It is quite common for politically exposed persons to camouflage their financial interests using legal entities. There exists a real possibility that you may already be doing business with these people through a legal entity. The RBI needs to act swiftly on domestic PEP front to ensure better compliance on money laundering

Politically exposed persons (PEPs) have been identified as high risk customers for banks and financial institutions for money laundering activities. Because of the risk profile of these customers, the Financial Action Task Force (FATF) and other international bodies acting in the areas of prevention of money laundering and terrorism financing activities have asked banks and financial institutions to carry out enhanced due diligence (EDD) for these customers. Enhanced due diligence involves digging deep into a person’s history and relationships to verify the identity of persons carrying higher risks. The objective of EDD measures in the context of PEPs are that they are identified at the time of account opening and banks and financial institutions carry out an ongoing check for transactions performed by these clients so that they are able to launder money across world.
 

Till recently, definition of PEP only covered international PEPs. As per initial definition of PEPs by FATF, “‘Politically Exposed Persons’ (PEPs) are individuals who are or have been entrusted with prominent public functions in a foreign country, for example heads of state or of the government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, important political party officials. Business relationships with family members or close associates of PEPs involve reputational risks similar to those with PEPs themselves. The definition is not intended to cover middle ranking or more junior individuals in the foregoing categories”.
 

• In February 2012, the FATF issued a revised set of its International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation, better known as the “40 Recommendations”, which expanded the definition of PEPs to include both domestic and international PEPs. The FATF definition of a domestic PEP is as follows,”Domestic PEPs are 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”.
   

The Reserve Bank of India (RBI) issues master circular every year on AML/KYC detailing the steps that banks and financial institutions regulated by RBI are supposed to carry out in order to effectively implement AML/KYC measures. The last master circular of the RBI on AML.KYC issued on 2 July 2012 expects banks to monitor only foreign PEPs and there is no mention of domestic PEP in the circular. The circular also excludes foreign PEPs in India. It is important to note that India is a member of the FATF and as a member country; it is supposed to implement the FATF guidelines. More than a year has passed since the FATF came out its revised guidelines, but the RBI is yet to come out with a circular on domestic PEPs.
 

What is it that is preventing the RBI to issue guidelines to banks and financial institutions regulated by it from monitoring domestic PEPs? Are there regulatory hurdles? Or is it that the otherwise self-proclaimed independent body on repo and reverse repo rate determination i.e. RBI is scared to take an independent view on determination of domestic PEPs because of the fact that a big list of who is who is involved in the list. It is important to note here that the PEP list does not alone cover politicians and includes other prominent officials as mentioned in the definition above.
 

In order to ensure that we are able to effectively monitor PEPs across the country, we as a country will need to create an extensive framework for monitoring PEPs and ensure that money laundering by them gets substantially controlled. Let us look at some of the steps we need to follow to ensure that PEPs are indentified in India:
 

Define and widen the scope of PEPs: As of now, India only follows the definition of the FATF in identification of PEPs and that too partially as domestic PEPs are not covered. A major misconception regarding PEPs is that one should only be concerned about individuals when identifying PEP risk. A FATF consultation paper issued in 2002, however, indicates that “the proceeds of corruption are typically transferred to a number of foreign jurisdictions and concealed through private companies, trusts or foundations.” The World- Check on PEP identification says, “It is quite common for PEPs to camouflage their financial interests using legal entities and there exists a very real possibility that you are already most likely doing business with PEPs via a legal entity”. So what should be covered under PEP? Ideally PEP should not only cover the PEP definition that has been given by the FATF but it should also include, “private companies, trusts or foundations owned or co-owned by PEPs, whether directly or indirectly” as covered by World-Check.  If we broaden the scope of PEP by including entities related to PEPs, an organization like the BCCI (Board for the Control of Cricket in India) will automatically get covered under enhanced due diligence for monitoring of PEP. The RBI may consider including senior private sector employees, certain category of journalists, etc under PEP as well.

Building a database of politically exposed persons (PEPs): The most challenging aspect of identifying politically exposed persons is a common database at the national level. The challenge gets further compounded by the fact that the database needs to be dynamic. Let us understand this with an example. In India so many elections are held at different levels. With new people getting elected, the database of PEP needs to be modified continuously and there is a need of an entity which will carry out this activity. While the Election Commission can provide data for newly-elected representatives and the government can provide details of other categories of PEPs, it is difficult to identify the details of political party officials which keep on changing. Some people may not be affiliated to a political party but still can classify as a PEP. The RBI needs to work on modalities related to these exceptions, as well.
 

Empowering of banks, freezing of assets and punitive action: The RBI along with the government needs to empower banks and financial institutions to empower banks to carry out a detailed check of financial transactions of PEPs and also bring necessary provisions for at least temporary freezing of assets till the time investigation is initiated by the government agencies. Also there is a need for strict punitive action if PEPs are found to be involved in money laundering.
 

While it is true that many of the PEPs carry out money transfers without using the route of banks and financial institutions, however, profiling of  PEP accounts, wherever available can provide better control on money laundering activities originating and linked to these accounts. World over a need is being felt to have tighter control and enhanced due diligence on PEPs and that is the reason the FATF has included domestic PEP within the scope of PEPs. The RBI needs to act swiftly on domestic PEP front to ensure better compliance on money laundering front.
 

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)