How Can Financial Institutions Ensure CDD And EDD In AML Compliance?

When high-risk individuals such as American political consultants Paul Manafort and Rick Gates took advantage of the banking systems in Ukraine to conduct money laundering between 2006 and 2016, they brought attention to a serious weakness in international AML compliance efforts.

Their money-laundering operations in Ukraine raised a major problem for banks: spotting risk before it gets out of control.

These Politically Exposed Persons (PEPs) or high-risk individuals successfully bypassed standard checks, making it clear that a one-size-fits-all approach to due diligence simply isn’t enough.

This is where enhanced due diligence (EDD) and customer due diligence (CDD) come into play, providing financial institutions with essential layers of security. Financial organizations should implement relevant risk management solutions to investigate whether the onboarded customer is a high-risk individual or innocent.

But what distinguishes these procedures, and why are they necessary to address the threats posed by figures such as Gates and Manafort? What happens if banks and other financial firms don’t implement AML solutions to fight against money laundering?

What is Customer Due Diligence (CDD)?

Customer Due  Diligence is the thorough process of identifying and assessing the customer’s risk profiles before having a business relationship with them or onboarding them in any financial institution.

Companies can collect and verify information, including the customer’s name, date of birth, account information, address, source of funds, occupation, and name.

The purpose of implementing CDD is to prevent terrorist financing and money laundering by recognizing and mitigating risks linked with clients. Financial institutions and all other firms must apply CDD to secure themselves from criminals and make long-lasting relationships with clients.

FATF Recommendations for Customer Due Diligence

Under Recommendation 10 of the 40 Recommendations of the Financial Action Task Force (FATF), all members must ensure effective identity verification and transaction monitoring by setting customer due diligence (or CDD) processes into action.

What is the Customer Due Diligence (CDD) Process for Customer onboarding?

Organizations must carry out due diligence procedures onboarding any customer. It includes:

Customer Identification & Verification

• Collect basic client information, such as name, address, and birthdate.
• Use trustworthy databases or  government-issued documents (passports, ID cards, etc.)

Customer Profiles Assessment

• Recognize the business type and general background of the customer.
• Examine the anticipated behavior of their transactions (frequency, amounts, etc.)

Risk categorization

• Evaluate the customer’s risk based on variables like geography, business type, and customer background.
• Assign a risk level (e.g., low, medium, high) based on their profile.

Ongoing Monitoring

• Regularly check that the customer’s transactions match their risk profile.
• Report any odd or questionable behavior so that it can be looked into further.

Record Keeping

• Record-keeping: Preserve records of the customer’s identity and transactions for the duration of the mandated retention period.
• Ensure that in the event of a regulatory inquiry, these records are easily accessible.

What is Enhanced Due Diligence (EDD)?

EDD is a more comprehensive level of CDD that is applied to high-risk clients whose activities seem more suspicious.

The customer is required to perform EDD if there are any discrepancies in the information provided or if the firm finds any reason to scrutinize the consumer further.

This usually takes longer and entails more in-depth research into the customer’s personal information, enterprises, and transactions.

FATF Recommendations for Enhanced Due Diligence

Recommendation 19 requires enhanced due diligence (EDD) for any transactions or connections with organizations from FATF-identified high-risk nations. Particularly when handling new business, sporadic transactions, or suspect conduct, these measures ought to be ongoing, not one-time

What is the Enhanced Due Diligence (EDD) Process for High-Risk Customers?

Banks and other financial institutions conduct EDD on customers by:

Extensive Identification and Confirmation

• Acquire additional identity documentation, like multiple IDs, and verify them thoroughly.
• Utilize third-party data sources (such as international watchlists, PEP databases, and government databases) to further confirm the customer’s identification.

Establish Source of funds

• Examine the customer’s wealth and funding sources through extensive official records (such as contracts and bank statements).
• Analyze their financial activities and business structure to verify the validity of the customer.

Advanced Risk Classification

• Apply enhanced risk measures, especially for politically exposed persons (PEPs), high-risk industries, or clients from high-risk regions.
• Perform background checks through global databases (e.g., sanction lists, PEP lists, adverse media, etc).
• Assign higher risk thresholds and adjust the due diligence measures accordingly.

Continuous & Intensive Monitoring

• Increase the monitoring frequency and set up automated alerts for high-value transactions or activities that differ from the customer’s profile.
• Examine flagged transactions as soon as possible and in detail.

Enhanced Record-Keeping and Reporting

• Maintain thorough records of the EDD procedure, including all extra papers gathered and notes from the investigation.
• Notify the appropriate authorities right away of any suspicious activity.

Role of Regulatory Bodies in Different Countries

Following regulatory bodies and financial intelligence units monitor money laundering activities and encourage financial institutes to implement CDD and EDD processes to reduce maximum AML risks.

FinCEN Anti-Money Laundering Act of 2020 (U.S.)

This act improves financial institutions’ risk detection through continuous monitoring, strengthens CDD regulations, and focuses on identifying beneficial owners. All of these measures increase transparency.

FinCEN – CDD Final Rule

Under the CDD Final Rule, financial institutions must keep risk profiles up to date, frequently monitor suspicious activity, and identify and validate beneficial owners and clients.

