relationship with a PEP or joint beneficial ownership of a legal entity with a PEP.
How to know if someone can be considered a Politically Exposed Person?
As recommended in its FATF’s recommendation number 10, effective customer due diligence (CDD) should be conducted to identify if the beneficial owner of an entity is a PEP, or if an individual can be labelled as PEP. This implies adequate due diligence processes, using reliable documents to confirm his identity, to determine the ownership structure of a company, and screening against specific PEP databases. If the transaction is considered as high risk, enhanced due diligence (EDD) should be performed to assess the different parameters surrounding the transaction. FATF suggests that failing to comply to CDD measures, DNFBPs “should not open the account, commence business relations or perform the transaction; or should terminate the business relationship; and should consider making a suspicious transactions report in relation to the customer”.
Politically Exposed Person (PEP) list
Under the EU Anti-Money Laundering Directive, member states must release a publicly available list of PEPs in the country. These should be identified by role, not by individual name. The EU will also make available an EU-wide PEP list. These lists are designed to help compliance teams identify PEPs that they should be screening for. In addition, several third-party vendors will hold lists of PEPs that can be used as part of KYC procedures.
How do you check if someone is a Politically Exposed Person (PEP)?
Regulators require businesses to implement PEP screening measures as part of their AML programs. This typically follows a risk-based approach, where different roles are assigned different risk levels.
Checks should be conducted when taking on a new business relationship as part of KYC and KYB procedures. There should also be ongoing checks to ensure that a change in PEP risk profile is not missed.
These checks can be carried out independently by the organization, making use of country and EU lists where appropriate, or conducted in collaboration with a third-party supplier. Most organizations will use a combination of automated checks and searches with manual oversight and monitoring. The requirements for Politically Exposed Person (PEP) identification and enhanced due diligence forms an important part of Anti-Money Laundering and Combating the Financing of Terrorism (AML CFT) frameworks.
At IDnow, we offer the option of conducting AML checks with on-time screening against PEP and global sanction lists in combination with our IDnow AutoIdent solution.