What is Enhanced Due Diligence? A Comprehensive Guide

Even though money laundering is widely denounced, it persists in many sectors and often remains unidentified. Regulatory bodies worldwide, such as the Financial Conduct Authority (FCA) and FinCEN, along with Financial Crime watchdogs like the Financial Action Task Force (FATF), aim to mitigate financial crimes. 

Businesses require strict verification protocols and a comprehensive due diligence process to adhere to regulatory frameworks and mitigate money laundering. It is necessary to verify all the customers and perform due diligence. However, enhanced due diligence of high-risk entities can help substantiate the actual level of risk associated with entities.

What are Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD)?

Customer Due Diligence (CDD) refers to the process of verifying customer identity and assessing the risk of being involved in any financial crimes. Performing due diligence on customers is a key requirement under FATF Recommendation 10. Here are some key steps of the CDD process: 

1. Customer Identification and Verification  (CIV)

CIV applies to an individual or legal entity to confirm identity and legality. It involves a review of various identity documents, including ID cards, passports, and company registration certificates, among others. 

2.  Beneficial Ownership Identification 

If the customer is a legal entity, such as a company or trust, it is necessary to identify the beneficial owners who ultimately control that entity.  

3. Ongoing Monitoring 

Companies are required to continuously review transactions that customers perform to ensure that they align with their profiles. It enables the detection and identification of suspicious and unusual behavior. 

4. Enhanced Due Diligence (EDD)

Enhanced Due Diligence  (EDD) refers to an advanced risk assessment process that goes beyond basic verification and provides a thorough and more rigorous approach for risk estimation. EDD process involves deeper checks such as verifying the customer’s source of wealth, applying strict monitoring, and is often required for:

• If the customer is a politically exposed person
• If a customer or transaction is associated with a high-risk country and sector
• If transactions are complex or large

This process is a step ahead of simplified due diligence. It is typically applied when entities stand higher at risk of being involved in money laundering or terrorist financing.

Who are High Risk Entities? 

High-risk entities include individuals in their ownership structure or representatives who have the potential to pose a serious threat to a company or its operation.  There are some attributes that define high-risk individuals who need EDD; they are mainly: 

• Politically Exposed Persons (PEPs) 
• Entities with complex ownership structures 
• Offshore Companies or Trusts 
• Cash-Intensive Businesses
• Non-Profit Organizations (NPOs) in High-Risk Areas
• Customers coming from countries with lax regulations on AML/CFT compliance
• Entities with suspicious transaction patterns

Enhanced Due Diligence Process – Key Steps

Compliance with FATF recommendations requires businesses to implement enhanced due diligence measures when dealing with high-risk entities. A thorough Enhanced Due Diligence process involves the following steps:

Risk-Based Approach 

Initially, organizations evaluate each client’s risk profile by looking at transaction type, geography, and employment, among other things. Regulators in various countries have been using this principle for risk identification. 

The UK’s Financial Conduct Authority (FCA), the U.S. FinCEN under the Bank Secrecy Act, and the European Union’s AML Directives all stress the use of a risk-based approach. It requires firms to allocate compliance resources efficiently and ensures that higher-risk relationships or transactions receive proportionally greater scrutiny through EDD.

Comprehensive Data Collection

Enhanced Due Diligence process involves collecting more thorough business data such as  sources of wealth, company connections, transaction patterns, and the intended use of the goods or services. There is a need to collect various documents that provide insight into business or company information, including the following documentation and the nature of information: 

• Official corporate record 
• Business registration documents, Articles of incorporation & partnership agreements
• Banking details often include bank statements and transactional histories 
• Identity documents of representatives, UBOs, and board members. 

If there is any Politically Exposed Person (PEP) within the ownership structure of the client organization, the following information is necessary to collect: 

• Title and details on the position a PEP holds within the company 
• When a Politically Exposed Person (PEP) has a close associate or family member, it is essential to thoroughly establish the individual’s identity, including their full name, title, and role. Additionally, it is important to assess their level of proximity to public office, detailing the nature of their relationship and any potential influence they may exert within the context of public affairs.

Review of Funds Source

The EDD process involves a thorough review of the company’s funding source and the financial background of all the UBOs. In case of any inconsistency in the earnings or source of wealth, the following additional details are required for thorough review: 

• Shares details 
• Salary, Bonuses, and Investment Details
• Property and asset details 

Transaction Monitoring and Payment Screening 

EDD measures include checking details of transactions to confirm their purpose. It also involves verifying the parties involved in a specific transaction. If there are any red flags, such as multiple small transactions or high-value transactions without a transparent purpose, it can be a sign of money laundering. High-risk businesses and their transactions must be subject to more frequent and comprehensive surveillance to identify abnormal or suspicious behavior, including transaction evaluations.

