Enhanced Due Diligence is a process that happens as part of Know Your Customer requirements and fits within the wider scope of Anti-Money Laundering (AML) policies. The goal of EDD is to detect financial crimes, money laundering and terrorist financing that could expose companies to financial or reputational damage. In addition to KYC and AML adherence, EDD is an essential component of customer onboarding, but it may also be triggered by periodic reviews or ongoing monitoring alerts.
EDD involves deeper investigations of high-risk customers, companies and transactions. Historically EDD investigations have been a reactive process, often requiring bulk reviews which may occur after the damage is done. Companies are now turning to preventive procedures for early detection through ongoing analysis of relevant risk categories.
How Does Enhanced Due Diligence Work?
When onboarding new clients, they undergo KYC and Customer Due Diligence (CDD) processes. Should a client be flagged under the high-risk category during KYC or CDD, based on parameters defined by an organization, they will then undergo more in-depth EDD workflows.
EDD requires:
- A high level of careful research and documentation sourced from multiple data avenues.
- Checking individual or company risk factors, which can include identifying beneficial owners or suspicious financial inconsistencies.
- Creating a plan to monitor associated accounts.
EDD aims to clearly identify risks, assess based on your business requirements, and ensure threats can be mitigated and promptly addressed.
When Do You Need Enhanced Due Diligence?
As mentioned, EDD is needed for entities that fall under high-risk categorization.
For example, a high-risk customer may be identified as a Politically Exposed Person, or a high-risk business may be flagged for being cash-intensive. EDD would also be needed if an individual or business has suspicious activities that may raise financial crime risk concerns, including money laundering, corruption, other criminal activity, and adverse media.
Here are indicators that would trigger EDD:
What is involved in the Enhanced Due Diligence Process?
The EDD process can include the following:
- Identify high-risk customers and or companies
- Produce supporting documentation regarding the source and allocation of funds
- Continue monitoring activities and analyze collected information
Other best practices include following the Financial Action Task Force (FATF) international standards. FATF recommends a Risk-Based Approach when there is a potential for your customers to have high-risk affiliations.
A Risk-Based Approach is a framework used to assess the level of risk to which a company or individual is exposed based on internal risk scoring methodology. Thresholds must be set high enough to avoid violating any international laws. Once high-risk customers are identified, AML measures commensurate with those risks are executed to mitigate the risk effectively.
There are many steps to support a Risk-Based Approach, including obtaining additional customer information, analyzing UBO source of funds, transaction monitoring, and adverse media checks.
Best Approaches for EDD
Use a Risk Based Approach
According to the Financial Action Task Force (FATF) international standards, a Risk-Based Approach is recommended when your customers may have high-risk affiliations. A Risk-Based Approach framework assesses the level of risk a company or individual is exposed to, based on internal risk scoring methodology. Thresholds must be set high enough to avoid violating any international laws.
Once high-risk customers are identified, AML measures proportionate to those risks are executed to mitigate the risk effectively. There are many steps to support a Risk-Based Approach, including obtaining additional customer information, analyzing UBO source of funds, transaction monitoring and adverse media checks.
Obtain Additional Customer Information
Enhanced due diligence goes beyond CDD, in that it requires obtaining extra documentation for identity verification using more than one external document, which can include:
- Verify the customer's identity using multiple documents (for example, obtain a copy of their social security card, passport and/or photo ID)
- Confirm the customer's residential address with a third party source (for example, tax records or utility bills)
- Verify the customer's residential address using one or more documents
- Confirm the customer's residential address using one or more documents
Analyze UBO and Source of Funds
According to FATF, an Ultimate Beneficial Owner (UBO) “refers to the natural person(s) who ultimately owns or controls a customer and the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement." To accurately perform Beneficial Ownership Validation, all layers of ownership must be thoroughly vetted and verified until all beneficial owners are accounted for, and the proper validating documentation is received.
Address the following:
- Identify and verify the source of funds and check the correlation between your customer's confirmed assets with their non-financial and financial assets value.
