Politically Exposed Persons PEPs

A Politically Exposed Person (PEP) refers to an individual who holds or has held a prominent public position in a government, international organisation, or political entity, along with their immediate family members and close associates. Because such persons are in positions of influence and authority, they are considered to pose a higher risk for involvement in bribery, corruption, money laundering, and other financial crimes.
The designation of PEPs is primarily used in financial regulation, banking compliance, and anti-money laundering (AML) frameworks, ensuring enhanced due diligence and transparency in financial transactions involving such individuals.

Definition and Classification

The concept of a Politically Exposed Person was first introduced by the Financial Action Task Force (FATF) — an intergovernmental body that sets global standards for combating money laundering and terrorist financing.
According to FATF guidelines, a PEP is:

“An individual who is or has been entrusted with a prominent public function, including heads of state, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, and important political party officials.”

PEPs are broadly classified into the following categories:

1. Domestic PEPs:
   • Individuals entrusted with prominent public functions within their own country.
   • Examples: Heads of government, ministers, members of parliament, judges, senior civil servants, or military officers.
2. Foreign PEPs:
   • Individuals who hold prominent public positions in a foreign country.
   • Examples: Foreign heads of state, ambassadors, or senior executives of state-owned enterprises abroad.
3. International Organisation PEPs:
   • Persons who hold senior positions in international or supranational organisations.
   • Examples: Directors, deputy directors, or members of boards of international institutions such as the United Nations, World Bank, or IMF.
4. Family Members and Close Associates:
   • Includes immediate family members (spouse, parents, siblings, children) and individuals known to have close business or personal relationships with the PEP.

Rationale for Classification

The PEP designation is not an accusation of wrongdoing. Rather, it reflects the potential risk associated with such persons due to:

• Access to public funds and influence, which may be misused.
• Susceptibility to bribery, extortion, or illicit enrichment.
• Ability to conceal assets or launder proceeds through financial institutions.

Because of these factors, financial institutions are required to apply Enhanced Due Diligence (EDD) when dealing with PEPs, rather than the standard customer verification process.

Regulatory Framework

PEP identification forms part of global Anti-Money Laundering (AML) and Counter-Terrorism Financing (CTF) regulations. Key international and national frameworks include:

• Financial Action Task Force (FATF) Recommendations (40 + 9) – Set global standards for recognising and monitoring PEPs.
• United Nations Convention against Corruption (UNCAC) – Calls for measures to prevent corruption among politically exposed persons.
• Basel Committee on Banking Supervision – Provides guidance on customer due diligence in financial institutions.
• European Union Directives on AML (4th, 5th and 6th) – Require EU financial entities to identify and manage PEP risks.
• Financial Intelligence Units (FIUs) in each country – Monitor and report suspicious transactions involving PEPs.

In India, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have issued directives under the Prevention of Money Laundering Act (PMLA), 2002 for the classification and monitoring of PEPs.

Due Diligence and Risk Management

Financial institutions are required to apply a risk-based approach when dealing with accounts or transactions involving PEPs.
Key due diligence measures include:

1. Identification and Screening:
   • Verification of customer identity against PEP lists maintained by governments, regulators, and international databases.
   • Continuous screening to identify existing customers who become PEPs during the course of business.
2. Enhanced Due Diligence (EDD):
   • Obtaining senior management approval before establishing business relationships with a PEP.
   • Understanding the source of wealth and source of funds.
   • Monitoring of account activity to detect unusual or suspicious transactions.
3. Ongoing Monitoring:
   • Continuous surveillance of financial behaviour and transaction patterns.
   • Immediate reporting of any suspicious activity to the Financial Intelligence Unit (FIU).
4. Risk Categorisation:
   • Institutions classify PEPs into high, medium, or low-risk categories depending on their position, influence, and country of origin.

Examples of Politically Exposed Persons

• Domestic Examples:
  • Prime Minister, Cabinet Ministers, Members of Parliament, Governors, High Court and Supreme Court Judges, senior military officials, heads of Public Sector Undertakings (PSUs).
• Foreign Examples:
  • Ambassadors, foreign ministers, heads of state or government, senior officials of international organisations, foreign central bank executives.
• Associated Persons:
  • Spouse or children of a cabinet minister, business partner of a head of state, or a financial advisor closely connected with a ruling political family.

Challenges in Implementation

Identifying and managing PEP-related risks present several challenges for financial institutions and regulators:

• Lack of updated global databases for PEP identification.
• Complex ownership structures used to conceal beneficial ownership or political connections.
• Balancing regulatory compliance with customer privacy.
• Cross-border transactions involving multiple jurisdictions with varying definitions of PEPs.
• Politically sensitive enforcement, as investigations may involve high-ranking officials.

Importance in Combating Financial Crime

The monitoring of PEPs is essential to:

• Prevent misuse of political power for illicit enrichment.
• Detect money laundering, corruption, and embezzlement of public funds.
• Preserve integrity and stability of the financial system.
• Comply with international AML standards and avoid penalties or sanctions.

By enforcing transparency and accountability, the concept of PEPs strengthens public trust in governance and financial institutions.

Global and Indian Context

• In the global context, major banking scandals — such as those involving funds embezzled by political elites in Africa, Latin America, and Asia — have underscored the need for strict PEP monitoring.
• In India, the PEP framework under the RBI’s Master Direction on Know Your Customer (KYC) norms (updated periodically) mandates that banks and financial intermediaries:
  • Obtain senior management approval for opening or continuing PEP accounts.
  • Establish the source of wealth and funds.
  • Conduct enhanced ongoing monitoring of transactions.

Non-compliance can lead to regulatory penalties, reputational damage, and in severe cases, revocation of licenses or sanctions from international bodies.