The treatment of UK politicians within the financial services sector has sparked political debate and generated media headlines over the past year, particularly in the wake of the Nigel Farage-Coutts scandal (see ‘Timeline of events’ below). In response, the UK regulator, the Financial Conduct Authority (FCA), has called on UK financial services firms to improve the treatment of Politically Exposed Persons (PEPs). With financial institutions’ management of PEPs subject to heightened scrutiny and new regulatory requirements, FINTRAIL summarises the key takeaways from the FCA’s latest guidance.
Timeline of events
July 2017 - The FCA releases its original guidance on PEPs (Finalised Guidance - FG 17/6 - The treatment of politically exposed persons for anti-money laundering purposes”) under regulation 48(1) of the Money Laundering Regulations., detailing how financial service firms should treat customers who are PEPs when meeting their AML obligations.
June 2023 - The UK private bank Coutts closes the account of British politician Nigel Farage. Farage claims the decision is politically motivated and files a Subject Access Request, which reveals the decision was made for reputational risk reasons and perceptions his views are ‘xenophobic and racist’. The case causes a political and media debate, and Chancellor Jeremy Hunt contacts the FCA regarding an urgent investigation into whether politicians are being debanked or denied services because of their status.
September 2023 - The FCA launches a multi-firm review on the treatment of PEPs, contacting 1,000 PEPs (from whom it receives 65 responses) and 15 financial service firms.
December 2023 - The UK government announces changes to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 in relation to the treatment of PEPs entrusted with prominent public functions in the UK (referred to as “domestic PEPs”). These changes come into force on 10 January 2024. (See FINTRAIL’s post on “PEP Guidance Reflecting Recent UK Regulatory Changes”)
July 2024 -The FCA publishes its final review, setting out its findings on how effectively firms are following the FCA guidance on PEPs. It also launches a guidance consultation (GC24/4) on proposed amendments to the FCA PEP guidance which is open for consultation until 18 October 2024.
What is a Politically Exposed Person?
Under the UK Money Laundering Regulations (‘MLRs’), firms are required to have appropriate risk management systems and procedures to determine whether a customer or the beneficial owner of a customer is a PEP (or a family member or known close associate of a PEP) and to manage the risks arising from this relationship.
Most national definitions of a PEP stem from the Financial Action Task Force (FATF) recommendations on anti-money laundering which define PEPs as individuals entrusted with a prominent public function. The FCA guidance states that the definition of a ‘prominent public function’ will vary according to the nature of the function held by a person; but firms are expected to understand the nature of the position held and consider whether it gives rise to the risk of large-scale abuse of position.
What is a prominent public function?
In line with the UK MLR’s Regulation 35(12)(a) PEPs are defined as individuals entrusted with prominent public functions, including:
Heads of state, heads of government, ministers and deputy or assistant ministers
Members of parliament or similar legislative bodies including regional governments in federalised systems and devolved administrations, including the Scottish Executive and Welsh Assembly, where such bodies have some form of executive decision-making powers. It does not include local government in the UK but it may, where higher risks are assessed, be appropriate to do so in other countries.
Members of the governing bodies of political parties. The FCA considers this only applies to political parties who have some representation in a national or supranational parliament or similar legislative body. The extent of who should be considered a member of a governing body of a political party will vary according to the constitution of the parties, but will generally only apply to the national governing bodies where a member has significant executive power (e.g. over the selection of candidates or distribution of significant party funds).
Members of supreme courts, constitutional courts or any judicial body the decisions of which are not subject to further appeal except in exceptional circumstances - in the UK this means only judges of the Supreme Court. Firms should not treat any other member of the judiciary as a PEP and only apply EDD measures where they have assessed additional risks.
Members of courts of auditors or of the boards of central banks
Ambassadors, charges d’affaires and high-ranking officers in the armed forces. The FCA considers this is only necessary where those holding these offices on behalf of the UK government are at Permanent Secretary/Deputy Permanent Secretary level, or hold the equivalent military rank (e.g. Vice Admiral, Lieutenant General, Air Marshal or senior)
Members of the administrative, management or supervisory bodies of state owned enterprises. The FCA considers this only applies to for-profit enterprises where the state owns 50% or more or where readily available information points to the state having control over the activities of such enterprises.
