With increasing regulatory requirements and trends toward greater transparency, understanding the Source of Funds (SoF) and the Source of Wealth (SoW) of the Beneficial Owner (BO) has become a cornerstone in the Customer Due Diligence (CDD) process, particularly for legal entities. Collecting such information during the on-boarding process is part of the CDD sets of controls which seek to address greater money laundering, financial crime and terrorist financing risks.
First of all, the term SoF refers to the origin of the particular fund and any other monetary instrument which are subjects of the transaction between a Financial Institution and the customer. For example, the SoF for a legal entity can be :
- Funds related to ongoing flows from operations in GBD or USD or CHF;
- Assets disposal from the sold subsidiaries;
- Funds from the future acquired companies.
Secondly, the term SoW refers to the origin of the entire body of wealth (i.e. total assets) of the customer. This information is a key element of the customer risk profile because it gives an indication of the volume of the customer’s wealth and gives a picture of how the customer has acquired the fortune. This information should be verified on a risk-sensitive basis. Reliable and independent information can be assessed from reputable sources on the internet or be a confirmation from professionals with knowledge of the customer.
A KYC analyst can undertake a comprehensive research on key components of the SoF valuation using both primary and secondary sources of information available on the customer, by cross-checking the information for financial and shareholding data from business articles, company data reports, and screening results. All legitimate assets that can be confirmed are valued and included within the customer’s net worth summary. Besides, the KYC evaluation should highlight any details related to alleged risks related to the SoF that may materially alter the valuation. At this point, a KYC analyst should put emphasis on any inherent risk factors that the customer can bring to the bank. For example, the analyst can highlight a particular industry risk which constitutes a material degree of reputation risk for the bank. The analyst may also focus on particular countries where a customer has business activities. Some countries represent higher risk due to poor AML regulations and high levels of corruption. These facts indicate “red flags” related to the customer risk assessment, pinpointing a signal to explore more.
This is where a KYC analyst should look at all the data that have been collected, asking following questions: “how inherently risky will be this account?”, “what risks can be controlled through the internal policies and procedures?” and “what residual risks will need to be managed throughout the customer life cycle relationship to make sure everything will be going as expected?
As a matter of fact, by researching SoF, a KYC analyst meets the regulatory requirements and better understands who the customer is because an independent and in-depth investigation has been undertaken; finally, a KYC analyst better comprehends the nature and the purpose of the account that is asked by the customer creating a realistic benchmark for the future account monitoring. This helps build better, stronger, and longer lasting relationships with the customer.
A KYC analyst should keep in mind that risks are the primary, not secondary consideration in the CDD process because there is a regulatory obligation to establish and document the SoW for high risk business relationships. The primary benefit of the SoW identification for the bank is that it will enhance its ability to comply with regulatory obligations. Secondly, the bank will identify those individuals that may have been previously flagged as “prohibited” or “sanctioned”. If banks choose to ignore the requirement to identify the BO, they may end up processing transactions in violation of
United Nations Sanctions,
FCPA,
UK Bribery Act,
OFAC, and even
Section 311 of the USA Patriot Act.
For compliance matters, identifying the Beneficial Owner (BO) and his/her SoW is a risk mitigating factor that serves to “know” who the bank is actually dealing with, making it possible to fully comply with verification against black lists and also identifying Politically Exposed Persons (PEPs) because the presence of PEP is a real material risk for the bank. The definition of PEPs is broad but under the risk-based approach (RBA), the PEP risk can be manageable. Generally, it is possible to say that PEPs are individuals holding an important State position or are those who are very close to them. The problem with PEPs is that these individuals could be involved in various corruption scandals. Or there is also a risk that PEPs could influence legislation to bribe or even misappropriate government funds. Consequently, they could cause an important reputation damage to the Financial Institution that holds their accounts. In this case, identifying the PEP’s SoW is an important regulatory requirement. For example, it is stated in
the 4th EU Money Laundering Directive, Article 18 -b (iii).
Finally, the KYC analyst’s objective should be to filter different sources of information with precaution choosing significant facts related to Anti-Money Laundering risk factors, to Financial Crime activities or to the client’s profession activities because the quality of the chosen information will affect the quality of the customer risk assessment.
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