The growing need for qualitative information in customer due diligence

Law firms must shift their focus towards understanding the narrative behind PEPs, sanctions and watchlist datasets

In June 2023, the Government opened a long-anticipated consultation that could lead to a new public body taking over the supervision of lawyers’ anti-money laundering efforts in place of legal regulators. This came in response to “significant weaknesses” in the UK’s current supervision system. 

A review of the UK’s anti-money laundering and counter-terrorism financing (AML/CTF) regime conducted last year underscored the need for further reform in this area. The consultation results haven’t been released yet, but are expected imminently.

New regulations were also introduced that further prohibit facilitating sanction breach. They specifically restrict access to legal advice from UK lawyers for individuals and businesses connected to the Russian regime, even when there is no direct link to the UK. 

These regulations, known as The Russia (Sanctions) (EU Exit) (Amendment) (No. 3) Regulations 2023, aim to prevent UK legal professionals from advising Russian companies on certain types of business transactions, such as global corporate trade deals or international money lending. 

Both these developments, and many others (Kingsley Napley has a useful round up), highlight the growing need for qualitative information in legal client due diligence. The complexity of KYC and AML requirements today mean that compliance data on its own is insufficient for understanding a client’s background and managing risks. 

The limits of databases

Compliance databases, which contain information on politically exposed persons (PEPs), sanctions, and watchlists, are valuable tools for due diligence and risk assessment. 

However, they have a number of limitations.

Lack of context

Databases provide isolated data points. They often lack the context necessary to understand the nuances of each case. For instance, they may flag a person as a PEP without explaining the specific circumstances or motivations behind their political exposure.

Incomplete information

Databases may not always capture the full scope of an individual’s or entity’s background. Relevant data such as adverse media is not included, leading to an incomplete picture.

Static data

Compliance databases are typically updated periodically. They may not reflect real-time changes or nuances in an individual’s status, or recent global developments that could affect sanctions or watchlists.

False positives

Databases can generate false positives, causing unnecessary disruptions and delays in onboarding and billable legal work. A purely quantitative approach may not distinguish between false positives and genuine risks.

Lack of depth

Compliance data is binary. It can provide a straightforward “yes” or “no” answer in background checks. This is useful for an initial screening process, identifying potential matches with individuals or entities on watchlists or associated with sanctions or PEP status. However,  relying solely on compliance data means that lawyers are limited to surface-level information. They are only able to determine if a match exists, missing the opportunity to gain a deeper understanding of the client.

Limited client understanding

By merely ticking boxes and not delving into the narrative behind compliance data, lawyers cannot claim to truly know their clients. This lack of understanding can hinder the ability to offer tailored advice or recognise subtle anomalies in client behaviour.

Inadequate risk assessment

Without a holistic view of the client, it is difficult to perform a comprehensive risk assessment. Lawyers may overlook potential risks or opportunities that quantitative data alone cannot reveal.

Qualitative data helps law firms understand the narrative

It’s clear that quantitative compliance data on its own is often insufficient for comprehensively assessing a client’s background and managing risks. To address this, law firms should consider shifting their focus towards the narrative behind politically exposed persons (PEPs), sanctions, and watchlist datasets.  

This holistic approach leads to:

Contextual understanding

PEPs, sanctions, and watchlist data are often devoid of context. By delving into the story behind this data, law firms can gain a better understanding of the specific circumstances and motivations of the individuals or entities involved, as well as whether representing them could pose a risk.

Better risk assessment

PEPs can have diverse backgrounds and motivations. Understanding their individual circumstances is essential for assessing the potential risks and challenges they may pose. This enables law firms to more accurately assess the level of risk associated with a client, which may not be clear from quantitative data alone.

Fewer false positives

Quantitative compliance data can generate false positives, leading to unnecessary delays and financial losses. By investigating the narrative, law firms can verify whether a match is a real concern or a false positive.

Better reputation management

Taking into account the specific circumstances that led to a client’s inclusion on a watchlist or sanction list can help law firms manage reputational risks effectively.

Regulatory compliance 

Many regulators now require firms to go beyond mere data checks and conduct more in-depth investigations. They often require evidence of this.

Stronger relationships

By understanding the context surrounding a client’s PEP status or sanctions history, law firms can build better relationships and demonstrate a commitment to addressing clients’ unique needs.

Tailored advice

The narrative behind compliance data can lead to more tailored legal advice and strategies. Clients benefit from advice that considers their specific circumstances and objectives.

More effective due diligence

Effective due diligence goes beyond surface-level data checks. Law firms need a comprehensive understanding of the risks and opportunities related to potential clients’ backgrounds, which necessitates exploring beyond their presence on a database.