Directors, deputy directors and members of the board or equivalent function of an international organisation. The FCA considers that such international organisations only include international public organisations such as the UN or NATO. This definition does not extend to international sporting federations.
What is not a prominent public function?
The FCA guidance makes clear that public servants below Permanent or Deputy Permanent Secretary should not be assessed to have a prominent public function.
The definition excludes individuals who are ‘junior or mid ranking’. However, firms can assess whether middle ranking or more junior officials could act on behalf of a PEP and therefore pose an elevated risk.
The UK MLRs define family members of PEPs as: (1) spouse or civil partner of a PEP (2) children and their spouses or civil partners, and (3) parents. NB: The FCA guidance also includes siblings in the definition of family members. A proportionate risk-based approach should be used for family members falling outside the regulatory definitions (e.g. aunts and uncles); it may be appropriate to include a wider circle of family members in cases where the PEP poses a higher risk.
The MLRs define close associates as: (1) individuals known to have joint beneficial ownership of a legal entity or a legal arrangement or any other close business relations with a PEP, and (2) an individual who has sole beneficial ownership of a legal entity or a legal arrangement which is known to have been set up for the benefit of a PEP.
Summary of the FCA PEP Guidance
Due to the nature of politicians' roles, there is an increased risk that they or their family members and close associates may be involved in bribery and corruption. This should be managed through senior management oversight, risk management measures and enhanced due diligence (EDD) as follows:
1. The firm must have in place procedures to identify whether a customer or the beneficial owner of a customer is a PEP or a family member or a known close associate of a PEP.
A useful starting point for firms is to clearly set out the definitions of PEPs, family members and RCAs which align to the definitions within the FCA PEP guidance. They should ensure these definitions are used to assess an individual's role and determine whether they are a true PEP at onboarding and if their status changes during the customer relationship.
The firm should also define how long a customer is considered a PEP once they have left public office. This should ideally be risk-based depending on the role and risk posed. There should be mechanisms in place to identify when an individual steps down from a public function to ensure they are not treated as a PEP for longer than necessary.
Per the MLRs, individuals should be subject to risk-based EDD for at least 12 months after the date they cease to be entrusted with a public function. This does not include family members who should be treated as ordinary customers from the date the PEP leaves office.
2. The firm must have in place appropriate systems and procedures to assess the level of risk associated with PEP customers and the extent of EDD measures that need to be applied to manage the enhanced risks arising from the customer.
The firm should apply a risk-based approach to identifying PEPs and apply EDD where relevant. The customer risk assessment should consider all factors relevant to the customer risk and not just PEP status; this will provide an accurate representation of the risk posed by the PEP customer and make it clear what causes a PEP to be high risk.
3. Where a PEP (or a family member or a known close associate) relationship is identified, the firm must:
Obtain senior management approval for establishing or continuing the business relationship with that person
Take adequate measures to establish the source of wealth and source of funds which are involved in the proposed business relationship or transactions with that person
Conduct enhanced ongoing monitoring of the business relationship with that person.
Recent changes to the UK Money Laundering Regulations
Since 10 January 2024, the MLRs have been amended to state that the starting point for the assessment of domestic PEPs should be lower risk than a non-domestic PEP, and EDD shall only be applied in the event that other higher risk factors are present. Some indicators of lower or higher risk factors are described below.
Lower risk factors
Product - The customer is seeking access to a product which poses a lower risk as defined by the firm’s risk assessment.
Geographical - The customer is entrusted with a prominent public function in the UK and is therefore considered a ‘domestic PEP’, or is a PEP in a country with similar lower levels of corruption and misconduct, and similar political stability. If there are other risk factors present then the individual may be considered higher risk.
Personal and professional - The customer does not have executive decision-making responsibilities or is subject to rigorous disclosure requirements.
Higher risk factors
Product - The customer is seeking access to a product which poses higher money laundering risks and is capable of being misused to launder the proceeds of large-scale corruption.
Geographical - The customer is entrusted with a prominent public function in a country considered to have a higher risk of corruption or political instability and weak AML defences.
