Table of Contents
- 1 Key Takeaways:
- 2 What Is Know Your Business (KYB)?
- 3 Importance of KYB for Businesses
- 4 What Is the Difference Between KYC vs. KYB?
- 5 What Are Shell Companies?
- 6 Key Steps in the Know Your Business (KYB) Process
- 7 Cost of KYB Compliance
- 8 Benefits of Know Your Business (KYB)
- 9 Challenges of KYB
- 10 Other Global Regulations for KYB
- 11 KYB in Cryptocurrency
- 12 Conclusion
- 13 Identity.com
Importance of KYB for Businesses
KYB is an essential component of an effective anti-money laundering (AML) and counter-terrorism financing (CTF) program. By conducting KYB, businesses can identify and mitigate risks associated with their business relationships. This can help businesses protect themselves from reputational damage, financial losses, and legal liabilities.
In the United States (U.S.), KYB is mandated by the Financial Crimes Enforcement Network (FinCEN) as part of the customer due diligence (CDD) final rule. This rule amended the Bank Secrecy Act (BSA) regulations to improve financial transparency and prevent criminals and terrorists from misusing legal entities to launder money and finance their illicit activities.
Prior to the CDD final rule, the BSA only required financial institutions to conduct due diligence on individual customers. This created a gap in the regulatory framework, as businesses were not subject to the same level of scrutiny. Criminals exploited this gap by creating shell companies and using them to facilitate illicit activities.
To address this issue, FinCEN implemented the CDD final rule in May 2018. This rule requires financial institutions to identify and verify the beneficial owners of legal entities when opening accounts. The beneficial ownership requirement provides law enforcement with valuable information to investigate financial crimes, helps prevent evasion of targeted financial sanctions, improves the ability of financial institutions to assess risk, facilitates tax compliance, and advances U.S. compliance with international standards.
KYB regulations apply to a wide range of businesses, including financial institutions, credit institutions, trusts, cryptocurrency service providers, gambling services, and others. By implementing a robust KYB program, businesses can mitigate risks, protect their reputation, and comply with regulations.
What Is the Difference Between KYC vs. KYB?
Know Your Customer (KYC) and Know Your Business (KYB) are both due diligence procedures designed to enhance financial security and combat financial crimes. However, they differ in their target clientele. While they share similar goals, they differ in their target clientele. KYC focuses on verifying the identity and legitimacy of individual customers, while KYB focuses on assessing the risk profile and compliance of businesses.
Key differences of KYC and KYB:
|Businesses, companies, organizations
|Verifying identity and legitimacy
|Assessing risk profile and compliance
|Personal information, identification documents
|Business registration information, ownership structure, financial documents
|Opening bank accounts, applying for credit cards, conducting online transactions
|Establishing business relationships, onboarding new clients, onboarding new vendors
What Are Shell Companies?
Shell companies are high-risk businesses with financial assets but no significant business activity, directors, or publicly known owners. They have no employees or revenue, but money flows in and out regularly. While they have legitimate uses, criminals often use shell companies for tax evasion, money laundering activities, and to conceal the identity of the owners behind the business.
Key Steps in the Know Your Business (KYB) Process
Know Your Business (KYB) has the following components:
1. Verification of Business Legitimacy
The first step in the KYB process is to identify and verify the business’s legal existence and legitimacy. This involves collecting and verifying information such as:
- Business name and address
- Business registration documents
- Licensing documentation
- Taxpayer ID number
2. Identification and Verification of Beneficial Owners
Beneficial owners are the individuals who ultimately own and control a business. They are often the true source of funds for the business, and they may be involved in illegal activities. KYB procedures require financial institutions to identify and verify the beneficial owners of any business they do business with.
- An individual who directly or indirectly owns 25 percent or more of a legal entity.
- A single individual with significant responsibility to control, manage, or direct a legal entity.
Financial institutions must have procedures for collecting information about beneficial owners, such as using FinCEN’s certification form or their own forms. They must also use risk-based procedures to verify the identities of beneficial owners, including verifying their existence and not just their status as a beneficial owner.
3. Development of a Risk Profile through Customer Relationship Analysis
Once a business has been identified and its beneficial owners have been verified, financial institutions must assess the risk of doing business with that business. This involves understanding the nature and purpose of the business relationship, and identifying any unusual or suspicious activity.
Financial institutions must collect information about the customer’s business, such as its type, industry, and annual revenue. They should also collect information about the customer’s personal history, such as their employment history and residential address. This information can be used to develop a risk profile for the business relationship.
4. Continuous Monitoring For Suspicious Transaction Reporting
Financial institutions must regularly review and update customer information to ensure that it is accurate and up-to-date. This is especially important for high-risk customers, such as shell companies.
