One of the main talking points in Ukraine in October 2023 was the new law on politically exposed persons (PEPs), which was introduced in light of the seven reforms required by the country to support its EU candidate status. While civil society was celebrating victory and a step forward to improved compliance with the Financial Action Task Force’s (FATF) standards, politicians claimed the new law would punish them with this ‘politically exposed’ status, with all that comes with it, for the rest of their lives. So, what’s the reality? Does the new law indeed deliver such a sentence and make the treatment of Ukrainian PEPs different to those in other countries?
A PEP is an individual who has been entrusted with a prominent public position, for example an elected politician or senior judicial and military appointments. These roles can expose PEPs to a higher risk of corruption, the misuse of public funds or abuse of their position. Therefore, understanding the risks associated with entering into a business relationship with a PEP and putting in place the procedures to mitigate the risks is a key to minimising the risk of the proceeds of corruption from flowing through the financial system. An institutional capacity to expose corruption threats and exercise the appropriate control over the PEPs should be established in Ukraine by complying with international standards. Ensuring Ukraine’s economic security will demonstrate to international allies its legislative predictability and investment attractiveness
While the above may sound simple, it is one of the most difficult areas to address. To start, there is no global agreement as to who constitutes a ‘PEP’ and thus it is not straightforward to identify who a PEP actually is. Moody’s Analytics research indicates that out of 7,500 respondents to a worldwide survey, only 45% were able to identify who is indeed a PEP. While the FATF provides a definition and financial crime standards that should be applied to PEPs, there is no global interpretation of this term, as it is subject to the context of an individual country. The language used in the FATF Recommendation 12 implies that a PEP should be regarded as a PEP without any time limit (i.e., ‘Once a PEP, always a PEP’).
Ukraine is not unique in its struggle to effectively implement the necessary standard of compliance with the FATF Recommendations. As of 2022, out of 120 jurisdictions evaluated for compliance with the relevant elements of the FATF Recommendations pertaining to PEPs, only 31% were found to be fully compliant, among which are Belgium, Greece, Lithuania. Notably, effective implementation of PEP legislation is not possible in a financial system with weak integrity, as it requires proper customer due diligence (CDD) and enhanced due diligence (EDD) to be in place and the availability of reliable information to verify aspects such as the PEP’s Source of Wealth and Source of Funds.
The complexity of the PEP issue is often amplified because of an open-ended approach of ‘Once a PEP, always a PEP’. This approach flies in the face of the ‘risk-based’ approach on which financial crime standards should be based. This includes risk assessing ex-PEPs, rather than applying a blanket rule. Such an assessment allows for consideration of such factors as the level of influence that an individual can exercise, the seniority of the position held, and link between previous and current functions.
For a regulated entity, applying the necessary level of due diligence to a PEP relationship can be a time-consuming and costly process. Applying these requirements to a PEP beyond the time at which they cease to be in role or have influence can therefore make it financially unviable to maintain the relationship, or onboard the customer in the first place.
The recent trend appears to show that banks are withdrawing or ceasing business relationships with clients perceived as higher risk more frequently than before. Anti money laundering (AML) and combatting terrorist financing (CTF) standards are often used as an excuse, while the true motives may actually be ethical, reputational, and commercial. To prevent the de-risking of an entire group of customers, PEPs included, it is necessary to ensure that regulatory expectations and application on AML are consistently applied globally.
The EU has implemented a common approach to defining PEPs across Members States via the introduction of guidelines in its the 4 AML Directive (AMLD) and the 5 AMLD. The 4 AMLD clarified the definition of PEPs without setting any specific time limits, including for domestic PEPs, and provided a clear explanation of the ‘family members’ and ‘persons known to be close associates’. It also strengthened the application of the risk-based approach to the assessment of the PEPs: when a politically exposed person no longer holds a public function, obliged entities must still consider their potential risk for at least 12 months and apply appropriate measures until they are no longer deemed a risk. While mostly replicating the FATF standards, the EU rightly emphasises the preventive and non-criminal nature of the requirements for PEPs and that PEPs should not be stigmatised and that having the status of a PEP does not mean that the individual is involved in any kind of criminal activity.
