Criminal financial fraud is dramatically increasing, in response to the 30% increase in fraud losses during the first half of 2021, financial and professional services providers are looking for solutions that improve the effectiveness of their know your customer (KYC) processes.
Enhanced due diligence (EDD) goes a step further than customer due diligence by requiring an enhanced risk assessment and much greater evidence and documentation.
EDD is one tool that helps financial service providers, and professional services practices such as tax experts, accountants and lawyers, to both better protect against fraud and improve the understanding of their customers’ needs.
Understanding the risks that require EDD
According to the UK financial regulator, the Financial Conduct Authority (FCA), if a potential customer falls into specific categories, then EDD is required. These categories include:
- Customers who work in or with high-risk business sectors. These can include gambling, adult entertainment, pharmaceuticals and tobacco.
- Customers living in, or who have come from, a high-risk country; the top ten according to the internationally recognised Basel Institute on Governance currently include Afghanistan, Haiti, Myanmar, Laos, Mozambique, Cayman Islands, Sierra Leone, Senegal, Kenya and Yemen.
- Politically Exposed Persons (PEPs), a unique category that according to the FCA are: “individuals whose prominent position in public life may make them vulnerable to corruption.”
In addition to the formal definitions of risk provided by the FCA and legislation in other jurisdictions, those conducting EDD are required to use professional skill, judgement and reasonable care.
What additional checks are needed for EDD?
The purpose of EDD is to mitigate the risk of fraudulent criminal activity and the resulting loss of financial assets. The financial or professional service provider, or their agents, completing the checks want to be sure their customer’s purpose and activities are legitimate.
Standard KYC due diligence processes to deter fraud and manage the risk presented by the vast majority of financial and professional services customers are now largely automated and include steps such as:
- Identity checks and credit referencing, including checking court records and other sources.
- Identifying and understanding the customers’ business or activities – this provides insights into the potential risk of fraud.
- Assessing the risk that the customer’s activities are for the purpose of terrorist financing and money laundering.
The additional checks will largely depend on the risk assessment completed on the potential customer that determined a need for EDD in the first place. These can include:
- A requirement for much greater documentation. For example, if the customer is a business, who are the beneficial owners? If the ownership trail moves offshore to a high-risk country, this could be a red flag.
- Greater documentation also includes confirming identity. Basic or simplified due diligence may require only photo identification such as a driving licence or passport. EDD may require in-person interviews with the service provider, evidence from government and law enforcement agencies and references.
- Detailed understanding of the nature of the proposed transactions. Who, what and where are third parties (including their identification and incorporation details) and supply chains, what are the currencies, volumes, amounts and patterns of funds being managed, what is the purpose of each transaction?
- Additional documentary evidence may be required to demonstrate a legitimate past trading activity.
- Details of the customer’s associates, family and friends, as they may be linked to a PEP or known criminals on law enforcement and international agency watchlists.
To support the above additional measures, enhanced record-keeping and data protection processes and policies are fundamental, particularly if the activity may one day endure the scrutiny of a criminal investigation and the courts.
Secure and compliant digital platforms are increasingly used to facilitate KYC processes between customers and financial and professional services providers.
Bonafidee’s digital engagement platform enables organisations and individuals to engage online in a safe, compliant and fully evidencable way. To find out more about digital customer verification solutions, download our guide, or contact our team.
