In the first part of this article, we reviewed the “tick the box” hurdles that a prospect must overcome in order to meet basic anti-money laundering requirements. In this second part, we will look at the considerations that must be made when taking a Risk Based Approach towards the client or counterparty.
Would you rather have the well-to-do local dentist or the billionaire foreign despot as your client?
The final hurdle in a customer or counterparty due diligence (CDD) is often difficult to set since it is a grey area in which the risk must be evaluated and compared against your own tolerance or appetite for risk. There are several factors that are considered in the evaluation of CDD risk.
First, there is the customer or counterparty themselves. The degree of political exposure is also a risk factor, as politically exposed persons (PEPs) are often in a position of power that is conducive to bribery and corruption. The reasons given for the proposed relationship should be scrutinized and validated. The nature of the relationship should be considered as well: how much business and of what kind is expected over the duration of the relationship. Finally, the history of the party is a risk factor with facts such as past criminal or civil investigations, indictments, and convictions playing a role in judging the risk.
Second, there is contextual and geographical risk. If the party is foreign, then this presents more risk than would a well-known local. If the party comes from a country or region where corruption and crime are high this will raise the risk profile. A party from country with significant extractive resource revenue will also present a higher risk. There is some truth in the stereo type of a third word government official from an oil rich country making off with stolen funds, as this happens much more often than it does with first world government officials from diversified service driven economies.
Finally, there is the business proposed. If the proposed transaction involves new and innovative products then it should be carefully reviewed. If the party is action through opaque and complex structures, particularly those located in certain “secrecy jurisdictions” then the risk profile should be increased. Finally, if the proposed business involves transactions that would be conducive to money laundering, i.e. cash or high value asset transactions, then the increase in risk must be considered.
In the Risk Based Approach it is up to your organization, based on a thorough understanding of your business risk tolerance, to decide which clients to accept as “low risk”, which ones to accept as “higher risk”, and which ones to “reject” and the processes used to make and continually evaluate these decisions. You may have several levels of risk and appropriate risk management procedures for each. It is up to you, within the confines of your regulatory regime, to select the right tools and define and implement the processes that are suitable for your business. In order to do this, you must understand the risks you face and press the pedal down hard enough to get your business to the finish line, while turning away any client that presents unreasonable levels of risk for your business.
In short, it is a much lower risk proposition to do business with a well-known community dentist who owns a local practice for the last 25 years and is planning for retirement than it would be to deal with a high-level judge from a foreign country who has been investigated for bribery in the past and wishes to open a “confidential savings account”.