CDD vs EDD in Financial Compliance
Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) are regulatory standards that form the backbone of every robust AML compliance program when it comes to risk management and mitigation. But what is the difference between CDD vs EDD? And which one should you follow?
Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) are regulatory standards that form the backbone of every robust AML compliance program when it comes to risk management and mitigation.
But what is the difference between CDD vs EDD? And which one should you follow?
Understanding the difference between CDD and EDD is crucial for financial institutions, as it determines the level of scrutiny applied to a business relationship. In this blog, we will delve into the intricacies of these concepts, shedding light on their role in maintaining regulatory compliance and ensuring the integrity of financial systems.
What is Customer Due Diligence (CDD)?
Customer Due Diligence (CDD) is a regulatory standard that financial institutions must adhere to as part of their compliance program. It's a process that involves gathering and verifying a customer's identity and activity information. This is an essential component of risk management, aimed at preventing illicit activities such as money laundering.
The CDD process begins with the identification of the customer. This involves collecting basic information such as the customer's name, address, and date of birth. The information is then verified against reliable, independent sources such as government-issued identification documents.
Understanding the nature of the customer's business relationship with the institution is another crucial aspect of CDD. This involves gathering information about the customer's transaction behaviour, which helps in developing a risk profile for the customer.
The level of due diligence applied is proportional to the risk posed by the customer. For customers posing a standard or lower level of risk, basic CDD procedures are usually sufficient. For customers associated with higher risk, a more intensive level of scrutiny, known as Enhanced Due Diligence (EDD), may be required.
What is Enhanced Due Diligence (EDD)?
Enhanced Due Diligence (EDD) is a more rigorous form of due diligence, a regulatory requirement that is applied when a customer or transaction is deemed high-risk. This level of scrutiny is necessary to ensure the integrity of a business relationship and is an essential component of any robust compliance program.
EDD involves a more comprehensive collection of documentation and information about a customer. This is to verify their identity and understand their activities in greater detail. The process is designed to provide a deeper insight into a customer's risk profile, which is crucial for effective risk management.
The need for EDD arises when a customer's risk profile indicates a higher probability of involvement in illicit activities. This could be due to factors such as their geographical location, profession, or political exposure.
EDD is a level of due diligence that goes beyond the standard identification and risk assessment procedures. It is a critical tool for risk mitigation, ensuring that businesses are not exposed to unnecessary risks.
The Role of Sanction, PEP and Watchlist Screening in CDD and EDD
Sanctions, Politically Exposed Persons (PEPs), and watchlist screening are all integral components of both Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) processes. These screening methods are designed to identify and mitigate risks associated with money laundering, terrorist financing, and other illicit activities.
Sanctions screening identifies individuals or entities subject to government or international sanctions, preventing financial institutions from doing business with them. PEP screening identifies politically exposed persons, who are considered higher-risk due to their positions of power. Watchlist screening identifies individuals or entities suspected of involvement in criminal activities, terrorism, or other illicit activities. While PEP screening is generally required for high-risk customers, sanctions and watchlist screening are often mandatory for all customers. These screening processes help financial institutions comply with anti-money laundering and counter-terrorism financing regulations and mitigate risks associated with illicit activities.
CDD vs EDD: The Key Differences
CDD and EDD are both integral parts of risk assessment in financial institutions. But as we’ve explained, the level of due diligence applied varies depending on the risk profile of the potential customer:
Level of Risk and Depth of Investigation
The primary difference between CDD (Customer Due Diligence) and EDD (Enhanced Due Diligence) lies in the level of risk and depth of investigation. CDD is a basic level of due diligence that every financial institution must perform to assess their risk level. It involves gathering information about a potential customer to create a risk profile.
EDD is a more detailed investigation. It is required when a customer's risk level is higher than usual. This could be due to their specific circumstance, such as being a politically exposed person, or having a history of financial crime.
The depth of investigation in EDD is more extensive. It delves deeper into a customer's background, financial activities, and risk factors. This is to ensure that the financial institution is not unknowingly facilitating illegal activities.
Monitoring and Documentation
The distinction between Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) is most evident in the areas of monitoring and documentation. Both processes are integral to financial compliance, but they differ significantly in their depth and scope.
