Comprehensive Guide to Enhanced Due Diligence to Mitigate Financial Risk

Enhanced Due Diligence (EDD) revolves around conducting a comprehensive examination of customers based on a risk-based approach. It entails gathering detailed information regarding their history and reputation. EDD is particularly relevant for high-risk and high-net-worth clients and individuals involved in uncommon or substantial transactions that carry increased risk.

However, the collective efforts of regulators, governments, and financial institutes are insufficient to uphold financial stability by implementing new legislation. Approximately $2 trillion of illicit cash resumes to flow through the global financial system every year. EDD is an in-depth know-your-customer (KYC) that helps firms in protecting against money laundering and terrorist financing. 

For What Purposes Is Enhanced Due Diligence Required? 

EDD is needed for individuals or situations that demonstrate a higher risk, including: 

• Non-resident clients or those subject to economic sanctions.
• A business relationship executed on unusual occasions. E.g.,  the geographic distance between the client and the organization
• Cash-intensive businesses
• Organizations that have nominee shares or shareholders in bearer form
• The beneficial ownership structure of the organization appears opaque, unusual, or excessively complicated
• Legal individuals or arrangements that are personal asset-holding vehicles
• Private banking
• Countries without satisfactory CFT/AML systems
• Payments received from unassociated or unknown third parties
• Countries subject to embargoes or sanctions or with immense corruption levels and criminal activity
• Countries supporting or finding terrorist activities and having designated territories companies operating within their country
• Non-face-to-face transactions or business relationships
• EDD is also required for politically exposed persons (PEPs)

EDD Best Practices

These include: 

• Carrying out additional searches
• Gain further information from the client about the nature and purpose of business relationships
• Access additional specifying information from a broader variety of sources
• Trusting an intelligence report on the client or beneficial owner
• Analyzing the fund’s sources to ensure they have no criminal record

Working of Enhanced Due Diligence(EDD)

In accordance with the guidance provided by the Financial Action Task Force (FATF), organizations are advised to adopt risk-based Enhanced Due Diligence (EDD) measures that align with the unique anti-money laundering and counter-terrorism financing (AML/CFT) risks associated with individual customers. These must include: 

• Specifying the wealth or funds source
• Enforcing ongoing monitoring process
• Acquiring additional client identification materials
• Organizations can apply a more thorough examination by subjecting the nature of the business relationship or the purpose of a transaction to closer scrutiny.

Enhanced Due Diligence (EDD) will be an integral component of the established relationship between the firm and recognized individuals or entities. Additionally, if a transaction monitoring system raises an alert, EDD may be triggered for a more in-depth investigation. However, obtaining additional information from the client or relationship manager information would be necessary. Furthermore, organizations should conduct both external and internal investigations to better understand the client and the transaction.

AML Requirements of EDD 

EDD regulations typically mandate that organizations retain their accumulated information records for a minimum of five years. This requirement typically includes maintaining copies of essential identification documents like birth certificates, driving licenses, and passports. Furthermore, organizations should be able to promptly and efficiently respond to regulators’ requests for records. This facilitates regulatory compliance and enables authorities to reconstruct individual transactions, including specific details such as monetary amounts and types of currency involved.

EDD measures are implemented when there is suspicion or reasonable grounds to believe that a client may be involved in illicit activities. In such cases, businesses must promptly report this information to their jurisdiction’s financial intelligence unit by submitting suspicious activity reports. It’s important to note that regulatory requirements may differ across various local jurisdictions, so organizations must verify the specific regulations applicable to their operating areas.

EDD in banking regulations do not explicitly require the consideration of adverse media, but they can be a valuable tool in conducting thorough assessments. Negative media refers to information sources that highlight potential involvement in activities like money laundering, financial fraud, drug trafficking, human trafficking, financial threats, organized crime, terrorism, or other illicit behavior.

Within Europe, Article 18 of the Fourth Anti-Money Laundering Directive (4AMLD) states that businesses operating in countries categorized as high-risk third countries must apply EDD measures. Additionally, individuals identified as politically exposed persons (PEPs), along with their close associates or family members, should undergo comprehensive scrutiny.

Across all jurisdictions, staying updated on constantly evolving anti-money laundering (AML) sanctions is essential. Regular screening of customers is necessary to ensure they are not listed on any watch lists. Industries that are particularly susceptible to money laundering risks, such as gambling, often have enhanced KYC due diligence requirements in various regions worldwide.

In the United States, guidance from the Financial Crimes Enforcement Network (FinCEN) advises that the scope of due diligence measures should be determined on a case-by-case basis, considering individual circumstances.

Conclusion 

EDD is a critical tool in mitigating financial risk and securing businesses against money laundering and terrorist financing. By conducting a comprehensive examination of clients based on a risk-based approach, EDD assists gather detailed information about their history, reputation, and financial activities. It is extremely necessary for high-risk and high-net-worth clients and individuals involved in uncommon or substantial transactions that carry increased risk.

Also Read: Quality Features of ActiveCampaign