AML KYC Customer Due Diligence: Standard vs Enhanced Due Diligence - EDD high-risk clients

What Is This?

Standard Due Diligence (SDD) and Enhanced Due Diligence (EDD) are risk assessment processes used to evaluate the credibility and reliability of high-risk clients. SDD is a basic risk assessment, while EDD is a more comprehensive evaluation.

This topic appears in exams to test your understanding of risk management and compliance procedures. Expect questions that require you to apply these concepts to real-world scenarios.

Why It Matters

This topic is crucial for exams like the Certified Anti-Money Laundering Specialist (CAMS) and the Anti-Money Laundering (AML) certification. It typically carries 15-20% of the total marks and tests your ability to identify and mitigate risks associated with high-risk clients.

Core Concepts

To tackle this topic, you must understand the following key ideas:

• High-risk clients: Individuals or entities with a higher likelihood of being involved in money laundering or other illicit activities.
• Risk assessment: A process to evaluate the likelihood and potential impact of a risk event.
• Due diligence: A procedure to verify the identity and credibility of a client.
• Enhanced due diligence: A more comprehensive evaluation of a high-risk client, including additional checks and verifications.

Prerequisites

Before tackling this topic, you should already understand:

• Basic risk management concepts
• Anti-money laundering (AML) regulations
• Client onboarding procedures

If you're missing these prerequisites, you may struggle to understand the context and application of SDD and EDD.

The Rule-Book (How It Works)

The primary rule for SDD is:

• Verify client identity: Obtain and verify the client's identification documents.
• Conduct basic risk assessment: Evaluate the client's risk profile based on publicly available information.

For EDD, the primary rule is:

• Conduct enhanced risk assessment: Evaluate the client's risk profile using more comprehensive and detailed information.
• Verify additional information: Obtain and verify additional information about the client, such as their business activities and financial transactions.

Exam / Job / Audit Weighting

Frequency: 20-25% of exam questions Difficulty Rating: Intermediate Question Type or Real-World Task Type: Scenario-based questions requiring risk assessment and due diligence procedures.

Difficulty Level

Intermediate

Must-Know Rules, Formulas, Standards, or Principles

The following rules and principles are crucial for this topic:

1. Know your customer (KYC): Verify the client's identity and obtain necessary documentation.
2. Enhanced due diligence: Conduct a more comprehensive evaluation of a high-risk client, including additional checks and verifications.
3. Risk-based approach: Evaluate the client's risk profile based on their likelihood and potential impact of a risk event.

Worked Examples (Step-by-Step)

Easy

Question: A client is applying for a bank account. What is the primary due diligence procedure to follow? Answer: Verify client identity and conduct a basic risk assessment. Key rule applied: Know your customer (KYC).

Medium

Question: A client is suspected of money laundering. What is the enhanced due diligence procedure to follow? Answer: Conduct an enhanced risk assessment and verify additional information about the client. Key rule applied: Enhanced due diligence.

Hard

Question: A client is a high-risk entity with a complex business structure. What is the risk assessment procedure to follow? Answer: Conduct a comprehensive risk assessment, including evaluation of the client's business activities and financial transactions. Key rule applied: Risk-based approach.

Common Exam Traps & Mistakes

1. Incorrectly identifying high-risk clients: Failing to recognize the characteristics of high-risk clients, such as unusual business activities or suspicious transactions.
2. Insufficient due diligence: Failing to conduct a thorough risk assessment or verify client identity.
3. Inadequate record-keeping: Failing to maintain accurate and up-to-date records of client due diligence procedures.
4. Failure to update risk assessments: Failing to re-evaluate a client's risk profile in response to changes in their business activities or financial transactions.
5. Inadequate training: Failing to provide adequate training to staff on due diligence procedures and risk assessment.

Shortcut Strategies & Exam Hacks

1. Use a risk assessment matrix: Create a matrix to evaluate the likelihood and potential impact of a risk event.
2. Prioritize high-risk clients: Focus on evaluating high-risk clients first, using a risk-based approach.
3. Use a checklist: Create a checklist to ensure all due diligence procedures are followed.
4. Stay up-to-date with regulations: Familiarize yourself with the latest AML regulations and guidelines.

Question-Type Taxonomy

This topic appears in the following question formats:

Practice Set (MCQs)

Question 1

What is the primary due diligence procedure to follow for a high-risk client? A) Verify client identity and conduct a basic risk assessment. B) Conduct an enhanced risk assessment and verify additional information. C) Conduct a comprehensive risk assessment, including evaluation of the client's business activities and financial transactions. D) Use a risk assessment matrix to evaluate the client's risk profile.

Correct Answer: B) Conduct an enhanced risk assessment and verify additional information.

Explanation: Enhanced due diligence is the primary procedure to follow for high-risk clients. Why the Distractors Are Tempting: Options A and C are tempting because they are related to due diligence procedures, but they are not the primary procedure for high-risk clients. Option D is tempting because it is a useful tool for risk assessment, but it is not the primary procedure.

Question 2

A client is suspected of money laundering. What is the risk assessment procedure to follow? A) Conduct a basic risk assessment. B) Conduct an enhanced risk assessment and verify additional information. C) Use a risk assessment matrix to evaluate the client's risk profile. D) Conduct a comprehensive risk assessment, including evaluation of the client's business activities and financial transactions.

Correct Answer: B) Conduct an enhanced risk assessment and verify additional information.

Explanation: Enhanced due diligence is the risk assessment procedure to follow for clients suspected of money laundering. Why the Distractors Are Tempting: Options A and C are tempting because they are related to risk assessment procedures, but they are not the correct procedure for clients suspected of money laundering. Option D is tempting because it is a comprehensive risk assessment, but it is not the correct procedure.

30-Second Cheat Sheet

• Know your customer (KYC): Verify client identity and obtain necessary documentation.
• Enhanced due diligence: Conduct a more comprehensive evaluation of a high-risk client, including additional checks and verifications.
• Risk-based approach: Evaluate the client's risk profile based on their likelihood and potential impact of a risk event.
• Verify additional information: Obtain and verify additional information about the client, such as their business activities and financial transactions.
• Use a risk assessment matrix: Create a matrix to evaluate the likelihood and potential impact of a risk event.
• Prioritize high-risk clients: Focus on evaluating high-risk clients first, using a risk-based approach.

Learning Path

1. Beginner foundation: Understand basic risk management concepts, AML regulations, and client onboarding procedures.
2. Core rules: Learn the core rules and principles of due diligence, including KYC and enhanced due diligence.
3. Practice: Practice applying the core rules to scenario-based questions.
4. Timed drills: Practice timed drills to improve your speed and accuracy.
5. Mock tests: Take mock tests to assess your knowledge and identify areas for improvement.

Related Topics

1. Anti-money laundering (AML): Understand the regulations and guidelines related to AML.
2. Know your customer (KYC): Understand the procedures for verifying client identity and obtaining necessary documentation.
3. Risk management: Understand the concepts and principles of risk management, including risk assessment and mitigation.