Politically exposed person

What Is a Politically Exposed Person?

A politically exposed person (PEP) is an individual who is or has been entrusted with a prominent public function.⁵⁶ This designation signifies a heightened risk for potential involvement in activities such as Bribery and Corruption due to their position and the influence they may hold. Consequently, the concept of a politically exposed person is a critical component within the broader field of Anti-Money Laundering (AML) and counter-terrorist financing, forming a core part of the Regulatory Framework that governs financial oversight.⁵⁴, ⁵⁵ Financial Institutions are mandated to implement enhanced Due Diligence measures when dealing with PEPs.⁵², ⁵³ The definition typically extends beyond the individual holding the public office to include their immediate family members and close associates, acknowledging that their relationships can also be exploited for illicit purposes.⁵⁰, ⁵¹

History and Origin

The term "politically exposed person" gained prominence in the late 1990s, largely in the wake of the "Abacha Affair." This notorious money-laundering scandal, involving the systematic theft of assets from Nigeria's central bank by then-dictator Sani Abacha, highlighted the urgent need for global measures to prevent political figures from abusing the Financial System.⁴⁸, ⁴⁹ Prior to this, international efforts to combat corruption included initiatives like the 1997 OECD Anti-Bribery Convention, which came into force in February 1999 and used the term "foreign official."

The Financial Action Task Force (FATF), an intergovernmental organization established in 1989 by the G7, became instrumental in formalizing the PEP concept. The FATF sets international standards and promotes the effective implementation of legal, regulatory, and operational measures for combating money laundering, Terrorism Financing, and other related threats to the integrity of the global financial system. Since 2012, the FATF's definition of PEPs has been widely adopted, categorizing them into foreign, domestic, and those associated with international organizations, and requiring specific risk-based approaches for financial institutions.⁴⁷

Key Takeaways

• Politically exposed persons are individuals who currently hold or have held prominent public functions, and they present a higher risk for potential involvement in financial crime due to their position.⁴⁶
• Financial Institutions are required to apply enhanced Customer Due Diligence measures for PEPs and their close associates as part of their Compliance programs.⁴⁴, ⁴⁵
• The Financial Action Task Force (FATF) provides the most widely recognized international definitions, classifying PEPs into foreign, domestic, and those from international organizations.⁴³
• The PEP designation does not automatically imply criminal activity but rather indicates a need for increased Risk Management and monitoring.⁴⁰, ⁴¹, ⁴²
• The regulatory focus on PEPs aims to prevent the abuse of public office for illicit financial gain, such as money laundering and corruption.³⁹

Interpreting the Politically Exposed Person

The designation of an individual as a politically exposed person is a regulatory and risk-based classification that prompts financial institutions to apply enhanced scrutiny. It does not imply that a PEP is inherently engaged in criminal activity, but rather acknowledges that their position carries a higher potential for the abuse of public office for private gain, including illicit activities like Bribery or Corruption.³⁷, ³⁸

When a PEP seeks to establish a relationship with a Financial Institution, the institution must perform Customer Due Diligence procedures that are commensurate with the assessed risk.³⁶ This typically involves obtaining additional information about the PEP's source of wealth and funds, the nature of their public function, and the country of residence, particularly if it is deemed a high-risk jurisdiction.³⁴, ³⁵ The level of scrutiny is not uniform for all PEPs; it is a risk-based approach, meaning that a PEP with a low transaction volume and a known legitimate source of funds may be treated differently from one associated with a high-risk country or industry.³¹, ³², ³³

Hypothetical Example

Consider a scenario where Ms. Elena Petrov, a recently appointed Minister of Trade in a developing nation, seeks to open a new investment account at a global bank. During the onboarding process, the bank's Know Your Customer (KYC) procedures flag Ms. Petrov as a politically exposed person.

The bank would then initiate enhanced due diligence. This would involve a more in-depth verification of her identity, requesting detailed information about her sources of income and wealth (e.g., salary, legitimate business dealings), and scrutinizing the purpose of the account and the expected transaction activity. The bank might also conduct background checks to assess the Corruption risk associated with her country and specific public office. This rigorous process is undertaken to mitigate the risk of money laundering or other illicit financial activities that could be linked to her public position, ensuring the bank meets its regulatory obligations.

Practical Applications

The concept of a politically exposed person is foundational in global efforts to combat financial crime and is integrated into the Regulatory Framework of financial markets worldwide.³⁰ Financial Institutions, including banks, investment firms, and other regulated entities, regularly apply PEP screening as a core part of their Anti-Money Laundering (AML) programs. This involves checking customer databases against PEP lists, which are often compiled by third-party data providers.

