Evidence of Potentially Lower Risk: Red Flags and Best Practices

In the ongoing efforts to combat money laundering and terrorist financing, regulators and financial institutions must remain vigilant in identifying potential risks and implementing effective risk management strategies.

Identifying Potentially Lower Risk

According to Annex I of the EU Directive, red flags indicating potentially lower risk include:

• Stock turnover ratios that are consistent with industry standards
• Business or employment history that is stable and verifiable
• Prior successful business operations or a good credit record

Factors Indicating Higher Risk

Annex II of the Directive highlights factors and types of evidence that may indicate potentially higher risk, including:

• Unstable addresses or professional/employment history
• Significant prior litigation history
• High turnover in senior management

For further guidance on risk assessment, financial institutions should refer to the ICPAC’s Guidance paper on the Client Risk-Based Approach.

Red Flags Mandating Further Investigation

The following is a non-exhaustive list of red flags that may indicate higher risk and require further investigation:

• Stock turnover ratios that are not in line with industry standards
• Promotion arrangements with a significant number of agents or individuals
• Frequent rotation of professional service providers
• Poor financial record history
• Prior failed business or bankruptcy

Reliance on Third Parties

Financial institutions may rely on third parties for the implementation of Client Identification and Due Diligence procedures, provided that:

• The third party applies CDD and record-keeping measures consistent with EU Directive requirements
• The third party is subject to supervision consistent with EU Directive requirements
• The firm assesses the systems and procedures of the third party and maintains records of the assessment

Best Practices for Transaction Monitoring

Effective transaction monitoring requires:

• Design and establishment of procedures and policies for transaction monitoring
• Segregation of monitoring responsibilities
• Internal audit function (where applicable)
• Classification/grouping of clients with similar characteristics
• Creation or adoption of typologies/rules based on past experience and international/national authorities
• Training of personnel to conduct effective transaction monitoring

Warning Signs for Transaction Monitoring

Non-exhaustive warning signs that may indicate suspicious activity include:

• Large or complex transactions with no visible economic or lawful purpose
• Aggregated frequent small transactions
• Unusual patterns of physical cash deposits or withdrawals
• Significant deviations from past account activity

By implementing these best practices and staying vigilant in identifying potential risks, financial institutions can play a critical role in preventing money laundering and terrorist financing.