What is Enhanced Due Diligence (EDD), and Why is it so Important?

Today, in this age where the finance sector is marred with increased turmoil and surveillance by relevant authorities, risks also come into play and are to be taken into account; there is a need to shield corporations and financial institutions from potential dangers.

This can only be achieved through identifying and vetting the sources of funds and those that receive the funds. This is where Еnhanced Due Diligence (EDD) is applied.

The following detailed analysis will define its importance, describe the processes included, and explain how it can reduce the risks. Not only this, but knowing and applying enhanced due diligence (EDD) measures is a popular requirement for a compliance officer, a credit officer, or a leader for their company’s financial well-being and safety.

What is Enhanced Due Diligence (EDD)?

Enhanced Due Diligence (EDD) indicates a deeper, thorough scrutiny of suspicious customers, transactions, or business affiliations that pose higher risks.

This level of diligence exceeds the standard one, engaging a more investigative approach and detailed search to ascertain risks and any possible underhand activities.

The EDD function is most often required in sectors like retail banking, real estate, and law, where not observing the requirements set by law could lead to severe financial, criminal, and reputation-related challenges.

When it comes to developmental analysis, the purpose is to detect and expose any inappropriate behaviors that an organization or individual may be engaging in, which, for instance, may include money laundering or even terrorist finances or any other fraudulent or criminal acts.

The process of due diligence toward these objectives is standard in most individuals or institutions perceived to be high-risk, such as politically prominent persons, people from high-risk countries, or those who are party to intricate and doubtful operations.

The Importance of Enhanced Due Diligence

Conducting due diligence holds great significance in managing business risks. These are the primary reasons why due diligence matters and should not be missed out:

Compliance Requirements

It is required under some laws that businesses undertake enhanced due diligence as per the guidelines laid down by regulatory authorities, including the FATF.

These laws are in place to protect the financial system from acts like money laundering, fraud, and corruption that can negatively affect its stability and institutional reputation.

The Prevention of Financial Crime

Due to the consequences such activities like money laundering or fraud may have, financial institutions, including companies, are constantly exposed. It becomes very dangerous not to detect such criminal activities.

EDD minimizes such incidences by detecting any suspicious clients or transactions that might be engaging in such activities early on to ensure that there is no trail of such activities and that the business is safe from any claims in the future.

Risk Management

In addition, it enables businesses through the early identification of high-risk customers and transaction efforts to prevent such risks from occurring before materializing any losses or damage to reputation. It helps businesses refrain from being engaged in activities that should have been prohibited or criminal.

Creating Mutual Trust and a Positive Image

Even for investors that tend to some extent to overvalue assets, companies with higher EDD involvement are welcomed even when the costs of integration and other risks are expectedly reached.

Business relations are enhanced with the ease of doing business quickly and with minimal fuss because of how customers perceive the business’ lawful behavior and steps taken to avoid trading with those likely involved in illegal or otherwise undesired activities.

Preserving The Brand’s Image

If any of these activities are lacking, it could lead to immeasurable damage to a company’s image or in financial terms.

This damage may be initiated by a bank that connives with fraudsters stealing from their concurrent clients because the bank has failed in its part to carry out high-level due diligence in determining that the clients were who they claimed to be.

When Is Enhanced Due Diligence Required?

Despite that, it does not mean that every business transaction per se necessitates some thorough background research of the risk involved. Often consequentially, enhanced due diligence (EDD) will be used in cases of a higher level of risk by a Customer, Transaction, or Business. The instances in which there is a need for EDD are as follows:

High-Risk Clients

Some clients are placed within risky classes, such as persons who have a political profile, and the way they relate might resort to the use of EDD. Political figures fall in the category of PEPs since they are officials or executives in organizations who tend to receive or give according to their needs.

Knowing this, there is also a risk of potential corrupt practices in higher-risk areas such as PEPs. In this particular case, EDD shall apply against such individuals to prevent the commission of any crimes.

High-Risk Countries

Countries with no legal protection stable political power, or where corruption is rife put such elements at risk. If a customer resides in such a country or has interacted with such a country’s nationals, then EDD is not negotiable.

Complex or Large Transactions

Transactions that are of exceptionally high amounts, include more than one party, and are seemingly without any credible purposes are likely to be sanctioned and may raise suspicions.

Enhanced due diligence enables one to understand the objectives or principles for which the transaction is being undertaken, ensuring that it does not further any wrongdoing.

Unexplained Activities or Transactions

In cases where entities are seen to be involved in certain things that do not entirely correspond with the images in possession, such as disparities in details provided or very odd money/asset movements, it is necessary to use enhanced due diligence to verify or elaborate on such indications.

New Customers

It is a good practice and advisable that the business takes wary steps in dealing with totally new customers or when the beneficial owners of the customer cannot be identified, which otherwise appears as opaque.

They should employ EDD in these situations to confirm the authenticity of the business undertaken by such a customer.

The EDD Process: How Does It Work?

The Enhanced Due Diligence (EDD) process is conducted to understand the client's history, purpose, and objectives to achieve detailed, thoughtful analysis and opinions discussed in the field of study. Here is a list of the steps involved:

Customer Identification

The first step in the EDD process involves confirming the client's identity. This includes obtaining individuals' personal information such as name, address, date of birth, and identification, among other details.

