PEPs by Association and Beneficial Owners
Individuals who are closely connected to a Politically Exposed Person (PEP), whether socially or professionally, are also considered PEPs.
Beneficial owners and associated persons
Those who are closely linked to a PEP are regarded as beneficial owners under anti-money laundering (AML) measures, whether through family ties or professional associations. These “close associates” are often referred to as “PEPs by association”, and financial institutions are required to apply enhanced due diligence when dealing with them.
This category includes family members as well as known business partners. They may be involved in suspicious or unusual transactions, which may trigger a suspicious transaction report (STR) to the competent financial intelligence unit (e.g. TRACFIN in France).
International Definitions
FATF and UNCAC
The Financial Action Task Force (FATF) defines a PEP as an individual who is or has been entrusted with a prominent public function.
To address the risks, Recommendations 12 and 22 require countries to ensure that financial institutions implement specific measures, as do designated non-financial businesses and professions (DNFBPs). These measures aim to prevent the misuse of the financial system and detect potential abuse by PEPs.
- In 2003, the FATF issued the first mandatory requirements covering foreign PEPs, their family members, and close associates.
- In 2012, the FATF extended these requirements to include domestic PEPs and PEPs of international organizations, in line with Article 52 of the United Nations Convention against Corruption (UNCAC).
UNCAC Article 52 defines PEPs as:
“individuals who are or have been entrusted with prominent public functions, their family members, and close associates.”
The main objective of Article 52 is to combat corruption. However, the FATF broadened its scope in 2012 to include AML efforts against predicate offenses such as corruption, tax fraud, and terrorist financing.
The EU Definition
The 4th EU AML Directive provides a precise definition of the functions covered by the notion of PEP in Article 3(9), and Articles 3(10) to 3(13) further specify the concept of family members and close associates for enhanced due diligence purposes.
This Directive was transposed into French law (Code Monétaire et Financier), under the supervision of the ACPR and the AMF, requiring obliged entities to implement robust procedures for dealing with PEPs. These include:
- ongoing knowledge of the source of funds,
- continuous risk assessment,
- enhanced monitoring of transactions.
Enhanced Due Diligence Measures
Managing PEP-related risks requires additional vigilance compared to ordinary clients. Key measures include:
- Collecting detailed information on the source of funds,
- Real-time monitoring of transactions carried out by PEPs and their associates,
- Detecting atypical transactions requiring suspicious activity reports (SAR/STR).
FATF Recommendations in Practice
FATF Recommendation 12 requires financial institutions to obtain senior management approval before establishing a business relationship with a PEP. Institutions must also assess the origin of wealth and the economic rationale of transactions.
High-Risk Sectors and Jurisdictions
Certain sectors pose higher risks when linked to PEPs, such as mining, construction, public procurement, and energy. PEPs from high-corruption jurisdictions (as measured by Transparency International’s Corruption Perceptions Index) are also subject to heightened scrutiny. The FATF maintains and regularly updates a list of high-risk jurisdictions.
Consequences of Non-Compliance
Failure to comply with PEP due diligence obligations exposes institutions to heavy financial penalties. In 2019, several European banks were fined over €70 million for deficiencies in PEP monitoring. Beyond financial sanctions, institutions face severe reputational risks if linked to money laundering cases involving public funds.
1stKYC’s Risk-Based Approach
At 1stKYC, our global Watchlist database goes beyond the EU definition by introducing PEP Levels 1, 2, and 3 for better risk assessment of ultimate beneficial owners (UBOs):
- Level 1 PEPs: those explicitly listed under Article 3 of the 4th EU Directive. They are subject to systematic suspicion reporting in case of unusual transactions.
- Level 2 PEPs: those holding regional political functions.
- Level 3 PEPs: those holding local political functions.
While Levels 2 and 3 do not represent the same level of risk as Level 1, they still require enhanced due diligence in business relationships.
Our risk-scoring grid allows compliance officers to:
- adjust the system’s default risk rating (up or down),
- justify their professional judgment within the AML/CFT framework.
At 1stKYC, we believe human expertise should prevail over automation when assessing financial crime risks, in line with regulatory expectations and financial sector best practices.
