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Politically Exposed Persons [PEPs]

PEPs principle first time came into existence as a response to the Ferdinand Marcos and his wife scandal case who kept money from corruption activity in Swiss banks. The fact that the money is illegal has ruined Swiss banks reputation. The effect was the Swiss bankers then started to pay attention to and created list of politically important and strong people in foreign countries both those who have become their customers and those who have not. The use of PEPs principle is still limited and not standardized.

The use of PEPs principle becomes stronger corresponds to the enactment of Patriot Act, October 2001 as the consequences of terrorist attack on WTC twin tower in New York, 11 September 2001. PEPs handling is included in Section 312 of the Patriot Act. PEPs is used as an instrument to prevent risk for financial institution as the result of business with people who are politically strong and that can potentially lead to ruin or to boost financial institution reputation. The price of reputation damage cannot be paid with fine or with any kinds of punishment as the consequences of financial institution negligence in handling their clients and It is also the wreckage of their whole business.

PEP itself is not a list of people who are automatically bad people. When someone is included in PEP list, he/she does not automatically become a bad person. PEP is one way or another of risk management to minimize potential risk that possibly can happen if a financial institution has contact with PEPs.

I. PEPs Definition
In the first 40 FATF recommendation created in 1996, PEPs was not yet recognized. PEPs principles only came into existence in the revision of the FATF 40 recommendation in 2003 which is defined as the following:

“individuals who are or have been entrusted with prominent public functions in a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials. Business relationships with family members or close associates of PEPs involve reputational risks similar to those with PEPs themselves. The definition is not intended to cover middle ranking or more junior individuals in the foregoing categories”.

All PEPs definition used in almost all financial institutions in the world is based on the definition made by the above FATF. Below is a short explanation about the above PEPs definition.

This PEPs definition emerged as the explanation of the 6th FATF recommendation obliging financial institution, when dealing with PEPs, in addition to apply due diligence they are also required to: [1] have a proper risk management system to determine whether or not someone is PEPs; and [2] have an approval from senior manager prior to having business contact with PEPs category people.

See how US financial regulator defines PEP.

The Banco Central del Uruguay have publicly released its "official" list of domestic Politically Exposed Persons (PEPs).
The Banco Central del Uruguay used broad definition of PEPs [contains individuals who are not senior official/politician] and and therefore do not fit any conventional model.

I. a. Beyond Ordinary Politician
The above definition says that not only and not ordinary politicians can be classified as PEPs. Only senior and influential politicians (in terms of position) can be categorized as PEP. This politician can be either incumbent or retired such as president or prime minister, government dignitaries (minister, director general, regents, governor, etc). Senior politicians [DPR member, regional representative council (DPD), etc], military and court officials [judges, chief of army division, attorney general, etc], State owned companies officials, and respected political party members.

It is a bit unclear about the criteria on somebody declared as senior, middle or junior. Moreover, whether or not he/she is influential. The Wolfberg Group tries to interpret what is called senior and influential officials by stating that such category should be interpreted incumbent or retired officials who can create publicity beyond his/her own country territory and his/her can be related to public affairs.

FATF requires only senior officials to be included in the PEP’s category. It is based on the fact that tracking money laundering cases is not an easy job and it requires lots of resources such as money, time and human being. Moreover if a financial institution should have a list of all middle and junior officials of developing countries, for example, it would create an administrative burden. Therefore, interpretation is deemed necessary.

I.b. No more related to foreign citizen
Based on the above definition, officials or politicians or cronies or clients who can potentially be included in PEPs should be from foreign countries and not from where financial institution originates. This is based on the hypothesis that PEPs will unlikely save their money in their country. For security reason, they usually save their money abroad where information on the official history or the fund is commonly very limited. The reality shows that lots of public officials save their money in foreign financial institutions whether for security reason, prestige or other motives.

In its development, PEPs is not only about officials/politicians/cronies/clients abroad or from foreign countries. FATF has requested member countries to broaden interpretation of the 6th recommendation for domestic officials.

I. c. Not only Politician
The above definitions also mention that doing business with family or close relatives of PEPs has the same risk as doing business directly with PEPs themselves. This causes PEPs cronies and clients are also included in PEPs category.

How far PEPs family members can be classified as PEPs? No standard regulation as yet to use. But as the best practice amongst financial institutions, family members who can be classified as PEPs are spouse (wife/husband), children, parents, and brother-sister, son/daughter in law, and even uncle and aunts.

Close clients is divided into two categories: business clients and advisor/expert staff/consultant of PEPs. The last definition can be applied to somebody who clearly benefited from his/her close relation with PEPs.

Besides “mankind”, attention to money laundering crime is also directed to “companies”. PEPs has the same principle. PEPs category also includes private companies or charity which is fully or partly owned by PEPs directly or indirectly. FATF pays big attention to the form of charity which is usually used to hide PEPs financial sources.