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N N OVEMBER 2016 ENHANCED DUE DILIGENCE (EDD) WHEN ARE ovember 2016

Enhanced due diligence (EDD)

When are you obliged to apply EDD?

Regulation 14 of the Money Laundering Regulations 2007 (MLR) provides that enhanced due diligence (EDD) must be applied in the following situations:

When the client, service, location or delivery channel is by its nature a higher risk of money laundering or terrorist financing;

When the client is not physically present for identification purposes (i.e. a non-face-to-face client);

When the client is a politically exposed person (PEP).

It is important to understand that, as with standard customer due diligence, enhanced due diligence also consists of ongoing monitoring. Therefore it is not simply a more robust verification process at the outset of the client relationship. It requires enhanced ongoing monitoring measures to be applied throughout the duration of the relationship, which are appropriate to the nature of the risk.

From the three EDD situations listed above, members are most likely to encounter the first two. However, further guidance is provided below on all three situations.

What EDD measures are needed?

The situation poses a higher risk of money launder or terrorist financing

The MLR does not outline what EDD measures need to be undertaken for situations that pose a higher risk of ML/TF. The type of EDD measures applied will therefore be risk-sensitive, requiring you to ascertain the nature of the higher risk and what measures will be appropriate to mitigate against it.

There is no exhaustive list setting out all higher risk situations. However, Annex III of the Fourth Money Laundering Directive (due to be implemented in 2017) provides useful guidance, containing higher risk indicators, including:

Client businesses that are cash-intensive;
Client ownership structures that appear unusual or excessively complex given the nature of the their businesses;
Where the business relationship is conducted in unusual circumstances;
Where clients are resident in geographical areas of higher risk;
Where the client requests products or services that might favour anonymity.

As mentioned, the Annex III list is not exhaustive, and no list can be due to the evolving nature of ML/TF methods. You must therefore be aware of and alert to other indicators that can be considered higher risk and/or suspicious. Furthermore, it highlights the importance of customer due diligence procedures at the outset of the relationship; acquiring relevant information to properly understand your client’s business makes it more likely you will identify activity that is inconsistent or suspicious at a later time.

Higher risk situations that you might more commonly encounter are clients with cash-intensive businesses, providing a payroll service, and high risk jurisdictions. Guidance on these specific areas are provided below.

Cash-intensive businesses

These are businesses that predominantly receive payment for goods and services in cash, such as retail shops, self-employed workers, taxi firms and restaurants. Cash-intensive does not mean businesses that hold a strong cash position, such as a cash reserve or cash on deposit with a bank (although such businesses can of course be cash-intensive if they predominantly receive payment for goods and services in cash).

The higher risk of ML/TF for such businesses arises from the susceptibilities for income to be undeclared (giving rise to tax offences), and the mixing of legitimate cash with illegitimate cash.

EDD measures for such clients can include:

Obtaining additional documentation at the outset of the relationship to ascertain and verify the source of funds as legitimate;

Acquiring detailed information at the outset of the relationship to understand the current and anticipated levels of business activity and income (enabling you to better identify any inconsistent or suspicious activity);

Stringent ongoing monitoring to ensure the business activity remains consistent with your understanding of the client, and to remain alert to information or activity that raises doubts about your understanding of the client or raises suspicion of ML/TF;

More frequent periodic reviews of the relationship (the timing of which will need to be determined by you on a risk-sensitive basis) to ensure the structure and nature of the client remains consistent with your understanding of them.

Payroll services

Providing a payroll service is generally considered higher risk for ML/TF due to the following susceptibilities:

A fictitious business can be established, with the criminal seeking to launder the proceeds of crime through a payroll service using fabricated employment and/or contractor relationships, invoices and timesheets.

False information can be provided to the payroll provider for the purpose of committing tax offences.

‘Ghost employees’ (persons recorded on a payroll system, but who do not actually work there) can be used to commit fraud.

