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What is Third Party Due Diligence? A Comprehensive Guide to Combat Risk

08 January, 2024

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The assistance of third parties has become inevitable to run business operations smoothly, whether a company functions at a national or international level. Organizations often need external support from financial and audit processes to human resource operations to compete in today’s fast-paced world of businesses. Nevertheless, extensive collaboration with multiple third parties comes with the risk of financial losses such as corruption. Hence, it is now more essential than ever to know your collaborators before making any business partnerships, and that’s where the KYB’s third party due diligence comes in. 

Robust third-party due diligence procedures help businesses make their operations smoother while mitigating the risk of fraud and financial crimes. Let’s explore how third-party due diligence allows organizations to detect and minimize the risk of losses.

What is Third Party Due Diligence? 

It is the process where businesses verify and authenticate the credibility of 3rd parties and analyze the potential risks associated with those organizations. This also refers to vendor due diligence, where organizations can determine the level of risk during business onboarding on a constant basis.

Furthermore, the process is an integral part of business risk assessment processes. Companies can utilize this to review the legal and financial records of third parties, perform background verification, and analyze their business interests. With this verification process, business owners can significantly save their industrial reputation.

Compliance Requirements: Third Party Due Diligence

Companies are always at high-level risk from 3rd parties. Hence, financial regulatory authorities worldwide have a standard set of regulations to ensure diligence. Let’s have a quick look:

FINTRAC’s Section 32

FINTRAC is the Canadian regulatory authority that directs companies to perform third-party due diligence when:

  • When larger transactions of cryptocurrency are conducted
  • For account opening applications
  • When a casino disbursement has to be reported
  • For larger bank or business transactions

Recommendation 17 by FATF

The Financial Action Task Force (FATF)’s articles 10, 11, and 17 demand financial organizations to ensure third party due diligence before making new business connections. As per their recommendations, any company or financial institution taking services from third parties must obtain certain knowledge as described in Article 10.

Additionally, thorough identity verification is mandatory for financial firms and is essential to ensure the legitimacy of entities before onboarding. Moreover, these extensive due diligence procedures are designed to confirm that the intermediate party also complies with regulations set by regulatory bodies.

FinCEN’s Final Rule

The Financial Crimes Enforcement Network (FinCEN) issued the Final Rule that amends the Bank Secrecy Act (BSA) to combat challenges associated with criminals involved in illicit financial activities. This regulation declares the standard requirements regarding third party due diligence, which are as follows:

  • Identifying and confirming the identity of the customer
  • Beneficiary owner verification is required
  • Creation of risk profiles for customers depending on the kind of business connection 
  • Using continuous consumer due diligence, questionable activity is identified and reported

Significance of Third party Due Diligence

5 Significant Methods to Improve Third-party Due Diligence

Criminals are continuously looking for methods to get around due diligence policies and get into the corporate community. But if you follow these five suggestions, businesses may have an excellent vendor due diligence approach, enabling them to operate a risk-free company.

1. Basic Understanding of Laws

Comprehending legal requirements is essential to creating a due diligence procedure for third-party screening. All state and international legislation must be adequately complied with by your due diligence procedures. Examining the legislation may assist businesses in building the ideal solution, integrating reputable providers, efficiently adhering to legal requirements, and stopping fraud.

2. Sort the Risks

Not every third party carries the same level of risk. The most prevalent risks associated with suppliers include compliance, transactional, reputational, strategic, and operational risks. To better understand the due diligence procedures, companies can classify the risk and carry out identity verification following the risk involved.

3. Articulate the Process

A company’s due diligence system’s procedure makes it simple to onboard authorized third parties. AI-powered screening systems quickly and easily check all your vendors, suppliers, and other third parties against worldwide watchlists in under a minute.

4. Confirm the Business Relationship with a Third Party 

The core of the onboarding process is a well-defined, automated screening procedure. However, you must specify your arrangement with the third party in order to guarantee the system’s effectiveness.

5. Examine the Process of Due Diligence

Don’t forget to audit the procedure and the results. For a firm, the verification findings are vital. To increase the onboarding process’s authenticity, set up specific metrics to establish the requirements and assess the system’s accuracy in meeting them.

Benefits of Third Party Due Diligence

Going a bit further, the sections that follow list some advantages of carrying out exhaustive third party due diligence:

  • Accessibility to Vendor’s History

Due diligence allows companies to learn more about the background of each potential provider. This details the vendor’s brand reputation, financial stability, prior legal troubles, and compliance problems. This information not only enables your business to assess the risk attached to this vendor, but it may also assist in selecting suppliers and provide guidance for any potential discussions.

  • Determine the Inherent Hazards

Third parties are independent companies. Therefore, entities don’t have the necessary monitoring and control to ensure their actions are consistent with the company’s values and objectives. They could break laws you wouldn’t feel comfortable breaking, make remarks in public, or provide political support that is directly at odds with your goals.

Companies may find any potential issues before they have an influence on their company by carrying out third party due diligence. It helps to get a clear idea of the third party’s identity and the people they collaborate with. In addition, the inquiry could turn up hidden dangers related to cybersecurity, operations, and corruption. Additionally, businesses should comprehend the regulatory and compliance requirements that apply to their company. 

  • Safeguard the Business Image

Reputation matters a great deal to many businesses. Simple social media discourtesy may damage reputation while causing legal troubles and compliance challenges. To safeguard the image of your business, every comprehensive due diligence research will examine the media presence and standing of potential third parties.

Along with media, companies could learn more about the third party’s interactions, location, personnel, and other details, all of which might have a favorable or unfavorable effect on the company’s image. For instance, certain countries have higher rates of bribery or corruption than others. Therefore, knowing whether a potential vendor is situated in one of these areas is critical.

  • Effective Risk Management

By doing comprehensive, third party due diligence research, companies can ensure that they comply with all legal requirements and don’t miss any opportunities or issues that may arise from contracts or interactions with other parties. In addition, it will reduce their overall risk exposure, lessen the possibility that they’ll be caught off guard by negative press, and avoid any further problems related to bribery or corruption.

In A Nutshell

Verification and screening of the businesses are crucial to ensure compliance with standard regulations worldwide. Since perpetrators keep on looking to identify loopholes, The KYB’s business verification services, aligned with effective vendor screening processes, help companies mitigate the risk of fraud and financial crimes. Ready to utilize our database with access to 250+ accurate resources? Talk to our experts today and leverage our verified data to make informed decisions.

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