Enhanced Due Diligence (EDD): How it Secures Transactions

Anti-money laundering (AML) and counter-terrorist financing (CTF) laws and regulations require financial institutions to take standard due diligence precautions and Enhanced Due Diligence (EDD) when onboarding a new customer.

Taking a risk-based approach with efficient onboarding processes can help mitigate and prevent illicit activities. For instance, the estimated amount of money laundered globally every year is nearly 5% of the global GDP, amounting to $800 billion. This magnifies the need for enhanced methods to combat financial crime.

Building the right EDD protocols on top of your Customer Due Diligence (CDD) process can help detect and prevent illegal activity effectively.

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What is Enhanced Due Diligence?

Enhanced Due Diligence is a security measure financial institutions use for Know Your Business (KYB) and Know Your Customer (KYC) processes. It is crucial for financial crime compliance as it allows businesses to understand their customers better and create a more accurate risk profile that can inform any next steps for AML procedures.

When is EDD required?

The diligence process is one of the Financial Action Task Force's (FATF) regulatory requirements when establishing new business relations. EDD is applied in various scenarios where the associated risk in a transaction or business relationship is higher than average.

EDD is done in situations that typically involve increased potential for money laundering, terrorist financing, or other illegal activities. These are some of the most common circumstances where EDD is kicked off:

• Identifying high-risk customers like Politically Exposed Persons (PEPs)
• Customers, transactions, or partnerships with entities from high-risk countries
• High-risk industry transactions
• Business relationships conducted online
• Negative news reports related to clients
• International business deals

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EDD vs. CDD

The primary difference between Enhanced Due Diligence and Customer Due Diligence lies in their depth and scope, particularly in assessing risks. Each is tailored to different levels of risk exposure and the regulatory requirements that come with them. So, while they may vary in processes, they work best together as due diligence can signal when EDD is needed.

Let's take a closer look at their key distinctions.

• Risk assessments
  CDD should establish a customer's risk profile, while EDD assesses and mitigates any higher risks for flagged customers.
• Information scrutiny
  The depth of information for CDD comes at face value, while EDD seeks more information on high-risk customers, which can later be analyzed.
• Documentation reviews
  Documentation required for CDD is minimal, while the EDD process needs more proof with reliable data and documents.

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The EDD process

The scope of EDD dives deeper into more detail on an individual or business's information as it is reserved for higher-risk customers, including PEPs and more complex transactions.

It includes all the checks of standard due diligence but includes a detailed review of the customer. Some of these details that Enhanced Due Diligence looks into are:

• Identity and additional document verification that can be cross-checked with third parties and other publicly available data
• Confirmation of the source of wealth and funds, ensuring its origins were not acquired through illegal means
• Enhanced ongoing monitoring with regular reviews of their transactions and changes to their risk profiles

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The CDD process

As a fundamental requirement of kickstarting a business relationship, the Customer Due Diligence process involves basic checks that are typically sufficient for low-risk customers and transactions. Standard diligence measures include checking the individual's credit history or double-checking that they are not listed in sanctions lists.

Reviews are conducted periodically rather than ongoing monitoring. The goal of CDD is to ensure that the entities involved are legitimate and that their transactions comply with legal and regulatory standards.

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Taking the right Enhanced Due Diligence measures

EDD seeks to understand the potential risks of engaging in a business relationship or transaction with a high-risk customer. It's important to take the right steps to conduct Enhanced Due Diligence.

Collect additional customer information

Gathering comprehensive information from various sources plays a factor in verifying the authenticity of the information provided by your customers.

To do this, the most important data should cover full legal names, addresses, dates of birth, and physical documentation. Cross-checking with additional resources like publicly available databases, sanctions lists, and adverse media searches will go a long way in accurately evaluating customers.

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Determine the Ultimate Beneficial Owner (UBO)

The Ultimate Beneficial Owner (UBO) is vital for the EDD process as it allows financial institutions to understand a company's true ownership and structure. Identifying UBOs can prove significantly useful for foreign entities or more complex businesses engaging with your organization.