Personal and professional - The customer’s personal wealth or lifestyle is inconsistent with their known legitimate sources of income or wealth, there are credible allegations of financial misconduct, or the customer is in a position of responsibility or has greater ability to influence decisions.
The table below highlights measures that firms can take depending on the specific risks posed by the individual in question. A firm may decline a relationship with a PEP where it has concluded the risks posed by a customer are higher than they can effectively mitigate.
Measures to take in lower risk situations
This could apply for domestic PEPs with no other high risk indicators
Source of wealth and source of funds - Less intrusive and exhaustive steps to establish source of wealth and source of funds (e.g. using publicly available information).
Adverse information - Standard adverse media screening or other checks in line with other lower risk customers.
Oversight and approval - At a level less senior than the board of directors (e.g. the MLRO).
Ongoing monitoring - The business relationship is subject to less frequent formal review (e.g. in line with the regular KYC refresh cycle for updating customer information or when the customer requests a new service or product).
Measures to take in higher risk situations
This could apply to non-domestic PEPs or domestic PEPs with other high risk factors present
Source of wealth and source of funds - More intrusive and exhaustive steps to establish the source of wealth and source of funds, such as requesting detailed information and documentary proof from the customer.
Adverse information - More comprehensive adverse media checks (e.g. more thorough open source research as well as standard automated screening), or specially commissioned due diligence reports.
Oversight and approval - At a more senior level of management (e.g. the board of directors).
Ongoing monitoring - The business relationship is subject to more frequent and thorough formal review to determine whether it should be maintained (e.g. annual review).
Findings from the ‘Treatment of PEPs’ review
From September 2023 to July 2024, the FCA conducted a review of firms' approaches to PEP customers to assess whether they were correctly applying its PEP guidance. The findings included the following:
Defining PEPs - some firms included definitions for PEPs and RCAs that were not in line with the regulations and the FCA guidance.
Conducting proportionate risk assessments - a small number of firms were not effectively considering the customer’s actual risk in the assessment and risk rating.
Applying EDD and ongoing monitoring proportionately and in line with risk - some firms’ policies and procedures and customer file testing showed that they were regularly applying “excessive” EDD.
Deciding to reject or close accounts for PEPs, family members and known close associates - firms were clear that they would not decline products or services to UK PEPs or their RCAs simply because of their PEP status.
Effectively communicating with PEP customers - some firms need to improve the clarity and detail of communications with PEP and RCA customers, especially providing more detail in their requests so that customers can understand what they are being asked to do and why.
Keeping PEP controls under review to ensure they remain appropriate - some firms need to ensure they update their policies to reflect the legislative developments and recent amendment to Regulation 35 of the UK MLRs.
Watch this space
The FCA is now consulting on proposed amendments to its PEP guidance, to follow up on its Treatment of PEP review. It is seeking feedback on three key areas:
Non-executive board members (NEBMs): NEBMs are appointed to government departments from the public, private and voluntary sectors. As their role is to provide advice and bring an external perspective, NEBMs do not have any executive authority. As such, the FCA is proposing to clarify in its guidance that these roles should not be considered as PEPs in the UK context.
Sign-off: Under the MLRs it is a requirement that all PEP relationships are signed off by senior management. The FCA guidance sets the expectation that all PEP relationships should be signed off by the MLRO at a minimum with higher risk relationships potentially signed off at a higher level. Industry feedback indicates this part of the guidance causes concerns about the MLRO’s independence. As such, the FCA is proposing to amend the guidance to allow for alternative approaches to sign-off provided the MLRO maintains oversight of all PEP relationships within the firm.
Regulatory changes: The FCA proposes making targeted amendments to reflect the legislative change that firms should treat domestic PEPs as lower risk unless there are other apparent risk factors unrelated to their PEP status.
Important links
At FINTRAIL, we combine deep financial crime risk management with industry expertise to optimise your anti-financial crime programme. We have extensive experience in creating robust policies and procedures, refining and testing systems and processes, and providing context-based training. Get in touch to find out how we can help you refine your enhanced due diligence measures and incorporate an effective risk strategy for PEPs.