Comprehensive Study Notes: IFSCA Guidelines for KYC Norms (Chapter 6 — Part 3)

This study guide represents Part 3 of the comprehensive series for Chapter 6: IFSCA Guidelines for KYC Norms. It covers key sections detailing the identification and verification of Beneficial Owners (BOs), Life Insurance Policy Beneficiaries, establishing Business Relationship Purport, Politically Exposed Persons (PEPs), Enhanced Due Diligence (EDD), and Simplified Customer Due Diligence (SDD).

1. Verification of Beneficial Ownership (BO)

A Beneficial Owner (BO) is defined under the Prevention of Money Laundering Act (PMLA) as an individual who ultimately owns or controls a client of a Regulated Entity, or the person on whose behalf a transaction is actively being conducted, including anyone exercising ultimate effective control over a juridical person.

1.1 Parameters for Company Beneficial Owners

Where the customer is a company, the Beneficial Owner is the natural person(s) who, acting alone or together, or through one or more juridical persons, has a controlling ownership interest or exercises control through other means.

• Controlling Ownership Interest: Ownership of, or entitlement to, more than 10 percent (10%) of the shares, capital, or profits of the company.
• Control: Includes the right to appoint the majority of the directors, or to control the management or policy decisions, including by virtue of shareholding, management rights, shareholders' agreements, or voting agreements.

1.2 Parameters for Partnership Firm Beneficial Owners

Where the customer is a partnership firm, the Beneficial Owner is the natural person(s) who, acting alone or together, or through one or more juridical persons, has ownership of or entitlement to more than 10 percent (10%) of the capital or profits of the partnership, or exercises control through other means (such as the right to control management or policy decisions).

1.3 Parameters for Unincorporated Association or Body of Individuals Beneficial Owners

Where the customer is an unincorporated association or body of individuals (which explicitly includes societies), the Beneficial Owner is the natural person(s) who, acting alone or together, or through one or more juridical persons, has ownership of or entitlement to more than 15 percent (15%) of the property, capital, or profits of the entity.

1.4 The "Senior Managing Official" Fallback

If no natural person can be identified under the company, partnership, or unincorporated association parameters listed above, the Beneficial Owner is deemed to be the relevant natural person who holds the position of Senior Managing Official.

1.5 Parameters for Trust Beneficial Owners

Where the customer is a trust, the identification of Beneficial Owners is comprehensive and must include the following parties:

• The Author / Settlor of the trust.
• The Trustee(s).
• The Beneficiaries who hold 10 percent (10%) or more interest in the trust.
• Any other natural person exercising ultimate effective control over the trust through a chain of control or ownership.
• Disclosure Mandate: Regulated Entities must ensure that trustees formally disclose their status at the commencement of the business relationship or when carrying out transactions.

1.6 Regulatory Exemptions from Beneficial Owner Verification

Unless the Regulated Entity has doubts about the veracity of previously obtained customer due diligence (CDD) information, or suspects that the customer is connected to money laundering or terrorist financing (ML/TF), it is not required to identify or verify any shareholder or beneficial owner in the following scenarios:

1. Listed Entities: The client or the owner of the controlling interest is an entity listed on a recognized stock exchange in India, or listed on stock exchanges in foreign jurisdictions formally notified by the Central Government.
2. Listed Subsidiaries: The customer is a direct subsidiary of a listed entity that meets the above criteria.
3. Depository Receipts / Equity Shares (Notified Jurisdictions): Where a customer is subscribing to or dealing with depository receipts or equity shares of an Indian company listed in notified foreign jurisdictions, and is acting on behalf of a beneficial owner resident in that jurisdiction, the determination, identification, and verification of the BO will be governed by the laws and norms of that foreign jurisdiction (the standard rules of the PMLA do not apply).

2. Identification of Life Insurance Policy Beneficiaries

For life insurance or other investment-related insurance business, Regulated Entities must conduct specific CDD measures on the designated beneficiary or beneficiaries as soon as they are identified or designated.

