The Malta Financial Services Authority has published new guidelines to govern financial institutions' business relationships with Politically Exposed Persons (PEPs), after the application of pressure from the European Union in the wake of the demise of Pilatus Bank.

The EU has long obliged the MFSA to require financial firms to identify PEPs in a risk-based way and to apply appropriate "extra/enhanced due diligence" or EDD when dealing with them. The Prevention of Money Laundering and Funding of Terrorism Regulations ascribe high risks to relationships between financiers and PEPs and require firms to apply EDD measures whenever they offer services to them. Not all PEPs are equally risky and the EDD measures to be applied should, in the regulators words, be proportionate to the risk attributed to a particular PEP. The text refers to financial firms or reporting entities as 'subject persons.'

The new notes, entitled Guidance on Politically Exposed Persons, outline and provide information about the EDD that the MFSA wants firms to take in the case of PEPs. The Financial Action Task Force, the world's AML standard-setter, describes foreign PEPs as individuals who are or have been entrusted with prominent public functions by a country that is foreign to the financial firm in question, taking in heads of state or of government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations and important political party officials. Domestic PEPs are their counterparts in the financial firm's own country. PEPs are not middle-ranking or more junior people in those categories.

EDD takes the form of senior managers having to approve the provision of services to PEPs beforehand; firms taking more stringent steps than usual to establish the sources of wealth and funds involved; and a never-ending regime of close monitoring. A PEP, a family member or a close associate who are thought to be of 'low risk' must always be subject to EDD measures, however innocuous they seem. The application of EDD to a PEP, members of his family and his close associates is mandatory as long as a PEP remains entrusted with a prominent public function, and for a subsequent 12-month period from the moment when he/she ceases to be a PEP. The risk-based approach, however, must continue to apply and CDD measures proportionate to the risk, including EDD where appropriate, should apply also.

How to spot a PEP

The Maltese regulations are unhelpfully silent about the defining characteristics of a "prominent public function." Regulation 2, however, does contain a non-exhaustive list of people who perform (the regulation mysteriously uses the word 'hold') such functions: heads of state and/or government; ministers or assistant ministers; parliamentary secretaries; Members of Parliament or similar legislative bodies; members of the governing bodies of political parties; members of the superior, supreme and constitutional courts of the land; members of courts of auditors; people on the boards of central banks; ambassadors, chargés d’affaires and high-ranking military officers; people on the boards of state-owned enterprises; and their counterparts in any institution of the European Union or any other international body.

The MFSA only adds to this with the comment that the position and powers of a mayor of a large city or head of a region in a foreign jurisdiction "might not necessarily be equivalent" to those of the mayor of a small village in Malta. It mentions 'powers' because of its conviction that public functions can be prominent if the powers (or type or size or budget or responsibilities) associated with it are themselves prominent.

In the text, the MFSA draws a distinction between PEPs and "family members and close associates," even though Article 52 of the United Nations Convention against Corruption (to which the new notes refer) is all-inclusive and describes PEPs as “individuals who are, or have been, entrusted with prominent public functions and their family members and close associates." Words such as father, brother, uncle, nephew and sibling do not appear in the MFSA's guidelines at all, so the boundaries of the category are amorphous. The text does, however, state that Maltese law includes spouses "or any person considered to be equivalent"; children and their spouses/people equivalent to spouses; and parents. The text acknowledges the difficulty that a bank might have in awarding a risk rating to the child of a PEP who is estranged from him.

The regulations classify persons known to be close associates as: someone known to have joint beneficial ownership of a body corporate or another form of legal arrangement; somebody who has close business relations with the PEP in question; and someone who has sole beneficial ownership of a body corporate/legal arrangement that is known to have been established for the benefit of that PEP.

KYC - the rules

Where publicly available information is used for the purpose of knowing one's customer, the bank in question should assess the reliability of the sources on which it is relying. It should refer to different sources and should not rely solely on one particular source - a far cry from the days after 11 September 2001 when the US Treasury's interpretation of the phrase "know your customer" was to "look them up on Google." The bank ought to keep a record of all searches it undertakes.

The following characteristics might suggest that a PEP is of a low risk:

• he wants access to a product/service/transaction that the bank thinks poses a low risk (such as products, services or transactions to which "simplified due diligence" measures may be applied);
• he does not have executive decision-making responsibilities (members of the House of Lords in the UK lobbied successfully for this let-out clause);  
• the PEP is subject to rigorous disclosure requirements (such as registers of interests, independent oversight of expenses etc); and
• his jurisdiction is politically stable and has low levels of corruption; free and fair elections; strong state institutions; strong compliance with AML/ATF rules; a free press with a track record for probing official misconduct; an independent judiciary; a track record for investigating political corruption and taking action; legal protection for informants or 'whistleblowers;' and well-developed registries for the ownership of land and companies.

Family members and close associates

A family member or a close associate of a PEP poses a higher risk if he has:  

• wealth derived from the granting of government licences;  
• wealth derived from preferential access to the privatisation of former state assets (this seems to have been written with Russian oligarchs in mind);
• wealth derived from commerce in sectors associated with high barriers to entry or a lack of competition;  
• wealth or a lifestyle that is inconsistent with known legitimate sources of income or wealth;
• a public office that appears inconsistent with personal merit (on 30 March 2016 the Times of Malta said that Maltese politics "starts with nepotism, cronyism and clientelism, then seeps into every pore of political life"); and/or
• credible allegations of financial misconduct (e.g. facilitated, made, or accepted bribes).