FCA – 5th AML Directive (UK)

For high-risk clients, such as PEPs, the 5th AML Directive (5AMLD) mandates stricter EDD processes and promotes the use of advanced AML technologies and digital identity verification methods.

European Union – 6th AML Directive (6AMLD)

6AMLD, which goes into effect in 2021, focuses on major and cross-border money laundering offenses and strengthens EDD measures for PEPs. It also imposes severe penalties for non-compliance with AML standards.

Germany – BaFin Guidance (EDD & CDD)

BaFin, under the German Money Laundering Act, directs Financial institutions to apply comprehensive CDD for all clients and EDD for high-risk or foreign transactions.

SEC – Rules for Investment Advisers and Broker-Dealers (U.S.)

SEC rules require stringent CDD and EDD procedures for investment businesses, with a focus on safeguarding against the hazards associated with high-risk and international clientele.

Now, at this point, it’s important to learn through real case scenarios what penalties you can face if you don’t implement CDD and EDD regulations obligated by these institutions.

5 Real-Time Examples of Firms that Didn’t Comply with EDD and  CDD Regulations

Organizations face penalties and fines when they don’t implement EDD vs. CDD regulations and allow money laundering to transfer illegal cash through them.

$1.1 Billion Fine on Standard Chartered

The United States and the United Kingdom imposed a $1.1 Billion fine on Standard Chartered Bank in 2019 because it wasn’t following AML regulations. The bank was involved in processing billions from sanctioned countries, including Iran, Cuba, and Syria.

HSBC Faced $1.9 Billion Penalty

In 2012, HSBC faced a penalty of $1.9 billion because it facilitated drug trafficking and money laundering activities.

“Mexico’s Sinaloa cartel and Colombia’s Norte del Valle cartel laundered $881 million through HSBC, and that the bank knew perfectly well what it was doing.”

U.S. Investigators

Investigators also stated that banks allow Mexican drug cartels and high-risk clients to launder money through different accounts.

Deutsche Bank Faced $630 Million Penalty

In 2017, Deutsche Bank faced a penalty of $630 million because they accepted approximately $10 billion from Russia, and it was directly linked with terrorism financing.

The United States and the United Kingdom stated that Deutsche Bank failed to comply with EDD vs. CDD regulations.

$920 Million Penalty Imposed on JP Morgan Chase

JP Morgan faced a penalty of $920 million due to its deceptive behavior and trading misconduct. It was involved in spoof trades in which people quickly place orders and cancel them because they don’t want to execute the transaction but to send a signal of some kind or maybe artificially increase the asset demand.

“The bank had engaged in deceptive trades over the last 8 years — specifically “spoof trades” to influence the market price.”

U.S. Regulator, The Commodity Futures Trading Commission

However, JP Morgan stated that he removed all the employees from his company who were directly involved in this illegal activity from 2008 to 2016.

$1.18 Billion Penalty Imposed on ING

In 2018, a Dutch multinational bank faced a heavy penalty of $1.18 billion because it didn’t comply with CDD vs. EDD regulations. Prosecutors also stated that financial security was too weak, which attracted money launderers to execute their illegal activities.

They also counter major discrepancies in the risk assessment process, transaction monitoring, and CDD.

Advanced Technology and Expertise for Streamlined Due Diligence

Are you ready to partner with a screening provider that guarantees thoroughness and reliability, helping you stay compliant with CDD and EDD obligations?

AML Watcher offers advanced AML screening solutions that incorporate more than 100,000 sanction lists, Watchlists, PEP Databases, adverse media sources, and international leak data sources to ensure that financial institutions continuously monitor customers for any potential risks.

How?

Through updated Sanctions Screening

Provides thorough coverage of more than 1300 international sanctions lists ensuring that institutions can screen for any individual or organizations that are subject to financial restrictions. This is essential for identifying clients who pose a high risk and meeting CDD/EDD requirements.

Make confident Decision

AML Watcher gives you the flexibility to screen through primary or secondary sanctions to onboard customers with manageable risks through proper due diligence.

With global PPP Screening coverage

Enables organizations to carry out extra due diligence on people with elevated risk profiles by providing real-time data on Politically Exposed Persons (PEPs) and covering risk levels 1 – 4.

Regular Adverse Media Screening

Keeps an eye on more than 5000 press and media stories for any unfavorable connections to clients. This helps organizations conduct more thorough due diligence on people who might be connected to financial crimes or reputational threats.

Configurable Risk Scoring

AML Watcher offers institutions the ability to modify risk scoring parameters, which allows them to evaluate client risks according to variables such as customer type, country, or industry for customized compliance procedures.

Through Real-Time Screening

AML Watcher regularly updates watchlists, PEP databases, sanctions lists, and unfavorable media sources. This ensures institutions get the most recent information for continuous CDD and EDD, allowing for the quick detection of modifications in customer risk profiles.

Creating Risk Assessment

The solution streamlines CDD for lower-risk clients while automating risk assessments for high-risk clients, enabling institutions to prioritize EDD while maintaining compliance efficiency.