- Be alert of any inconsistencies between earnings, source of wealth, and net worth should be addressed.
If you want to learn more about identifying UBOs within your observed network, check out our blog on UBOs and their importance and identification processes for gathering more information.
Transaction Monitoring
Transaction history is a fundamental element of financial analysis. It includes transaction details, such as the background, purpose, nature, and duration of the transaction, as well as the parties involved. A financial institution should search for information related to the customer’s prior transactions, and present ones if available.
Effective EDD includes up-front assessment and ongoing transactions evaluation to determine any change in risk level. This means creating a framework that outlines regular assessment timelines and in-depth record-keeping.
Adverse Media & Negative News Checks
Adverse media checks are critical to the success of any EDD process. To construct a successful EDD program, a company must clearly understand each customer’s reputation and whether or not they have been investigated for money laundering, terrorism financing, tax evasion, sanctions, or other unlawful activities.
A financial institution should perform adverse media checks on all high-risk customers as part of its EDD process. Ongoing monitoring is vital for a successful screening program. In addition to ensuring that customer-related data is regularly updated and remains accurate, monitoring helps organizations recognize patterns of potentially risky behavior and develop a more transparent, more accurate understanding of customers over time.
On-site Visit
Without a physical address, or an address that does not correspond to official documents, a company may be at high risk of fraud. Conducting an on-site visit to the physical address is a requirement for all legal entities, including banks and companies. Documents that cannot be sourced digitally can be physically confirmed.
Report and Ongoing Monitoring
Risk-based monitoring is a strategy that allows businesses to monitor high-risk customers for illicit activity. It involves continuously monitoring their transactions and comparing them with the data and information they've already provided, and any suspicious activities that have been reported. Businesses can benefit from software that automates monitoring and alerts them of changes to their customers' profiles, like when a suspicious activity is tracked.
Enhanced Due Diligence vs Customer Due Diligence
Enhanced Due Diligence is the further investigation needed for a customer who triggers alerts after CDD and KYC. While CDD involves capturing an initial customer risk profile through identification details provided by the customer, EDD is a more thorough 360° analysis of high-risk customers and their transactions.
EDD is different from CDD in that it pays special attention to:
- PEPs (Politically Exposed Persons): PEP customers are at high risk because they have greater vulnerability to public positions or relationships and, therefore, may have entry to funds through corruption or other unlawful means
- Clarifying Evidence: Requires a further collection of evidence and data to understand the origin of accounts and transactions sufficiently
- Documentation: EDD must be recorded in detail, and regulators should be able to have quick access to reports
Enhanced Due Diligence Keys to Success
To understand the entire picture of potential risks after a client is onboarded, indicators that point to PEP, money laundering, corruption, criminal activity and other adverse media can be useful during assessments. By gathering and consolidating all available data from disparate sources, organizations can have a solid understanding of relevant risk factors.
The three most helpful practices to follow include:
Tip 1: Consolidate risk for a complete picture of risk. There are many pieces of the puzzle when assessing risk, and each source of information can surface different risk factors. It’s important to bring disparate data together in order to adequately support findings in high-risk situations
Tip 2: Leverage real-time alerts for decision-making. Have an ongoing monitoring system for identified risk factors to keep you informed and up-to-date on the current situation
Tip 3: Create a strong culture of compliance within your organization. Companies must prioritize periodic staff training to review and update procedures for close examination of monitored entities. This form of training is crucial during staff onboarding
Final Thoughts
When dealing with high-risk entities, CDD does not provide enough descriptive information, presented in an efficient format, to indicate that financial fraud is happening. EDD can provide those insights. EDD involves analyzing various data sources to create a 360º analysis of risk. If the data sources are not unified and monitored consistently, it can be challenging to procure in-depth documentation.
Sigma Ratings provides a way to streamline the EDD process through a unified entity data management platform global risk intelligence and data monitoring management. If you're interested in learning more about how Sigma streamlines EDD, take a look and try a demo on how Sigma Ratings is your EED solution : https://www.sigmaratings.com/request-a-demo
