Know Your Customer (KYC) compliance regulation has proved to be
one of the biggest operational challenges banks, accountants, lawyers and
similar financial service providers worldwide have had to
overcome.

World-Check, the industry standard KYC compliance solution,
provides an overview of KYC compliance and its origins, and outlines the
compliance mandate as applicable to banks, accounting firms, lawyers and other
regulated financial service providers – not just in the UK, Europe and the USA,
but all around the world. Relied upon by more than 3,000 institutions worldwide,
this KYC database solution provides effective legal and reputational risk
reduction.

Why “Know Your Customer?”


The 9/11 terrorist
attacks on the World Trade Centre revealed that there were sinister forces at
work around the world, and that terrorists activities were being funded with
laundered money, the proceeds of illicit activities such as narcotics and human
trafficking, fraud and organised crime. Overnight, the combating of terrorist
financing became a priority on the international agenda.

For the
financial services provider of the 21st century, “knowing your customers” was no
longer a suggested course of action. Based on the requirements of legislative
landmarks such as the USA PATRIOT Act 2002, modern Know Your Customer (KYC)
compliance mandates were created to simultaneously combat money laundering and
the funding of terrorist activities.

What is Know Your Customer
(KYC)?


Know Your Customer, or KYC, refers to the regulatory
compliance mandate imposed on financial service providers to implement a
Customer Identification Programme and perform due diligence checks before doing
business with a person or entity.

KYC fulfils a risk mitigation function,
and one its key requirements is checking that a prospective customer is not
listed on any government lists for wanted money launders, known fraudsters or
terrorists.

If preliminary KYC checks reveal that the person is a
Politically Exposed Person (PEP), for example, Advanced Due Diligence must be
done in order to ensure that the person’s source of wealth is transparent, and
that he or she does not pose a reputational or financial risk in terms of their
finances, public positions or associations. Beyond customer identification
checks, the ongoing monitoring of transfers and financial transactions against a
range of risk variables forms an integral part of the KYC compliance
mandate.

But to understand the importance of KYC compliance for financial
service providers better, its origins need to be examined.

Origins of
Know Your Customer (KYC) compliance


The arrival of the new millennium
was marred by a spate of terrorist attacks and corporate scandals that unmasked
the darker features of globalisation. These events highlighted the role of money
laundering in cross-border crime and terrorism, and underlined the need to clamp
down on the exploitation of financial systems worldwide.

Know Your
Customer (KYC) legislation was principally not absent prior to 9/11. Regulated
financial service providers for a long time have been required to conduct due
diligence and customer identification checks in order to mitigate their own
operation risks, and to ensure a consistent and acceptable level of
service.

In essence, the USA PATRIOT Act was not so much a radical
departure from prior legislation as it was a firmer and more extensive
articulation of existing laws. The Act would lead to the more rigorous
regulation of a greater range of financial services providers, and expanded the
authority of American law enforcement agencies in the fighting of terrorism,
both in the USA and abroad.

In October 2001, President George W. Bush
signed off the USA PATRIOT Act, effectively providing federal regulators with a
new range of tools and powers for fighting terror financing and money
laundering. During July 2002, the US Treasury proceeded to introduce Section 326
of the PATRIOT Act, a clause that removed some key burdens for regulators and
added significant enforcement muscle to the Act.

What 9/11 changed, in
essence, was the extent to which existing legislation was being implemented.
Using the provisions of the earlier anti-terrorism USA Act as a foundation, it
included the Financial Anti-Terrorism Act, which allowed for federal
jurisdiction over foreign money launders and money laundered through foreign
banks. Significantly, it is this anti-terror law that would make the creation of
an Anti Money Laundering (AML) programme compulsory for all financial
institutions and service providers.

Section 326 of the USA PATRIOT Act
dealt specifically with the identification of new customers (“CIP regulation”),
and made extensive provisions in terms of KYC and the methods employed to verify
client identities.

In accordance with this piece of updated KYC
legislation, federal regulators would hold financial institutions accountable
for the effectiveness of their initial customer identification and ongoing KYC
screening. Institutions are required to keep detailed records of the steps that
were taken to verify prospective clients’ identities.

Although current
KYC legislation does not yet demand the exclusion of specific types of
foreign-issued identification, it recommends the usage of machine-verifiable
identity documents. The ability to notify financial institutions if concerns
regarding specific types of identification were to arise, combined with a
risk-based approach to KYC, proved to provide a robust mechanism for addressing
security concerns.

Effectively, the risk-based approach to customer due
diligence grants regulated institutions a certain degree of flexibility to
determine the forms of identification they will accept, and under which
conditions.

KYC compliance: Implications for banks, lawyers and
accounting firms


The KYC compliance mandate, for all its positive
outcomes, has burdened companies and organisations with a substantial
administrative obligation. Additionally, KYC compliance increasingly entails the
creation of auditable proof of due diligence activities, in addition to the need
for customer identification.