To provide a clear approach to identifying PEPs in the EU, in November 2023, ‘PEP lists’ were released for each member state indicating which public functions qualify as prominent for assessing financial crime risk, and therefore should be treated as PEPs. This requirement is a part of the 5 AMLD, which helps to properly characterise domestic PEPs and thus avoid confusion when financial institutions of different countries are dealing with foreign PEPs. More broadly, clarifying this status and the resulting required checks and controls should help avoid the perceived hindrance they pose to political activity, turning people away from public service to the private sector instead.
In 2017, the Moneyval Mutual Evaluation Report (MER) of Ukraine indicated that, while Ukraine was broadly in compliance with the Recommendations related to PEPs, there was a material weakness in Ukrainian PEP legislation as it included a limitation period of three years, after which a person is declassified as a PEP. This weakness was resolved in 2019 with the introduction of a new law which implemented a life-long status for PEPs.
In 2022, as a part of the response to Russia’s invasion of Ukraine, the Ukrainian parliament voted for a law, which expanded the list of high-risk clients for financial monitoring by including citizens and legal entities who are residents of the state that carries out armed aggression against Ukraine. However, during the voting in the parliament hall, a Member of the Parliament (MP) (who previously was a deputy of the pro-Russian party) proposed the three years limitation on PEPs. This amendment was not previously discussed with civil society or approved by the Committee on Finance, Tax, and Customs Policy. Hiding under the rush to protect the financial system from the aggressors, MPs voted for the amendment. All MPs are classified as PEPs under the Ukrainian legislation, and this new amendment allowed them to avoid EDD or face any problems with accessing financial services after three years of ceasing to hold the position. This unexplained step back from the FATF standards during the time when the country was getting international financial support clearly came as a surprise. As the reconstruction considerations is ongoing it is vital to ensure the transparency of the process and avoid any corruption or money laundering risks inside Ukraine.
As a part of the reforms and due to the active involvement of civil society, in October 2023, Ukraine passed a new law aimed at overcoming all the legal deficiencies around the status of PEP. The law removed the three year limitation and imposed a risk-based approach: for 12 months after the PEP has ceased to perform prominent public functions obliged entities should apply EDD, and after this period use the risk-based approach to determine whether EDD is still required. If an institution rejects a client, the obliged entity must provide the client with a reasonable explanation within five days or it can be fined up to UAH 1.7 million. How different is this rule from the EU approach? Article 22 of the 4 AMLD imposes the same requirement to consider the continuing risk posed by a person and apply risk-sensitive measures for at least 12 months until the person is deemed not to pose the risks. The Ukrainian approach does not make PEPs different from those in other countries.
The EU Commission recommended the National Bank of Ukraine (NBU) issue clear guidance on who would constitute a PEP and the need for a risk-based approach to identifying PEP status. It should be noted that the EU Commission assessment cannot prejudge in any way the future assessment of Moneyval, which is expected at the end of 2024.
From a practical perspective, the new law means that Ukrainian banks and regulators should be able to prevent the application of a blanket approach to PEPs and ensure that a risk-based approach is embedded within the approach to compliance. All regulated entities will need to ensure that their policies and procedures are up to date and reflect the new requirements. It is important to highlight that Ukraine is not starting from scratch implementing FATF PEP standards, as the NBU already issued regulations and guidance, supporting their application with ongoing awareness-raising work.
One of the most problematic issues around the PEP status in Ukraine is its communication with PEPs. These new requirements should not be seen as merely formality, dictated by the EU as part of Ukraine’s candidacy or lobbied for by civil society to punish the politicians. The task is to explain to the PEPs that international standards are not an obstacle to going into politics, especially in this turbulent time, and that the requirements in relation to PEPs are important in demonstrating Ukraine’s commitment to a transparent financial system. It is vital for the implementation of the law that everyone considers it as a systemic step forward for the national system, not back.