For businesses, it consists of establishing and clarifying the legality of the business's existence and its management. This step guarantees that the person or organization is legal.

Risk Assessment

Having successfully identified the client, a risk assessment is done to ascertain the level of risk the client poses.

This includes, among others, issues like the client's position, the nature of the business, the likely financial structure of the client, and whether any registration is required. The need for most due diligence intensifies if a higher risk score is obtained.

Enhanced Investigations

If investigations are recommended further due to the client’s high-risk nature, additional inquiries will be made, and these include specific public, oral, and other procedures:

• Checks of the client’s antecedents: obtaining information about the client by identifying and researching available sources.
• Checking against sanction or Politically Exposed Persons (PEP) lists: making sure no international identification appears on this information that has been drafted by, for example, the USDOS or the United Nations.
• Business inquiries: how the client interacts with the suppliers, consumers, the services they fulfill, and subcontractors to be assured that the client is not raising illegal funds via other enterprises to become a source of income, whether legally or not.

Transaction Monitoring

Monitoring has become the most integral part of EDD, as it represents a continuous examination of all the transactions and business operations of all customers of the organization.

The monitoring can be done through various sources like electronic systems or manual procedures that alert unusual and risky/ fraudulent transactions. Monitoring relieves the organization as new risks or red flags can easily be dealt with in real time.

Creating and Submitting a Report.

Everything that came to the attention of relevant employees during investigations is carefully documented. Such suspicious findings shall be disclosed to the authorities in more severe cases.

Documentation that provides, in particular, a meticulous account of activities undertaken is also vital as evidence if, due to any reasons, the organization is subjected to an external audit or regulatory review.

Examples of Enhanced Due Diligence

Let us discuss some recent cases where enhanced due diligence was used:

A Bank’s EDD on a Politically Exposed Person (PEP)

The European bank worked for their client based on delivering service, and the clients self-presented themselves as a government supplier with “bound intense ties to bureaucrats in some other country in the Middle East.”

For some reason related to this business, the bank under DLI is inquiring into the client's finances, acquaintances, and business dealings. This inquiry revealed worrying issues, such as income earned abroad and several shell companies hinting at illegal remitting.

This led to the bank stopping the business with the client and making a report to the relevant authorities.

EDD on a Large Real Estate Transaction

An intent was there for a real estate business for the eventual purchase to take place regarding an expensive property from a foreign investor.

In this case, the money being paid in terms of the purchase price of the real estate and the other costs, the transaction was characterized by high risk as a lot of money was at stake and business was taking place across countries to such an extent that there were several middlemen.

As part of the exercises in additional due diligence, the company’s staff conducted a proper check on the buyer's identity, financial position, and payment source. The review showed that the purchases were intended to acquire assets owned by a firm conducting illegal businesses.

It was also decided that the evasion of restricted execution would be too risky, and the transaction would not be conducted.

Challenges in Enhanced Due Diligence

Though it is rather significant, Enhanced due diligence may face resistance when implemented. Here are a few of the most common risks involved.

Obtaining and Confirming Valid Information

Information from the clients’ records, especially in high-risk regions, is not always easy, especially if the information has to be current.

There is a probability that public records documenting the client may be insufficient, especially when it is needed the most. Moreover, there are not many such available third-party sources.

Complex Ownership Structures

In dealing with most of these institutions’ clients, it has been ascertained that very sophisticated corporate structures, such as offshore structures, shell collars, or trusts, for example, have been incorporated in their countries.

Notably, the use of these structures exposes covered parties. Therefore, considerable effort is required.

Very Time-Consuming

Implementing the many requirements, although very critical and cost-effective, salon EDD itself can be very expensive because of the human, financial, and other resources utilized.

Due to the cost implications, such doings on their present scale are frightfully out of reach to most small and medium enterprises.

Vertical Integration

Due diligence as a practice finds itself in a very dynamic regulatory environment. Many factors may affect these changes, the most significant being the legal framework.

Additionally, the requirement to keep up with the laws and guidelines is even more pronounced for specific legal requirements.

Best Practices for Conducting Enhanced Due Diligence

Maximizing the contribution made through the implementation of EDD, some exercises adopted by the business include:

Invest in Technology

Such tools, which are used for work, permit the activities to promptly cover the EDD. The activities may be a part of such work as identifying any match of customers' names, being against global sanctions, or adopting transaction monitoring with AI solutions.

Having Policy and preparedness

Organizations need clear-cut instructions on how EDD will be carried out and the circumstances under which Non-standardized DD should be carried out. Such procedures should be documented, and program changes assess the need for alterations.

Training and good supervision practices

All the due diligence stakeholders need regular in-service as well as short course training so as not to lag with what is right according to the laws and the procedures.

Engage with Professional Services

It may be necessary to bring in professional services and third-party engagements when servicing high-risk clients, such as investigative and forensic accounting services.

Hence, Stakeholders have begun to appreciate that heightened scrutiny will be critical in 2024. The demands of increasing financial transaction complexity, international commerce, and the expanded risk of economic crime strongly necessitate enhanced due diligence.

For corporations, implementing a formalized program for EDD is necessary for compliance and reducing other risks that can hurt their operations. Enhanced due diligence would be a prudent investment for an organization focused on risk management, particularly in challenging sectors such as regulated industries.