• Specifically Named Beneficiaries: If the beneficiary is a specifically named natural person, legal person, or legal arrangement, the RE must obtain their full name, including any aliases.
• Class-Designated Beneficiaries: If beneficiaries are designated by characteristics or class (e.g., "spouse" or "children" at the time the insured event occurs) or through a will, the RE must collect sufficient information to satisfy itself that it can establish the identity of the beneficiary at the time of the payout.
• Sanction and PEP Screening at Payout: In relation to life insurance policies, the RE must take reasonable measures to determine whether the beneficiaries, and/or the ultimate Beneficial Owner of the beneficiary, are Politically Exposed Persons (PEPs). This screening must occur, at the latest, at the time of the payout.
• Escalation Protocol: If higher risks or PEP status are identified during this screening:
  1. The RE must inform Senior Management prior to making any payout of the policy proceeds.
  2. Conduct enhanced scrutiny on the entire business relationship with the policyholder.
  3. Actively consider filing a Suspicious Transaction Report (STR) with FIU-IND.

3. Purpose and Intended Nature of Business Relations

When establishing a business relationship, a Regulated Entity must understand and obtain clear information from the customer regarding the purpose and intended nature of the business relationship.

• The specific measures and inquiries taken to understand these parameters must be directly commensurate with the risk profile and complexity of the customer's business.

4. Accounts of Politically Exposed Persons (PEPs)

4.1 Legal Definition of a PEP

Politically Exposed Persons (PEPs) are individuals who have been entrusted with prominent public functions by a foreign country. This includes:

• Heads of State or Governments.
• Senior politicians.
• Senior government, judicial, or military officers.
• Senior executives of state-owned corporations.
• Important political party officials.

4.2 Mandatory PEP Compliance Procedures

Regulated Entities must implement appropriate internal risk management systems, policies, and procedures to determine if a customer, an authorized representative, a Beneficial Owner, or an insurance beneficiary (or their BO) is a PEP.

If PEP status is identified, the RE must execute the following six mandatory measures:

1. Information on Source of Wealth: Collect, by appropriate and reasonable means, adequate information about the source of wealth and income of the PEP, their family members, any beneficial owner, and close relatives.
2. Prior Verification: Verify the customer’s identity before accepting the PEP as a customer.
3. Senior Management Approval: Obtain formal approval from Senior Management before opening a PEP account or making any payout under a life insurance policy to a PEP.
4. Transition Approvals: If an existing customer or beneficial owner subsequently becomes a PEP, the RE must obtain Senior Management's approval to continue the business relationship.
5. Enhanced Transaction Monitoring: Increase both the degree and the nature of ongoing monitoring of the business relationship to determine if transactions appear unusual or suspicious.
6. Payout Restrictions: Carry out additional, detailed Customer Due Diligence before executing any payout under a life insurance or investment policy.

4.3 Risk-Based Approach for PEP Categories

A Regulated Entity may apply a Risk-Based Approach (RBA) when deciding the extent of enhanced CDD measures for:

• Domestically based PEPs, their family members, and close associates.
• International Organisation PEPs, their family members, and close associates.
• PEPs who have stepped down from their prominent public functions. In such cases, the RE must analyze the level of ongoing influence the individual continues to exercise after stepping down, unless their transaction profiles present an inherently high risk of ML/TF.

5. Enhanced Due Diligence (EDD) Framework

Where the risks of money laundering or terrorist financing are identified as high, a Regulated Entity must conduct Enhanced Customer Due Diligence (ECDD) measures that are consistent with the identified risks.

5.1 Standard Enhanced CDD Measures

The EDD process consists of six core operational mandates:

1. Additional Background Inquiries: Obtain additional information on the customer (such as occupation, volume of assets, and information available through public databases or the internet).
2. Regular CDD Updates: Update the identification data of the customer and their beneficial owners at a significantly higher frequency.
3. Financial Auditing: Obtain information and take additional active steps to examine the ownership, financial position, source of wealth, and source of funds of the customer or beneficial owner.
4. Transaction Clarification: Obtain information and document the specific transaction purpose and the intended relationship between transaction parties.
5. Senior Management Approvals: Obtain the express approval of Senior Management to commence or continue the business relationship.
6. Enhanced Monitoring: Conduct intensified monitoring of the business relationship by increasing both the number and timing of controls applied and selecting specific transaction patterns that require deep examination.

5.2 The First-Payment Safeguard Rule

Where applicable, the first payment made by a customer to open an account with a Regulated Entity in the IFSC must be executed through a bank account held in the customer's name with one of the following institutions:

• A licensed Bank.
• A regulated financial institution whose entire operations are actively supervised and regulated for AML/CFT compliance in a jurisdiction where the regulations are equivalent to the standards set by the FATF.
• A subsidiary of such a regulated financial institution, provided the governing law of the parent entity guarantees that the subsidiary strictly observes identical AML/CFT standards as its parent.

