How the UK’s FCA is set to scrutinise banks’ treatment of PEPs with new review

After the UK financial industry landed itself at the centre of a storm surrounding the treatment of politically exposed persons (PEPs) this summer, the Financial Conduct Authority (FCA) is actively engaging in a new review to determine the fair treatment of this demographic by UK financial firms.

The FCA is reviewing banks’ treatment of PEPs

The review seeks to understand the measures firms deploy when dealing with PEPs, and specifically how they assess potential risks, communicate with their customers and conduct and apply due diligence.

Although the outcome of this review is not expected to arrive until June next year, the instigation of it is both timely and critical to the success and security of the UK’s current financial landscape.

As outlined in its Money Laundering, Terrorist Financing and Transfer of Fund Regulations 2017 legislation, the FCA defines a PEP as “people who hold prominent public functions” who “may be able to abuse their public office for private gain and may use the financial system to launder the proceeds of this abuse of office”.

The treatment of PEPs has been on the regulator’s radar for the best part of the last two decades, but was brought sharply back into focus over the summer when a row erupted between UK banking giant NatWest and Nigel Farage, the former leader of the UK Independence party, who alleged that he had been ‘unbanked’ by the bank’s private banking arm Coutts.

The row resulted in the resignation of both Alison Rose, NatWest Group’s chief executive, and Coutts chief executive Peter Flavel, and caused the FCA to pursue its action more keenly.

In August, it put out an industry wide request to the country’s largest banks and building societies to provide all information concerning account closures, and particularly to uncover whether terminations were the result of “political or other opinions”.

Maintaining its pace on the matter, the regulator’s latest review will seek to determine whether financial institutions are conducting proportionate risk assessments on UK PEPs, and why if a termination is instigated, how this decision was reached.

Sarah Pritchard, the FCA’s executive director of markets, says the proposed rules are designed with the intention of keeping the financial system “clean, free from corruption” and to “guard against financial crime”.

“It’s important that they are implemented proportionately and don’t create unnecessary barriers for public servants and their families,” she adds. “We have already persuaded some firms to improve their approach and we will use this review to identify if we need to provide further guidance to firms.”

While the timing of the review has coincided with the treatment of PEPs hitting the headlines and becoming mainstream news, Dr Henry Balani, global head of industry and regulatory affairs at Encompass Corporation, emphasises that the FCA’s latest review is part of a wider initiative to ensure the efficiency of actively imposed financial sanctions.

KYC, AML and PEPs

Founded in 2012 and headquartered in London, UK, regtech Encompass Corporation specialises in helping banks onboard typically large corporations and PEPs through the automation of know your customer (KYC) solutions.

With his finger naturally on the pulse of the FCA’s actions, Balani recognises the association its review has with NatWest’s recent turbulence, but goes on to clarify that the original remit of the review was “trying to understand what some of the risks are generally, especially given some of the challenges that we are seeing today”.

When pressed on what these challenges are, Balani identified Russia’s invasion of Ukraine in February 2022 as a clear example.

The FCA proved its effectiveness as a regulator last year when it imposed a significant volume of sanctions on Russia as a consequence of the country’s unjust military action on its neighbour Ukraine. It reacted quickly and mandated firms to increase their focus on sanctions systems and money laundering due diligence.

“What’s really interesting about the Russian sanctions is that the number of sanctions that have been placed on Russia have been larger than any price sanctions programmes in terms of the number of actual sanctions themselves,” explains Balani, who carries 15 years of sanction system expertise.

“The FCA’s action is recognising that we’ve got an increased volume of these types of activities, and that we need to really better understand what the impact on the banks actually is.”

The impact of a bank servicing a sanctioned individual is, for all intents and purposes, evidently clear cut, and the FCA has shown no hesitation in bringing down the heavy hand of the law on those that choose to go against its orders.

But as Balani explains, servicing a PEP is “a bit of a grey area”, primarily due to the level of risks that need to be assessed.

“Part of the challenge is that when you look at a bank that’s opening up a bank account for a PEP, there’s a recognition that PEPs are typically more susceptible to corruption,” he says.

“That’s just the reality in terms of the position that they’re in. The higher the level of that particular PEP, the more at risk that they are of potentially being being corrupted.”

Enhanced due diligence

As part of their compliance with the FCA’s review, banks in the UK will be required to perform enhanced due diligence when onboarding a PEP to ensure that not only their own interests are protected, but to also ensure that that particular customer won’t be at risk of being unbanked in the future.

New technology can help banks improve their KYC and due diligence operations

At the most basic level, “all of us are entitled to basic bank accounts”, Balani emphasises. However, the risk potential outlined in his earlier comments arises more prominently through the introduction of value-added services.

Banks aren’t just in the business of providing basic financial services, they’re also seeking to make money. And Balani outlines how due diligence metrics should seek to accurately portray the full risk potential of offering PEPs these value-added services, such as during the issuance of loans and extended lines of credit.

These metrics, he suggests, should not only seek to validate the PEP’s legal position in the UK beyond all reasonable doubt, through home ownership for example, but in the context of business banking specifically, should serve as a deep dive into their operational models.

This could include information regarding their line of business, in which jurisdictions they carry out their business and who with, who their investors are, and so on.

“If I have a corporation and 80% of that corporation is owned by a Russian oligarch, that’s a problem,” says Balani as an example.

Adding to this, Wayne Johnson, CEO and co-founder of Encompass Corporation, recognises how banks face the challenge of “proving treatment of customers is consistent, considered and fair”.

As means of a solution to this challenge, Johnson says that “it is critical that institutions utilise technology-driven processes that enable them to act based on verifiable facts, presented by live, authoritative, publicly available data – and prove it”.

“Today, as banks look to mitigate risk and keep up with an evolving regulatory landscape, technology exists to establish a customer’s identity, providing real-time profiles, generated on demand, to validate and verify a company with full transparency.”

He says that this approach will enable banks to “evidence compliance and preserve reputation”, while also “maximising business efficiency”.

Above all, the FCA’s review of banks’ treatment of PEPs isn’t just to mitigate the risks of another unbanking row, it’s to protect the integrity of the industry in which UK banks operate.

The regulator is expected to complete its review by the end of June 2024, at which point it is to take “prompt action if any significant deficiencies are identified in the arrangements of any firm assessed”.