Measures that can be taken to mitigate these risks include:

Obtaining additional documentation at the outset of the relationship to ascertain and verify the business and its source of funds as legitimate;
If the source of funds does not come from the client business, ensuring there is a good reason for the third party involvement, and identifying and verifying the identity and source of funds of the third party;

Stringent ongoing monitoring to ensure payments are consistent with your understanding of the client and its business activity, and to remain alert to information or activity that raises doubts about your understanding of the client or raises suspicion of ML/TF, including having regard to:

Whether there are unusual changes to the number of employees;

Whether there are unusual changes to the nature of the workforce (for example, the introduction of or increase in the number of contractors);

Whether there are unusual changes to the salary and expenses of the workforce;

Whether the client is reluctant or unwilling to provide sufficient information for payment requests (for example, a request to make payments to new employees, but failing to provide their National Insurance numbers);

Whether persistent and/or substantial discrepancies are identified (such as duplicated details), indicating that these might be intentional incorrect entries rather than genuine errors;

Whether the client seeks to change the manner in which the service is performed, where the change is unusual and/or without good reason.

More frequent periodic reviews of the relationship (the timing of which will need to be determined by you on a risk-sensitive basis) to ensure the structure and nature of the client remains consistent with your understanding of them.

High risk jurisdictions

If you have a client resident or with interests in a high risk location or jurisdiction then there exists a higher risk of ML/TF.

Therefore you will need to apply EDD measures and enhanced ongoing monitoring of any related activities or transactions.

There is no exhaustive list of higher risk countries, but such countries will include:

Countries identified as having no or ineffective AML/CTF controls;

Countries identified with significant levels of corruption or other criminal activity;

Countries identified as providing funding or support for terrorist activities, or that have designated terrorist organisations operating within their country;

Countries subject to sanctions, embargos or similar measures.

The following resources are of use in identifying such countries:

Financial Action Task Force- High-Risk and Non-Cooperative Jurisdictions;
Transparency International - Corruption Perceptions Index;
Office of Financial Sanctions Implementation

The client is not physically present for identification

Where a client is not physically present for identification, regulation 14 outlines examples of EDD measures that can be taken, including:

Establishing and verifying the clients identity using additional documents, data or information (for example, electronic verification, and/or additional information and documentation as set out in sections 5A and 5B of the Consultative Committee of Accountancy Bodies’ guidance);

Obtaining additional documents that have been certified or verified by another regulated person or sector (for example, a certified copy of the client’s passport from their lawyer, or a bank verifying the client’s identity);

Receiving the first payment for the engagement through an account opened in the client's name with a credit institution. EU regulations require credit institutions must provide the payers name, address and account number with all electronic fund transfers. Therefore the information provided can be used to further verify the client’s identity.

These are only suggested actions to mitigate the higher risk of ML/TF that arises when the client has not been met and had their identity verified in person. Furthermore, the number of measures applied will depend on the level of risk posed by the client, with the higher the risk (which will be informed by other factors such as the type of services requested, the location of the client, and their structure) then the more measures may be needed to satisfy yourself as to the client’s identity.

Politically Exposed Persons

A politically exposed person is defined by the MLR as a person who has been entrusted, within the last 12 months, with a prominent public function by a community institution, an international body, or a state other than the UK (for example heads of state, ministers, members of parliament and members of senior judicial bodies). A PEP will also include both the family members and known close associates of such persons.

If a client falls under the definition of a PEP, regulation 14 outlines the EDD measures that must be taken, including:

Requiring approval from senior management to establish the business relationship; and

Taking adequate measures to establish the source of wealth and source of funds; and

Conducting enhanced ongoing monitoring of the relationship.

Establishing the source of wealth and source of funds involves asking relevant questions to and obtaining appropriate documentation from the client, and doing so for each engagement. A PEPs salary and source of wealth is often publicly available on a register of their interests. This can be checked to ensure there is consistency with their wealth profile and the nature of the services requested.

Enhanced ongoing monitoring will require you to stringently monitor the relationship to ensure there is continued consistency with your understanding of the client and the products, services and transactions you are requested to deal with. It will also require you to remain alert to information or activity that raises doubts about your understanding of the client or raises suspicion of ML/TF, and to undertake more frequent periodic reviews of the relationship (the timing of which will need to be determined by you on a risk-sensitive basis).

Disclaimer: This document and information contained therein, is not intended to supply legal, regulatory or professional advice. AML/CTF compliance is the legal duty and responsibility of the accountant member in practice and supervision by CIMA does not transfer any part of those duties and responsibilities to CIMA. The information and comments provided in this document are given strictly for the purposes of general guidance and/or for illustrative purposes only. No responsibility or liability whatsoever is accepted for any error, omission or mis-statement (whether or not arising out of negligence) or for any loss or damage sustained as a result of reliance on information supplied, examples given or statements made. Any primary sources including relevant regulations or legislation should always be carefully referenced before any action is or is not taken.

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