Applying customer due diligence (CDD) to both the customer and the customer’s counterparty in international banking/financial transactions is crucial for a comprehensive risk management and compliance strategy that adheres to BSA/AML/CFT/Sanctions regulations. Screening both a financial institution’s (FI) customer and their counterparty provides a more complete view of a transaction’s overall risk. By assessing the compliance risks on both sides, FIs can better understand the potential risks associated with an entire transaction.
Defining a counterparty
Every financial transaction has a counterparty. From the point of view of a FI, a counterparty is either a business or an individual that is the sender or receiver of a transaction involving the FI’s customer. In many instances, the counterparty is not a customer of the FI – but it can be.
Customers that participate in money laundering, terrorist financing, and other financial crimes can perform illicit transactions with nefarious actors in many ways. Hence, it’s important to perform due diligence on both the client and the counterparty.
The risk grows even greater when transactions involve foreign financial institutions and cross-border payments.
Special counterparty risk in cross-border payments
The market size for consumer-initiated cross-border payments reached $1.7 trillion dollars in 2023 and is expected to surpass $3 trillion per year within this decade. On the B2B side, those figures grow to $39 trillion and $56 trillion, respectively. Therefore, defining counterparty risk for international counterparties is growing increasingly important for FIs. The Financial Crimes Enforcement Network (FinCEN) issued a notice in June of 2023 in which they pointed to two new statements from FATF (the Financial Action Task Force) that describe and name jurisdictions with “strategic deficiencies in their AML/CFT/CPF regimes.” There are two categories of deficient, or unsafe, jurisdictions as defined by FATF:
Jurisdictions under Increased Monitoring are those with strategic deficiencies in their AML/CFT/CPF regimes that have committed to, or are actively working with, the Financial Action Task Force (FATF) to address those deficiencies in accordance with an agreed upon timeline. The FATF is the global money laundering and terrorist financing watchdog.
High-Risk Jurisdictions Subject to a Call for Action are those with significant strategic deficiencies in their AML/CFT/CPF regimes and which FinCen calls on all FATF members to apply enhanced due diligence to, and, in the most serious cases, apply countermeasures to protect the international financial system from the money laundering, terrorist financing, and proliferation financing risks emanating from the identified countries.
As part of the June notice, FinCen gave a pointed reminder to US-based FIs regarding their obligations to act upon the two FATF statements in the context of foreign financial institutions (FFIs):
“U.S. covered financial institutions are reminded of their obligations to comply with the due diligence obligations for foreign financial institutions (FFIs) under 31 CFR § 1010.610(a) in addition to their general obligations under 31 U.S.C. § 5318(h) and its implementing regulations”
“…covered financial institutions should ensure that their due diligence programs, which address correspondent accounts maintained for FFIs, include appropriate, specific, risk-based, and, where necessary, enhanced policies, procedures, and controls that are reasonably designed to detect and report known or suspected money laundering activity conducted through or involving any correspondent account established, maintained, administered, or managed in the United States.”
Examples of transaction types in need of enhanced CDD
There are numerous transaction types that are worthy of closer inspection via enhanced CDD. Among them, several types occur most frequently:
- Transactions involving a counterparty located in a high-risk jurisdiction.
- Transactions that happen as part of “structuring.” Structuring occurs when a customer intentionally structures multiple payments in a way that is intended to avoid detection or the need to submit a CTR. For example, the customer sends to a counterparty 5 consecutive days of payments, each just under $10,000.
- Transactions in which the identity of the ultimate beneficiary or counterpart is undisclosed.
- Transactions in which the counterparty to the transaction is unknown.
- Transactions in which the customer’s stated line of business does not align with the counterparty’s line of business (e.g., a frozen fish company sending payment to a timber company).
Identifying the risk associated with both parties in a transaction allows an FI to take appropriate risk mitigation measures. Banks and other FIs need to continue to invest in tools that can help them understand their customers via optimized CDD and adverse media screening to address the unprecedented growth in cross-border financial transactions, including RTP and other cross-border transactions. This is where WorkFusion helps thousands of CDD and KYC (know your customer) analysts at FIs every day.
Our AI Digital Worker, , is a fully digital CDD analyst that collects information and documentation to conduct due diligence on customer relationships.
Our AI Digital Worker Evelyn can perform adverse media screening of a counterparty with as little information as just a name. She can find data in the public domain that yields more in-depth insight into the counterparty that otherwise would not be required to provide any information about itself.