Compliance rules are not to keep the regulators happy. As Emilia Michalak explains, they are about keeping your business safe and much can be learned from the current investigation into FIFA.

    Have you ever wondered why regulators make such a fuss around Know Your Customer (KYC) and enhanced due diligence? You’ve known your clients for years, why would you suddenly need to ask them about source of wealth and a corporate structure, just because a financial company holding their assets decides torefresh their due diligence or sample check a client’s background?

    The risk-based approach allows a focus on your high-risk clients but different financial companies may have different definitions ofwhat that means to them. The obvious high-risk client type is a PoliticallyExposed Person (PEP), however until the recent publication of the European Union 4th Money Laundering Directive (4MLD), there has only been a requirement to classify foreign PEPs as high risk; which meant obtaining enhanced due diligence i.e. source of funds and source of wealth and ongoing monitoring. Financial Action Task Force recommendations 12 and 22, published in 2012, already recommend reviewing KYC of domestic PEPs to establish money laundering risk. With 4MLD, all EU countries will need to update their legislation to expand the definition of a PEP and due diligence required on them, meaning treating foreign and domestic PEPs the same.

    Both the source of wealth and source of funds are useful for ongoing due diligence."

    It’s however not only PEPs that can be high risk, there are other risk factors to consider like a complex corporate structure; involvement of shareholders and beneficiaries residing in high-risk countries and high-value investments not matching a client’s profile, etc.

    All these background checks seem like a tick-box exercise, but are they? If you follow the news, even if you don’t, you’d have heard of the recent FBI investigations into FIFA corruption. Apparently the alleged bribes and the abuse of trust by two generations of FIFA officials date back to atleast 1991. They had to launder this money somehow and this hadn’t been noticed until just recently. Maybe if financial institutions involved had better client due diligence, this wouldn’t have lasted as long. Further investigations into the banks involved will most likely answer this question.

    Another, less publicised, example of money laundering, highlighting the importance of due diligence is closer to home. Scottish shell companies; repeatedly registered at the same addresses in Edinburgh and Inverness; were involved in laundering money defrauded from banks in Moldova.

    There’s also an issue of the source of wealth with a constant misunderstanding of what it is and why it is different from source of funds.

    Source of wealth refers to the origin of a client’s total accumulated assets. This gives an indication of how a client obtained the money they want to invest and if the volume of wealth is as expected given the client’s background.

    Source of funds meanwhile refers only to the amount being the subject of the business relationship. For example a bond is beingopened and the investment amount is coming from the client’s nominated UK bank account or an investment for a new ISA is being transferred from another ISA with another financial company.

    Both the source of wealth and source of funds are useful for ongoing due diligence and may highlight investments which seem inconsistentwith a client’s profile and can’t be reasonably explained.

    The regulations are getting stricter and within the next two years, we will have new legislation-tightening rules around PEPs, risk assessment and enhanced due diligence. However it’s not only about making regulators happy: It’s mainly about keeping your business safe and not doing business with criminals, who may cause your business a loss of reputation, if not worse.

    There is news on financial crime published by FCA, NCA, Action Fraud and newspapers every day. So if you don’t want your company name featured in one of these stories, pay more attention to your client due diligence, make sure you identify where your higher risks are and check details like the source of wealth.

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