Certain UBOs may have an unpleasant history of legal issues and can be categorized as PEPs, making this useful for risk management and ensuring your business stays compliant.

Failing to verify the identity of UBOs can also lead to penalties and sanctions. Regulators who enforce this include Europe's 4AMLD and the United States’s Financial Crimes Enforcement Network (FinCen), both of which require accurate information on an entity's UBO.

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Verify sources of funds

Investigating the true origin of a customer or entity's funds and wealth enables financial institutions to determine their risk for financial crime. You can review financial statements, business activities, and revenue sources to verify this.

Background checks can also inform the organization of any criminal records, involvement in litigations, and other negative media coverage. This information can further clarify whether the intended nature of transactions they may engage in is illicit or not.

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Consult private databases

Using external databases and third-pary services for more detailed media and official reports provides organizations with the best insight on individuals, companies, and industries.

Investing in a good PEP & Sanctions Screening tool will grant you access to private databases, with more thorough information on PEP databases, sanctions lists, and the most important regulatory watch lists.

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Enhance ongoing monitoring processes

Once a customer is categorized as a high-level risk, following through with ongoing monitoring is key. You can create a program best suited to their case based on their ranking.

An ongoing monitoring process should be set up to review the client's business or personal profile regularly. The right tool will alert you to changes to information, including updates on sanctions lists and changes in a customer's PEP status.

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Prepare a detailed report

A detailed report is a valuable record of findings from your EDD process. Aside from regulatory compliance when audit season rolls around, the report allows you to manage risks effectively with a deeper understanding on who you do business with.

Reports should contain methodologies used, sources consulted, and vital findings that demonstrate the organization has conducted due diligence. This information can later serve as a reference and allow you to make any important changes to their categorized risk level should the opportunity arise.

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Craft a risk-based monitoring plan

Based on all EDD findings, an informed decision must be made. This includes whether or not the organization should proceed with the relationship or transaction with the client. If they pass the requirements creating the appropriate risk-based monitoring plan is the next step.

With a monitoring plan, you can decide what additional controls must be implemented. A risk-based approach will allow you to better allocate monitoring resources where they matter most and ensure that high-risk clients receive more attention and scrutiny for threats.

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The benefits of Enhanced Due Diligence

Enhanced Due Diligence is critical in managing financial risks, particularly in high-stakes industries and transactions. Implementing an EDD process effectively provides several significant benefits.

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Reduces the risk of financial crimes

EDD significantly reduces the risk of business relationships with entities involved in money laundering, terrorist financing, and other illicit activities. When your organization thoroughly verifies customers' identities, understand their business activities, you can detect and mitigate potential threats before they cause harm.

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Ensure regulatory compliance

As regulations continue to change on a global scale due to heightened security risks with advanced technology, EDD allows organizations to stay compliant with legal and regulatory requirements for AML, CFT, and other standards. Additionally, with the right tools, you can easily stay compliant and avoid penalties.

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Protection from reputational risk

Organizations that associate with corrupt entities or are inadvertently involved in illegal activities can negatively impact an organization's reputation. EDD enables financial institutions to avoid such associations by ensuring that the businesses and individuals they deal with operate and transact legally and ethically.

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Improved business decision-making

The deep insights gathered from EDD processes enable more informed decision-making on business relationships. Gaining a better understanding on a potential client's or partner's business background, financial health, and market reputation allows organizations to make the right strategic choices.

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Automating Enhanced Due Diligence procedures

Equipping your business with effective EDD measures can do more than just ensure you stay compliant on regulatory requirements, you can safeguard exposing your organizations to financial crimes and the risks they pose.

The EDD process is a tough and thorough one. It takes several vital steps like verifying documents and cross-checking databases to protect your business. Fortunately, there are advanced tools that make it easier.

With Vespia, you can automate the entire EDD process with the KYB Verification tool. Book a demo today and discover how you can make the most of the solution.

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