PEP Risk Categorisation: Differentiating between High, Medium, and Low-Risk Entities

Quick summary:

Learn what PEPs are and how they are classified according to the level of risk they pose.
Understand the significance of identifying and managing PEP-related risks.
Discover future trends in PEP risk categorisation.

In early September 2023, the Financial Conduct Authority, a regulator responsible for the British financial sector, declared that it was launching a review into the mandatory checks that banks were conducting on politically exposed persons (PEPs). The announcement followed a much-publicised story involving Nigel Farage, a former leader of the Brexit Party, in which his bank account was said to have been closed because of his political leanings.

The announcement and the story that preceded it shone the spotlight on the subject of PEPs, as well as the PEP screening process and the reasoning behind it. In simple terms, a PEP is someone who is more exposed to bribery/corruption due to their prominent political position; PEP screening is the process that financial institutions (and numerous other organisations) must undertake prior to working with such individuals.

Understanding PEPs and Risk Assessment

Being politically exposed does not make someone a criminal, nor does it imply that they are involved in illegal activities. It is all about risk, and the simple fact is that these individuals are more likely than the average person to be involved in the following:

Fraud
Embezzlement
Bribery
Corruption
Money laundering

Take sanctions, as an example. PEPs are more likely to have connections to sanctioned entities and the penalties of dealing with these entities are high for everyone involved.

Risk mitigation strategies must therefore be employed to determine whether an individual is at risk and to grant them and their activities a sufficient degree of attention.

Factors Influencing Risk Categorisation

PEPs can be split into three main risk categories: low, medium, and high. The first step to determining an entity’s risk evaluation criteria is to learn which category applies to them:

Entities with minimal influence and exposure.
Usually includes regional government officials, such as mayors.
They have few international connections and little global authority.
Despite the low risk, these entities still require attention.

A level of influence/exposure that is greater than a low-risk entity.
Can include consuls and ambassadors, as well as heads of financial institutions and religious leaders.
Although they are not in the highest category, they can exert a lot of influence and require vigorous screening.

The highest risk entity, with far greater exposure and influence than those in the low/medium categories.
Can include heads of state and members of parliament.
As entities with the greatest risk, individuals in this category must be thoroughly screened.

As an example, imagine that your company is considering a business partnership with a local mayor, someone considered to be a low-risk entity. The mayor seems respectable, and in an age before regulatory frameworks and anti-money laundering risk management, you would not hesitate to sign on the dotted line.

But those regulations exist for a reason. The mayor’s influence leaves them exposed to organised criminals, money launderers, and fraudsters, among others, so screening is essential.

On the other end of the spectrum, you have high-risk entities like members of parliament. They may have connections with sanctioned individuals as part of their work. They may have had previous political or business dealings with them. Your duty, therefore, is to make sure all current connections are legal.

Classifications and differentiating risk levels can vary based on the framework used by differing organisations and regulators. A robust due diligence process must therefore be utilised to ensure regulations are followed and PEPs are screened sufficiently.

Significance of Identifying and Managing PEP-related Risks

Anonymous payments/suspicious transactions, large global fund transfers, associations with high-risk countries or entities—these are just a few of the red flags that might be associated with PEPs.

By maintaining a proper PEP risk mitigation strategy, an organisation can identify all of these risks—and more—and ensure that they:

Remain compliant with all current regulatory frameworks
Avoid penalties and legal issues
Protect their professional reputation
Limit financial losses associated with fraud and embezzlement, as well as legal repercussions
Maintain a high level of ethical responsibility
Give investors and clients more confidence in the business

Implementing Effective Risk Mitigation Strategies

There is no single unified approach to dealing with PEPs. Strategies are usually diverse and in-depth and may include:

Sanctioned lists:

These lists are published by governments and list all currently sanctioned entities. These databases can also be searched automatically as part of enhanced due diligence.

KYC:

Know Your Customer (KYC) checks are key to most due diligence processes. They require the organisation to confirm the user’s identity, ensuring that they are who they say they are.

AML:

Anti-Money Laundering (AML) is all about proving that the money being spent/transferred comes from a reputable source, such as employment or an inheritance. It can be tricky in some cases (such as with cryptocurrency transfers, which are harder to trace), but is used across the financial, legal, and gambling sectors.

Adverse media screening:

Articles, blogs, comments, and news posts are scrutinised through a process of manual/automated media screening to provide additional due diligence.

The high risk associated with PEPs, along with the continued evolution of regulatory framework, necessitates continued monitoring and ongoing checks. In other words, due diligence checks should be performed periodically and not just at the start.

Future Trends in PEP Risk Categorisation

The world is a lot more complicated than it was a few years ago. Countless Russians have been sanctioned, and there have been major regulatory changes in response to these sanctions (see our guide to recent European regulatory changes for more info). On the one hand, it has made life harder for the organisations tasked with following these regulations, but at the same time, improvements in machine learning and AI have helped to manage the changes.

The work we do at A Data Pro is a prime example. We combine the skills of experienced data professionals with state-of-the-art AI to create faster and more accurate systems. We have regularly updated lists of all sanctioned entities and PEPs, along with over 25 due diligence reports.

Red flags are detected with greater accuracy, new regulatory changes are incorporated seamlessly, and the end result provides greater protection and less hassle for your business.