Adverse Media Screening 

Enhanced Due Diligence involves the review of press articles, reports, and other media, including social networks. It aims to check the reputational status of a company or business. As part of EDD, it is important to identify the reputational status of the business and verify if it appears in adverse media. 

Onsite Visit 

In case of inconsistency of address details, it is mandatory to conduct onsite visits for verification. A non-corresponding address registered in official documents is a red flag and a high-risk indication that businesses consider for fraud prevention and regulatory compliance. 

Documentation and Reporting 

Organizations have to thoroughly record all information acquired, risk assessments completed, and measures taken in response to potentially suspicious activity. It is also the step in completing the EDD process. Following the detection of suspicious activity, companies notify the appropriate authorities, such as the Financial Intelligence Unit (FIU) or other regulatory agencies, of the incident.

Why is Enhanced Due Diligence Necessary? 

Enhanced Due Diligence (EDD) is important for an AML program as it allows the detection of money laundering. In addition to the AML compliance framework, EDD is important for the following reasons:

For Accurate Risk Management 

Where EDD contributes to overall AML compliance by providing insight into financial assets and activities of potential entities, it serves in accurate risk management. Detailed information about entities and their transactions enables organizations to detect suspicious activities and mitigate financial crimes. In addition to this, the EDD program helps organizations to comprehend associated risk in a better way and reduce financial loss, legal fines, and reputational damage by compliance with regulatory requirements. 

For Improved Internal AML Controls 

Enhanced Due Diligence (EDD) process works for  strong and effective AML compliance programs. By acquiring comprehensive details and cross-referencing with available data sources, companies can better assess the risk of money laundering associated with potential entities. 

In general, the Enhanced Due Diligence process empowers companies to handle high-risk entities and minimize the risk of dealing with such entities that can bring significant challenges in the form of noncompliance fines and reputational damage. 

Streamline Your Enhanced Due Diligence Process with The KYB

Manual due diligence process is challenging as it takes a long time full of errors. Businesses need tech-based automated solutions to have quick service and accurate results. 

The KYB empowers Enhanced Due Diligence by automating the identification of complex ownership structures and screening of UBOs for PEPs, sanctions, and watchlists. It also integrates adverse media screening APIs to ensure review of a business’s reputational risk. 

In addition, The KYB also offers perpetual benefits for real-time alerts of evolving regulations and emerging threats. Therefore, investing in The KYB  will empower an enhanced due diligence process and help businesses to stay compliant with regulatory standards. 

FAQs

What Makes EDD Different from CDD? 

EDD (Enhanced Due Diligence) differs from CDD (Customer Due Diligence) primarily in the level of scrutiny and the risk profile of the customer. EDD is a more comprehensive investigation required for high-risk customers, while CDD is a standard process for all customers. 

Although Customer Due Diligence (CDD) establishes a groundwork for risk assessment, EDD offers additional measures for a more comprehensive evaluation of high-risk entities.  

It requires a more in-depth investigation into the customer’s background, financial activities, and risk factors. 

What is an example of EDD?

An example of Enhanced Due Diligence (EDD) is a bank that has to onboard a new client who is a Politically Exposed Person (PEP) from a high-risk jurisdiction, like a country on the FATF blacklist.  For such an individual, the bank needs to be more rigorous in its scrutiny than for a regular client. This includes gathering more comprehensive information about the client’s identity, verifying their source of funds and wealth, and implementing continuous monitoring of their transactions. 

What is EDD, and who is it done for?

Enhanced Due Diligence (EDD) is a risk-based process of verifying a customer’s and business’s identity and assessing their risk profile beyond standard due diligence. Financial institutions and businesses primarily use it to comply with regulations and prevent financial crimes like money laundering and terrorist financing. EDD is typically conducted for customers or business partners who pose a higher risk, such as Politically Exposed Persons (PEPs) or those operating in high-risk sectors. 

In simpler terms, EDD is a deeper level of screening that goes beyond basic identity verification to assess the overall risk associated with a customer or business relationship. It involves collecting more information, verifying sources thoroughly, and conducting more in-depth analysis to understand and mitigate potential risks.

Which situations require EDD?

Enhanced Due Diligence (EDD) is required in situations where there’s a heightened risk of money laundering, terrorist financing, or other financial crimes. This includes dealing with high-risk customers like Politically Exposed Persons (PEPs), those from high-risk jurisdictions, or those in industries prone to such activities. Complex transactions, unusual transaction patterns, and the use of shell companies also trigger the need for EDD.