These applications aim to identify individuals who could potentially exploit their positions for illicit gain, such as facilitating money laundering or financing terrorism. If a PEP is identified, the financial institution must conduct enhanced Due Diligence, which may include stricter monitoring of transactions and, if necessary, filing a Suspicious Activity Report (SAR) to relevant authorities.²⁸, ²⁹ In the United States, for example, the Financial Crimes Enforcement Network (FinCEN) and federal banking agencies issued a joint statement in August 2020 to clarify banks' due diligence obligations regarding PEPs, underscoring the ongoing regulatory focus on managing these risks.²⁶, ²⁷ This guidance emphasizes that banks must manage their AML risks through appropriate due diligence, recognizing the threat foreign corruption poses to the U.S. financial system.²⁵

Limitations and Criticisms

Despite its crucial role in financial crime prevention, the politically exposed person regime has faced significant criticism. A primary concern is the potential for "de-risking," where Financial Institutions may unilaterally terminate or avoid relationships with PEPs due to the perceived high Compliance burden and risk, rather than applying a proportionate, risk-based approach.²², ²³, ²⁴ This can lead to legitimate PEPs, their families, and close associates struggling to access essential financial services.²⁰, ²¹

Regulators, such as the UK's Financial Conduct Authority (FCA), have acknowledged these issues. A multi-firm review by the FCA highlighted concerns that some firms were applying disproportionate due diligence requirements, exceeding regulatory expectations, and not adequately reviewing PEP status after individuals left public office.¹⁸, ¹⁹ The FCA has sought to clarify its guidance, emphasizing that UK PEPs should generally be treated as lower risk unless other higher risk indicators are present.¹⁶, ¹⁷ Challenges also arise in consistently defining when PEP status should expire, with some institutions maintaining the designation indefinitely, creating ongoing friction within the Financial System.¹³, ¹⁴, ¹⁵ This highlights the fine balance between robust financial crime controls and ensuring fair access to financial services.¹²

Politically Exposed Person vs. Senior Foreign Political Figure

While the terms "politically exposed person" (PEP) and "senior foreign political figure" (SFPF) are sometimes used interchangeably, particularly in the United States, there is a distinct difference in their scope and application. The term "politically exposed person" is a broader international designation, primarily defined by the Financial Action Task Force (FATF). The FATF's definition encompasses individuals who are or have been entrusted with prominent public functions, categorized into three types: foreign PEPs, domestic PEPs, and PEPs of international organizations.¹¹ This comprehensive classification is widely adopted globally in anti-money laundering frameworks.

In contrast, "senior foreign political figure" is a specific term predominantly used in U.S. anti-money laundering regulations, particularly under the Bank Secrecy Act and USA PATRIOT Act. An SFPF is defined as a current or former senior official of a foreign government, a major foreign political party, or a principal immediate family member or close associate of such an official.⁹, ¹⁰ Essentially, all Senior Foreign Political Figures are considered PEPs, as they fall under the "foreign PEP" category. However, not all PEPs are necessarily SFPFs; for example, a domestic PEP in a country outside the U.S. would be a PEP under FATF guidelines but typically not an SFPF under U.S. regulations. The distinction is crucial for U.S. Financial Institutions in determining the specific enhanced Beneficial Ownership and due diligence requirements.⁷, ⁸

FAQs

Who is considered a Politically Exposed Person?

A politically exposed person (PEP) is an individual who holds or has held a prominent public function. This can include heads of state, government ministers, senior politicians, senior government or military officials, senior executives of state-owned corporations, and important political party officials.⁶ The designation also extends to their immediate family members and close associates due to the potential for abuse of influence.⁵

Why are Politically Exposed Persons subject to special scrutiny?

PEPs are subject to special scrutiny not because they are presumed to be involved in criminal activity, but because their positions of power and influence create a higher risk of them being involved in Bribery, Corruption, or money laundering.³, ⁴ This enhanced scrutiny is a preventive measure to safeguard the integrity of the Financial System.

What is "enhanced due diligence" for PEPs?

Enhanced due diligence (EDD) for PEPs involves collecting more detailed information about the customer, such as their source of wealth and funds, the nature of their public office, and conducting more rigorous ongoing monitoring of their transactions.¹, ² The aim is to thoroughly assess and mitigate the heightened Risk Management associated with their position, ensuring compliance with Anti-Money Laundering (AML) regulations.