Politically exposed persons (PEPs) and how to define them

The concept of a “politically exposed person” (PEP) is one of the fundamentals of anti-money laundering (AML) and counter-terrorist financing (CTF) compliance. In short, PEP can potentially be involved in corruption, money laundering, and other illicit activities due to his political or administrative role.

PEP-specific compliance is mandatory for financial institutions and designated non-financial businesses and professions (DNFBPs), which include industries through which money laundering can occur: real estate, precious metals and stones, luxury items, legal services, and trust and company service providers.

Here I’ll briefly examine the history, the commonly accepted definition, and the flaws of the PEP concept.

An insight into the history

The concept of a “politically exposed person” emerged in the late 1990s during the investigation of an over a billion dollar embezzlement of state funds by the former Nigerian dictator, his family members, and high-ranking officials. The “dirty money” in question had been transferred to numerous overseas accounts (for instance, in Switzerland and the UK), and the government succeeding his regime tried to recover the funds.

The case highlighted the lack of specific anti-money laundering regulations regarding people who abuse political and administrative power for illicit financial gains. After September 2001, it became apparent that PEP-specific compliance should also consider the risks related to terrorism financing. The debate about politically engaged persons resulted in the development of the United Nations Convention against Corruption.

The definition of a PEP

While there’s no universal definition of a “politically exposed person,” most countries build their legislation on recommendations provided by the Financial Action Task Force on Money Laundering (FATF) recommendations. According to FATF, a politically exposed person is entrusted with a prominent public function. By virtue of his role, PEP can be involved in state corruption, money laundering, and other illicit activities. To mitigate the risks associated with such customers, PEP-specific compliance recommends an enhanced due diligence process to reduce the risks associated with such customers.

Despite the minor differences in national and supernational legislation, people in the following roles will qualify as PEPs in the absolute majority of jurisdiction:

*Heads of state and heads of government *Ministers, deputy ministers, assistant ministers, or parliamentary secretaries (a role in several Commonwealth and EU countries). *Parliamentarians and prominent political party members. *The head judges of any judicial body (country-specific). *The Chancellor of Justice (or equivalent official responsible for supervising the lawfulness of the government’s actions). *Auditor General. *Head, board directors, and top officials of a Central Bank. *Ambassadors, envoys, or chargé d’affaires. *High-ranking officers of the armed forces. *Board directors and top officials of state-owned organizations. *International and supernational business and NGO officials.

For compliance, close relatives (such as a spouse, parents, children, and their spouses) are also considered PEPs. Close business associates of politically engaged persons are also subject to PEP-specific compliance, especially in joint ownership over a trust or a company or if they own an organization acting in the interests of a PEP.

FATF advises additional scrutiny towards foreign PEPs—high-ranked individuals from countries that differ from the organization's location.

Evaluating information about foreign politically engaged persons is more complex than locals. Therefore, FATF recommends enhanced due diligence and suggests treating them as PEPs indefinitely. Domestic PEP status typically lasts a year after an individual resigns from his prominent public role.

Some countries and supernational bodies, such as European Commission, provide lists of people holding administrative and political roles and qualifying as PEPs. Yet FATF recommends organizations to “do their own research” and independently assess risks, as such lists may be outdated, incomplete, or incorrect.

Why is the PEP concept great?

PEP-specific compliance addresses the connection between government corruption, money laundering, and terrorism financing. It provides a comprehensive framework to question sources of funds, monitor transactions, and increase transparency. Accepted as an international standard, it prevents “dirty money” from spreading from one country to another.

But what are the limitations?

PEP-specific compliance underperforms when it comes to systematic state corruption. Due to its formal nature, PEP compliance doesn’t identify sophisticated schemes to launder money and hide illicit assets. It also doesn’t suggest any additional control for people formally and informally tied to a PEP but not considered “close associates.” It focuses on a limited number of high-ranked individuals, not middle and junior-level political and administrative roles, which are significantly more prone to corruption.

The problem isn’t limited to some highly corrupt political regimes. For decades, the UK capital was a safe harbor for money from Russia and other countries with widespread corruption. Former politicians and businesspeople with apparent ties to high-ranked individuals in their home countries abused the relaxed approach of British authorities towards questionable money. Despite the calls from anti-corruption activists and journalists, it only changed after the universally condemned Russian invasion of Ukraine in 2022.

The definition of a “politically engaged person” doesn’t tackle the informal influence of retired high-ranked politicians or highly influential people without formal status, such as the Russian politician Alexei Navalny.

Should we redefine PEPs?

In April 2022, Alexei Navalny’s Anti-Corruption Foundation published a so-called List of bribe-takers and warmongers. By March 2023, they had 7,000 entries with dossiers that elaborate on how a specific person benefitted from Vladimir Putin’s regime. The vast majority of them don’t qualify as PEPs for the means of compliance while being informal “close associates” of corrupt politicians and state administrators.

The question is whether the definition of a “politically engaged person” should be broadened to meet the new challenges of corruption and money laundering. In February 2023, FATF suspended Russia’s membership, meaning that financial and non-financial institutions will scrutinize all Russian operations and request additional explanations for each transaction. Such measures significantly increase compliance costs for companies on regulated markets but don’t address the “political” component of corruption and money laundering.

At Dataspike, we strictly follow current FATF recommendations and definitions. But as a company working in compliance, we understand that such measures cause collateral damage for our clients and their law-abiding customers.