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What is Enhanced Due Diligence? A Comprehensive Guide

22 December, 2023

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Business transactions always hold the risk of illicit financial activities, particularly when they occur at the global level. According to the UK’s National Crime Agency, businesses, financial sectors, and the public face fraud of €219 Billion annually. In fact, only the United Kingdom has to bear the loss of €115 Billion every year. In this regard, the Financial Action Task Force (FATF), the Financial Conduct Authority, and the FinCEN develop specific regulations requiring companies and financial institutions to comply. These globally working regulatory authorities impose Enhanced Due Diligence (EDD) solutions on businesses to address high-risk companies and large-volume transactions. This article explores Enhanced Due Diligence and its significance in the financial sector to prevent fraud and financial crimes.

What is Enhanced Due Diligence? A Quick Overview

Enhanced Due Diligence surpasses standard due diligence methods by providing a more thorough and rigorous approach to business identification, verification, and risk assessment. EDD is often used in commercial settings to reduce the possible legal and financial risks connected to illegal activity. Additionally, it is typically applied to high-risk clients or business partnerships. Most banking regulations, such as those in the United States about Know Your Business (KYB) and Anti-Money Laundering (AML), are based mainly on EDD.

Significance of Enhanced Due Diligence

The financial security issues may vary from region to region. Hence, regulating all business transactions is essential to combat the challenges like financial crimes. Nevertheless, with the assistance of the Bank Secrecy Act, EDD was mandated by the Patriot Act in 2001. Its laws and rules are considered essential because they need a significant amount of evidence and accurate information. Especially throughout the account creation and business risk assessment phases, the EDD process has to be meticulously documented.

Role of EDD in Banking Sector

An essential part of the KYB compliance process in banking is EDD. It comprises obtaining data to verify the identity of businesses and estimate the level of money laundering risk each company presents. Hence, the companies provide consolidated information during the EDD process, eventually reducing the risk. The FATF recommends the following achievable actions for EDD in the banking sector:

  • Acquiring more identifying data from a wider variety of trustworthy and impartial sources
  • Conducting more searches (such as negative media searches)
  • Analyzing the intelligence report of the company or beneficial owner to investigate if they are engaged in any illicit activity
  • Checking the source of income or resources in a business venture
  • Getting additional details about the nature and goal of the business relationship
  • Implementing a risk-based monitoring system to identify any suspicious activity or modifications to the customer’s risk profile

When is It Necessary to Conduct Enhanced Due Diligence?

In general, Enhanced Due Diligence should be carried out when establishing new business connections and during continuous monitoring to stay informed about any changes in risk exposure. However, other triggering situations may put companies at higher risk and need advanced screening. The takeaway is to consider risk management constantly. Businesses and Financial Institutions (FIs) can discover their exposure to various dangers and risk levels that vary based on the kind of firm they work for and the third parties they do business with. In the following four phases, we’ll review the specific situations when Due Diligence may be required by law:

Politically Exposed Persons (PEPs)

PEPs are individuals holding influential political positions and can be readily misused for the goal of money laundering or corruption. Therefore,  Enhanced Due Diligence is necessary when PEPs are involved. Of course, this does not imply that all PEPs are dishonest. Businesses need up-to-date details regarding PEPs, such as their address and identity papers, while evaluating them to comply with AML (Anti-Money Laundering) compliance and EDD regulations. 

Furthermore, to create a risk profile, companies must enquire about the residence of PEPs, their affiliations with high-risk families, and the organizations they participate in. Searching on the internet and social media platforms helps further identify whether there are any active investigations against them and examine their media coverage. A PEP’s status may be ascertained by consulting PEP listings that some nations make available. Additionally, it is possible to examine the internal PEP databases of some firms. 

High-Risk Jurisdictions

High-risk countries could not have robust enough Anti-Money Laundering (AML) policies and processes or have an unstable or unpredictable economy. Hence, companies are at a heightened risk of money laundering. Global efforts to combat corruption and money laundering are centralized under the Financial Action Task Force (FATF). Around the globe, AML laws are in place to aid in detecting suspicious conduct. Since high-risk businesses, industries, or nations might increase the risk of money laundering, completing Enhanced Due Diligence is essential to comply with AML legislation requirements.

Penalties

Verifying the government’s sanctions list is a mandatory regulatory need for your improved due diligence activities. The Ultimate Beneficial Owners (UBOs) with the highest stake must be reviewed during the OFAC screening process. Additionally, companies cannot lawfully do business if a corporation is controlled 50% or more by a person or entity on the sanctions list, according to the OFAC 50 Percent Rule. Enhanced Due Diligence becomes pertinent upon discovering sanctioned businesses with a significant stake (not nearly 50%) in the third-party entity. Nevertheless, companies may have to pay hefty fines when found guilty of association with high-risk businesses.

High-Risk Industries

Companies operating in high-risk sectors like real estate, banking, mining, oil and gas, or gaming, where large sums of money and high net-worth transactions are involved, require due diligence procedures. Nevertheless, businesses can conduct Enhanced Due Diligence checks and be subject to various laws depending on their industry. For example, the Bank Secrecy Act (BSA) provides a basic structure for the AML checks that financial institutions and broker-dealers must perform while partnering with other clients or businesses. 

EDD Procedures

How to Perform EDD?

A thorough Enhanced Due Diligence process requires the following steps:

  • Determining High-Risk Businesses

Initially, organizations evaluate each client’s risk profile by looking at affiliations, transaction type, geography, and employment, among other things. Businesses that represent a high risk to the industry might be politically exposed people (PEPs), residents of high-risk countries, or operating in sectors where fraud and money laundering are more common.

  • Information Gathering

Compared to standard due diligence, Enhanced Due Diligence necessitates collecting more thorough business data. The sources of wealth, funding sources, company connections, transaction patterns, and the intended use of the goods or services are all included in this data.

  • Enhanced and Continuous Surveillance

High-risk businesses and their transactions must be exposed to more frequent and comprehensive surveillance to identify abnormal or dubious behaviour, including transaction evaluations.

  • Escalating Fishy Activities 

Following the detection of suspicious activity, companies must notify the appropriate authorities, such as the Financial Intelligence Unit (FIU) or other regulatory agencies, of the incident.

  • Documentation

Organizations must keep thorough records of all information acquired, risk assessments completed, and measures taken in response to potentially suspicious activity.

How The KYB Can Help

In-depth and robust Enhanced Due Diligence processes are mandatory to protect your business from financial crimes and fraud. It will help your organization comply with AML regulations and be aware of the companies you are connecting with. With the KYB’s business verification solutions, leverage due diligence processes with AI-driven verification solutions. Additionally, our robust risk assessment procedures assist companies in strengthening their growth and making more informed decisions.

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