5.3 FATF Geographic Mandates

Regulated Entities are legally required to apply enhanced due diligence measures, proportionate to the risks, to any business relationships or transactions involving natural or legal persons (including financial institutions) from countries for which this is formally called for by the Financial Action Task Force (FATF).

6. Simplified Customer Due Diligence (SDD) Framework

Where the risks of money laundering or terrorist financing are determined to be low, a Regulated Entity may apply Simplified Customer Due Diligence (SCDD) measures. These measures must be directly commensurate with the identified low-risk factors.

6.1 Permitted Simplified Measures

Simplified measures are designed to reduce administrative friction for low-risk clients and can include:

• Deferred Verification: Verifying the identity of the customer and the beneficial owner after the formal establishment of the business relationship (under the strict conditions of the deferred verification framework).
• Reduced CDD Update Frequencies: Decreasing the frequency of customer identification updates.
• Throttled Monitoring: Reducing the degree of ongoing monitoring and transaction scrutiny based on a reasonable, documented monetary threshold.
• Inferred Relationship Purpose: Not collecting specific documentation to understand the purpose and intended nature of the business relationship, but instead inferring the purpose directly from the nature of the transaction or relationship established.

6.2 The Absolute Prohibition on SDD

Crucial Compliance Rule: Simplified Customer Due Diligence (SDD) measures shall never be conducted if there is any suspicion of money laundering or terrorist financing (ML/TF). Furthermore, simplified measures are not acceptable whenever specific higher-risk scenarios apply or where the risk identified is inconsistent with India's National Risk Assessment.

7. Practice Exam Questions (Topic-Specific)

MCQs — Beneficial Ownership, PEP Screening & CDD

Q1. Under the IFSCA guidelines, what constitutes a “controlling ownership interest” when determining the Beneficial Owner of a company?

A) Ownership or entitlement to more than 5% of shares or capital.
B) Ownership or entitlement to more than 10% of shares, capital, or profits.
C) Ownership or entitlement to more than 15% of shares or capital.
D) Ownership or entitlement to more than 25% of shares, capital, or profits.

Answer: B

Q2. When verifying the Beneficial Owner of a trust, which of the following parties must be identified and verified?

A) Only the trustee and the primary beneficiary.
B) The author, the trustee, any beneficiary with 10% or more interest, and any person exercising ultimate effective control.
C) Only the settlor and beneficiaries with more than 15% interest.
D) The senior managing official of the trust’s corporate office only.

Answer: B

Q3. At what milestone must a Regulated Entity perform PEP screening on the beneficiary of a life insurance policy?

A) Only at the time of initial underwriting.
B) Annually during the policy term.
C) At the latest, at the time of the payout.
D) Only if the policy value exceeds USD 100,000.

Answer: C

Q4. Which of the following is a mandatory operational requirement under the Enhanced Due Diligence (EDD) framework?

A) Allowing the client to verify their identity within 120 days.
B) Obtaining the approval of Senior Management to commence or continue the business relationship.
C) Utilizing simplified monitoring based on a high monetary threshold.
D) Waiving the requirement to verify the source of wealth.

Answer: B

Q5. Under what circumstance is a Regulated Entity strictly prohibited from applying Simplified Customer Due Diligence (SDD) measures?

A) The customer is an international listed company.
B) The customer resides in a low-risk country.
C) There is a suspicion of money laundering or terrorist financing.
D) The transaction value is below USD 1,000.

Answer: C

8. Key Terminology for Quick Recall

• Beneficial Owner (BO): The natural person who ultimately owns or controls a client, or on whose behalf a transaction is being conducted.
• Controlling Ownership Interest: The regulatory threshold (more than 10% for companies and partnerships, and more than 15% for unincorporated associations) that defines beneficial ownership.
• Politically Exposed Person (PEP): Individuals entrusted with prominent public functions by a foreign country, subject to enhanced compliance measures.
• Enhanced Due Diligence (EDD): Intensified KYC and transaction monitoring procedures mandated for clients categorized as high-risk.
• Simplified Due Diligence (SDD): Relaxed KYC verification and monitoring procedures permitted exclusively for low-risk, non-suspicious clients.