In CDD, monitoring is typically periodic and focuses on identifying deviations from the customer's normal transaction patterns. The aim is to ensure consistency with the customer's profile and to detect any anomalies. The documentation collected during CDD is usually sufficient to establish the customer's identity and understand their financial activities.
EDD requires more stringent and continuous monitoring of the customer's transactions. Financial institutions must closely observe the activities of high-risk customers to promptly identify and investigate any suspicious or unusual transactions. The monitoring under EDD is more detailed and frequent, with a focus on understanding the customer's transaction behaviour and assessing the risks associated with their activities.
In terms of documentation, EDD requires the collection of additional documentation and information to gain a deeper understanding of the customer's background, financial history, and risk profile. This may include financial statements, tax returns, and information on business associates and family members.
When to Use CDD vs EDD?
In the financial compliance landscape, the decision to use Customer Due Diligence (CDD) or Enhanced Due Diligence (EDD) is a crucial one. This decision is primarily driven by the level of risk associated with a customer. It's about striking the right balance between protecting your organisation from possible fraudulent activity and providing a seamless customer experience:
Start by Identifying High-Risk Customers
Identifying high-risk customers is a critical step. This process involves assessing the risk level associated with each customer, which is where the difference between Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) comes into play.
CDD is the standard process of gathering information about a customer to assess their risk level. It involves understanding the customer's financial profile, their business activity or reputation, and monitoring their financial transactions for possible suspicious activity.
When a customer's risk profile indicates a higher level of risk, EDD becomes necessary. EDD is an in-depth process that requires additional documentation and information about the customer's source of funds and business activities. It's designed to provide a more comprehensive risk assessment, particularly in cases where there's a higher risk of fraudulent activity.
Assessing the Source of Funds
Next, assessing the source of funds (SOF) is a critical step in distinguishing between Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD). This process involves a thorough examination of a customer's financial transactions to identify any possible suspicious activity that could indicate fraudulent behaviour.
The SOF assessment is particularly crucial when dealing with high-risk customers. These individuals or entities often have a complex financial profile, which necessitates additional documentation and scrutiny. The goal is to understand the origin of their wealth and the nature of their business activities, which can provide valuable insights into their risk level.
The level of risk associated with a customer isn’t static and can fluctuate based on changes in their financial transactions or business activities. Continuous monitoring is essential to promptly identify any shifts in their risk profile.
In some cases, the gathered information may raise red flags, indicating a higher risk level. This could trigger the need for EDD, which involves a more in-depth risk assessment. The aim is to gather additional information about their business and financial activities to better assess their risk level.
Monitoring and Documenting Suspicious Activities
Monitoring and documenting suspicious activities is a crucial part of conducting Enhanced Due Diligence (EDD). This process involves keeping a close eye on the financial transactions of high-risk clients to identify any possible suspicious activity.
The first step is to establish a baseline for the client's normal business activity. This involves understanding their financial profile, including the source of funds and the nature of their transactions. This baseline serves as a reference point for identifying any deviations that may indicate fraudulent activity.
Next, it's important to continuously monitor the client's transactions. This involves looking for any unusual patterns or inconsistencies that deviate from their normal business activity. For instance, a sudden increase in transaction volume or a significant change in the source of funds could be a red flag.
It's also crucial to document any suspicious activities. This involves gathering additional documentation and information about their business activity or reputation that could help assess their risk level.
The goal of EDD is not just to comply with regulations, but to protect the institution from the potential risks associated with high-risk clients.
The Importance of Understanding CDD and EDD in Financial Compliance
Understanding the difference between Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) is crucial in financial compliance. They help in identifying high-risk customers, assessing the source of funds, and monitoring suspicious activities, thereby mitigating the risk of fraudulent financial transactions..
While CDD is applied to all customers, EDD is reserved for those who pose a higher risk. This distinction is vital in ensuring that resources are effectively allocated and that the financial institution is adequately protected against potential risks.
Lastly, it's important to remember that these processes are not once-off events. They require continuous monitoring and updating to reflect changes in customer behaviour, regulatory standards, and risk factors.
sanctions.io assists businesses with customer due diligence and enhanced due diligence by providing access to extensive sanctions lists, PEP databases, and regulatory watchlists for screening business entities and customers.
To learn more about how sanctions.io can support your organisation's sanctions and AML compliance program:
We also encourage you to take advantage of our free 7-day trial (no credit card is required).
