Enhanced Due Diligence

Mar, 03 2020

Contents:

Enhanced due diligence (EDD) is one of many types of due diligence procedures used by companies in order to avoid or minimize risks when entering into high-value deals. The main purpose of EDD which distinguishes it from other types is that it usually conducts when a high-risk customers (counter parties, partners) are involved into a deal. To identify whether the potential customer can be categorized as high risk it is necessary to address KYC (know your client) risk rating system elaborated by Financial Action Task Force (FATF). FATF is an international organization primarily focused on identifying legal and natural persons who may be dangerous by being involved into money laundering or terrorism financing activities.

The main factors which may lead to the enhanced due diligence.

Customer risk factors:

  • The majority of the company’s clients are foreigners or non-residents.
  • Customer is a Politically Exposed Person (PEP), their family members or known associates.
  • Presence of nominee shareholders or shares in the company’s bearer from.
  • Cash-intensive business. In this case the level of risk is regulated by the anti-money laundering and countering the financing of terrorism (AML/CFT) policies of each company as well as local regulations. In Russia the main law regulating the above activities is Federal Law № 115-FZ dd. 7.08.2001 “On AML/CFT”.

Geographical risk factors:

  • Countries without adequate AML/CFT systems. For example, North Korea and Iran are identified by FATF as such.
  • Countries under sanctions and embargoes or similar measures.
  • Countries with a high level of corruption.
  • Countries blacklisted for financing or supporting terrorist activities.
  • Locations where the designated terrorist organizations operating within their country.
  • Countries that are not members of FATF.

Other risk factors:

  • Private and correspondent banking. Such institutions are mostly located at the offshore areas and maintain a high level of confidentiality which usually leads to the accumulation of activities related to money laundering.

In order to indemnify business from cooperating with dishonest or fraudulent customer (counter party, partner) it is extremely important to do enhanced due diligence especially if the potential customer corresponds to the criteria mentioned above.

The procedure of enhanced due diligence is very similar to the ordinary legal, commercial or financial however is oriented to high risk customers and situations.

In case if you run into the potentially dangerous customer the following steps are recommended in order to conduct enhanced due diligence:

Implement a risk-based approach

The risk-based approach gives a lot of understanding of the high-risk customers in business and other cases measured by high-risk status. Normally, it shall be specified in the company’s local policy referred to the AML issues.

Obtain additional identifying information

Company may provide a special questionnaire to the potential customer in accordance with its local risk-based policies. This questionnaire should provide both basic and in-depth information about the customer. Thus, it is important to collect this data from the customer and possibly the third parties.

The approximate questionnaire may require the following information:

  • Registration documents from the local registrar of companies.
  • Articles of incorporation, partnership agreements and business certificates (depending on the incorporation type and nature of business).
  • Names and locations of customers and suppliers.
  • Banking information and relationships with other financial institutions.
  • Identification of executives and beneficiaries.

Analysis of the sources of funds/wealth and ultimate beneficial ownership

This stage is mostly referred to the financial DD and focused on the research of the company’s financial history and current/future prospects.

  • Collect basic details on corporate history and structure.
  • Search company’s filings and business articles for financial and shareholding data.
  • Value the legitimacy of beneficiary’s net worth.
  • Highlight any discrepancies between income, source of wealth and total net worth.
  • Value documents proving the property title.
  • Research of assets and liabilities, particularly: analysis of stock (gross and net); analysis of debtors; analysis of creditors by nature and age and description of their repayments bases; details of any liabilities and recent claim history; details of any contingent, off-balance sheet financing; etc.

Monitoring of ongoing transactions

It is important to collect data on transactions details such as their background, purpose and nature. Additional details as duration, parties involved, etc. shall be covered too.

Also, all the transactions shall be in line with the stated purpose and if they are in the usual or expected threshold. In order to analyze this, the following documentation shall be evaluated:

  • Copies of all manufacturing, partnership, agency, distributorship, licensing, supply out-sourcing agreements and standard contracts for sale of goods/supply of services.
  • Copies of loan/credit agreements and related guarantee documentation.
  • Details of non-compliance with any contracts.

If everything is in order, the next step should be taken.

Analyze social media and negative check

In order to establish customer’s reputation, it is recommended to accurately check all publicly available sources containing reviews, articles, feedbacks etc. Overwhelmingly negative result is a strong indication that company is too risky for business.

On-site visit

This stage is considered important for the purpose of physical check of premises owned/rented by the company which also makes it possible to certify that the address stated in official documents corresponds to the physical address. Also, it provides opportunity to verify documents which cannot be provided digitally.

Develop a relevant risk-based monitoring strategy

Ongoing monitoring of high-risk customers is time consuming and requires a lot of effort, so employing a risk-based monitoring strategy is optimal. Under risk-based monitoring, it means:

  • Understanding essential parameters to monitor high-risk clients.
  • Estimating how often you need to monitor these clients.
  • Applying human or software enhanced due diligence approach and creating a process of alerts and swift decision making.

What shall be done in order to develop an effective culture of DD?

First of all, to maintain business from external abuse it is necessary to develop an effective process of compliance eliminating risk of money laundering within the company.

The team should not ignore obvious violations or suspicious activity because the client generates huge revenue for the company. It is important to never compromise on enhanced due diligence procedures because the regulator’s penalty for poor diligence outweighs any profit a customer brings.

Secondly, coordinate the information sharing. Compliance team needs to be informed of risks and processes throughout the organization. Otherwise, violations may go undetected and unreported. Integrating systems that handle different customer data can help effectively notice suspicious trends.

Thirdly, install enhanced due diligence software. Technological solutions such as KYC compliance providers, offer automation in conducting EDD. These solutions can be cloud-based or on-premises. One of the many advantages of these solutions is they simplify EDD by clearly identifying key risk issues using accurate information in a well-structured format.

However, many software solutions are quite ineffective, difficult to use and they have a poor customer conversion rate.

And lastly, use the assistance of professionals even if there is a tiny part of suspicion that the potential customer (counter party, partner) acts in bad faith.

VALEN lawyers have many years of experience in conducting different types of due diligence including enhanced one. Depending of the nature of the due diligence target’s business we will consult you regarding your situation and advise the best DD option. In case if your potential customer seems as a high risk, our specialists will conduct enhanced due diligence in order to eliminate any possible risk and secure your business. Also, our specialist will be glad to elaborate internal compliance policy for your organization or revise and improve the existent one.

Please contact us by any of the available methods of communication or visit our office by making an appointment by phone +7 (495) 7-888-096.

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