Enhanced due diligence (EDD) is a process undertaken by financial institutions to identify and manage potential risks associated with high-risk clients. EDD is an extension of the standard due diligence process and involves a more detailed and rigorous investigation of a client’s financial history, background, and reputation.
The origins of EDD can be traced back to the early 2000s when the Financial Action Task Force (FATF) introduced the first set of international standards on anti-money laundering (AML) and counter-terrorism financing (CTF). These standards required financial institutions to implement customer due diligence (CDD) measures as a means of preventing financial crime. However, as financial crime became more sophisticated, regulators recognised the need for enhanced due diligence to identify and manage higher-risk clients.
EDD is typically used for clients who present a higher risk of money laundering or terrorist financing. These may include clients who are politically exposed persons (PEPs), those who operate in high-risk jurisdictions, or clients who have complex ownership structures. EDD measures may include additional verification of identity, scrutiny of financial transactions, and on-going monitoring of the client’s activities.
One of the main benefits of EDD is its ability to identify potential risks before they materialise. By conducting a more thorough investigation of a client’s background and activities, financial institutions can mitigate the risks of financial crime, protect their reputation, and comply with regulatory requirements. EDD can also help financial institutions build stronger relationships with their clients by providing them with greater confidence in their ability to manage risk effectively.
In recent years, the importance of EDD has increased significantly due to the rise of new technologies such as cryptocurrencies, which can be used to facilitate illicit activities. According to a report by the Financial Crimes Enforcement Network (FinCEN), the use of virtual currencies for money laundering and terrorist financing has increased significantly in recent years. This has led to increased scrutiny of financial institutions by regulators, who are now requiring them to implement more robust EDD measures to prevent financial crime.
The effectiveness of EDD can be seen in the statistics. According to a report by the Association of Certified Anti-Money Laundering Specialists (ACAMS), financial institutions that implemented EDD measures saw a significant reduction in their exposure to financial crime. The report found that 81% of financial institutions reported a decrease in their exposure to money laundering and 78% reported a decrease in their exposure to terrorist financing.
In addition, EDD has been shown to be a cost-effective way of managing risk. A study by the International Monetary Fund (IMF) found that financial institutions that implemented EDD measures saw a reduction in their operational costs due to a decrease in false positives (i.e., instances where potential risks are identified but turn out to be false alarms). The study also found that the benefits of EDD outweighed the costs, making it a sound investment for financial institutions.
Despite its benefits, implementing EDD can be challenging for financial institutions. This is due to the additional resources required to conduct more detailed investigations, as well as the need to balance the benefits of EDD with the potential impact on customer relationships. Financial institutions must also ensure that they are complying with regulatory requirements, which can be complex and time-consuming.
EDD is an essential process for financial institutions in today’s markets. It provides a more robust means of managing potential risks associated with high-risk clients, including those who operate in high-risk jurisdictions or have complex ownership structures. EDD has been shown to be effective in reducing exposure to financial crime and is a cost-effective way of managing risk. However, implementing EDD can be challenging and requires financial institutions to balance the benefits with the potential impact on customer relationships and ensure compliance with regulatory requirements. With the increasing use of new technologies and the rising sophistication of financial crime, the importance of EDD is only set to increase. Financial institutions that are able to implement effective EDD measures will not only protect themselves from potential risks but also build stronger relationships with their clients based on trust and confidence in their ability to manage risk effectively.