The power of putting yes/no answers from compliance data into context

Quantitative data from compliance sources offers a binary response – a “yes” or “no” – to whether a client matches a particular risk profile. However, the true understanding of risk and the ability to make informed decisions come from putting these answers into context with qualitative information. 

This leads to a better understanding of:

Context

Qualitative information delves into the context behind the quantitative data, explaining why a client might have appeared on a watchlist or as a politically exposed person (PEP). For instance, understanding that a client’s political exposure was due to a familial connection rather than personal involvement can significantly affect the degree of risk. On the other hand, a client might not currently appear on a sanctions list, but qualitative insights may reveal ongoing activities or relationships that could raise concerns.

Behaviour

Qualitative information can provide insights into a client’s behaviour and motivations, helping lawyers evaluate whether a particular action was a red flag or a result of an understandable circumstance. This allows for more precise risk assessment.

Trends and developments

Monitoring news and global developments helps place risk indicators into context. For instance, if a client is associated with an industry or region that is under increased scrutiny, this qualitative insight can help lawyers anticipate potential sanctions and adapt their advice accordingly.

The absence of a client’s name on a watchlist or sanctions list at a particular moment does not guarantee their immunity from future inclusion. Qualitative information allows law firms to consider the potential for future risks and plan accordingly.

How can law firms use qualitative insights?

Enhanced due diligence

When dealing with a prospective client, law firms can use qualitative insights to supplement compliance data and conduct enhanced due diligence. This might involve reviewing their business activities, affiliations, and potential future risks based on industry trends and political developments.

Tailored advice

Law firms can offer more tailored advice to clients by considering the “why” behind risk indicators. For instance, they can advise clients on mitigating risks associated with their PEP status by demonstrating their commitment to transparency and ethical behaviour.

Reputation management

If a client’s inclusion in a watchlist or PEP category is due to a misunderstanding or a historical issue, law firms can use qualitative insights to help clients manage their reputation and explain the situation to relevant authorities.

Risk mitigation 

Qualitative information allows law firms to proactively develop risk mitigation strategies. They can anticipate potential issues and assist clients in preparing for changes in their risk profile, such as advising on how to stay compliant with evolving sanctions regimes.

Find relevant, actionable qualitative information in minutes with AI

The benefits of qualitative information are nothing new, but until recently, finding that information was a huge drain on resources. It would take researchers hours to check through search engines for information about a client – and even then they wouldn’t be certain they’d found everything important. 

It recently was noted that 70% of the 24 Suspicious Activity Reports (SARs) sent by the Solicitors Regulation Authority (SRA) to law enforcement agencies involved either sole practices or law firms with 10 or fewer fee-earners, primarily within the field of conveyancing. The SRA’s Money Laundering Reporting Officer, Sara Gwilliam, shared this statistic in her annual report during an SRA board meeting in June 2023. 

There could be a number of reasons for this. If limited resources is one of them, AI-powered tools like Xapien solve this by delivering in-depth, quantitative due diligence in minutes.

Here’s how AI enhances risk assessment and due diligence.

Uncovering hidden associations

AI can identify hidden associations and connections that may not be immediately apparent from standard data sources. For example, Xapien can analyse vast amounts of data to identify when an individual is mentioned in media articles as a “close friend” of a problematic figure. This contextual information is crucial for understanding the extent of a potential risk.

Read more: Xapien: How it works 

Analysing diverse data sources

Xapien analyses a wide range of data sources in over 133 languages from across the entire indexed internet, including news articles, company information, financial reports, and more. The result is a comprehensive profile of a client or entity. This multidimensional approach provides a nuanced understanding of potential risks.

Pattern recognition

AI is adept at recognising patterns and anomalies in data. Xapien can identify connections that might not be immediately evident to human analysts, helping to uncover potential risks that might have otherwise been missed.

Comprehensive reports

Xapien doesn’t stop at identifying potential risks. It goes a step further by generating human-like reports. These reports provide a comprehensive and holistic picture of a subject’s background, incorporating fully-sourced data from various sources and presenting it in a structured and actionable format. They are ready for executive review or regulatory checks immediately.

Conclusion

Developments in the legal and compliance fields highlight the increasing need for qualitative information in client due diligence. Quantitative compliance data, while valuable, falls short in providing a holistic understanding of clients’ backgrounds and motivations. Law firms are now focusing on understanding the narratives behind compliance data, recognising that quantitative information alone may not suffice in today’s complex regulatory environment. 

Want to see Xapien in action?

AI-powered tools like Xapien enhance risk assessment by uncovering hidden associations, analysing diverse data sources, and generating comprehensive reports. This empowers law firms to conduct more effective due diligence and offer tailored advice, ultimately improving their risk management and compliance practices. To learn more, fill in the form below for a chat with the team.