Financial institutions must also monitor customer activity for suspicious transactions. This includes transactions that are unusual in size, frequency, or pattern. If a financial institution suspects that a transaction is suspicious, it must file a suspicious activity report (SAR) with the Financial Crimes Enforcement Network (FinCEN).
Cost of KYB Compliance
Complying with the rules and regulations of Know Your Business (KYB) comes at high costs, including the following:
- Staff training costs
- Expenses incurred from revising compliance policies and procedures.
- Costs from onboarding new accounts
- Costs from Information technology upgrades
- Cost from internal controls and audit functions for financial institutions.
- Clients will spend additional time at account opening.
However, complying with these regulations will have a significant impact on reducing illicit activities in the country. It will also prevent financial institutions from incurring reputational damages and legal issues. Additionally, all citizens benefit from the actions to mitigate these activities regardless of who pays for the prevention.
Benefits of Know Your Business (KYB)
Here are some of the key benefits of KYB:
- Reduces Financial Crimes and Terrorist Activity: KYB can significantly hinder the ability of criminals to use shell companies and other illicit means to conceal their activities, therefore reducing money laundering, fraud, and terrorist financing.
- Assists Financial Investigations by Law Enforcement: The beneficial ownership information collected through KYB can provide law enforcement with valuable insights into the true ownership structures of businesses and individuals involved in financial crimes. This information can be critical for identifying and prosecuting criminals.
- Protects the Integrity of Financial Systems: By ensuring transparency and preventing illicit activities, KYB helps maintain the integrity of the financial system and reduces the risk of financial institutions being used for illegal purposes.
- Encourages Transparency from Legal Entities: KYB promotes transparency by encouraging businesses to be more open about their ownership structures and activities, making it more difficult for criminals to hide their illicit activities.
- Improves Risk Management and Compliance: KYB enables financial institutions to better understand the risks associated with their business relationships, which helps them make more informed decisions and comply with anti-money laundering (AML) and other regulations.
Facilitates Tax Compliance and Sanctions Evasion: By collecting beneficial ownership information, KYB can help financial institutions identify and report suspicious transactions that may involve tax evasion or sanctions evasion. This can lead to increased tax revenue and enforcement of sanctions.
Challenges of KYB
Despite its numerous benefits, KYB implementation is not without its challenges:
- Expensive Cost of Compliance: KYB can be a costly undertaking for financial institutions, as it requires them to invest in new systems, procedures, and personnel.
- Privacy and Data Protection Concerns: Beneficial ownership information contains sensitive personal data, raising privacy concerns and the potential for data breaches.
- Business Migration and Foregone Profit: Businesses may choose to relocate their accounts to jurisdictions with less stringent KYB requirements, leading to lost revenue for financial institutions.
- Accuracy and Manipulation of Beneficial Ownership Information: Beneficial ownership information can be inaccurate or manipulated, potentially allowing criminals to conceal their identities and activities.
Complex Ownership Structures and Obscure Beneficial Owners: Legal entities may have complex ownership structures involving multiple subsidiaries and offshore companies, making it difficult to identify the true beneficial owners and detect illicit activities.
Other Global Regulations for KYB
Beyond the US CDD final rule, the European Union’s Anti-Money Laundering Directives (AMLDs), particularly under the 4th, 5th, and 6th AMLDs, constitute another significant regulatory framework for KYB. These directives establish detailed guidelines for identifying and verifying beneficial owners, along with standard practices, penalties, and sanctions for non-compliance. Entities are mandated to maintain up-to-date ownership information in a centralized registry accessible to relevant authorities and other authorized bodies or persons.
KYB in Cryptocurrency
The increasing adoption of cryptocurrency has introduced novel challenges and risks associated with transactions due to its inherent anonymity. Criminals can easily conceal their money laundering, terrorist financing, and other fraudulent activities through cryptocurrency payment systems. To address these challenges, various regulations, including KYB regulations for cryptocurrency, are emerging worldwide. Cryptocurrency exchanges, wallets, and payment processors are now obliged to register with the relevant authorities in their respective jurisdictions, conduct customer due diligence to obtain and verify their individual customers and legal entities, and prepare suspicious activity reports (SARs) when necessary.
KYB is a proactive approach to verifying business legitimacy by performing required customer due diligence using risk-based procedures. The nature of business transactions has undergone significant changes in recent times. Regulatory agencies have shifted their focus from merely knowing the customers to comprehending the businesses they represent. This includes a deeper understanding of the beneficial owners and controllers of those businesses. For an effective AML compliance framework, KYB and other processes are necessary.
As a company leading a blockchain technology that will be helpful in the finance industry, we also believe in the ability to reduce fraud and all irregularities in the financial world. More reason Identity.com doesn’t take the back seat in contributing to this future via identity management systems and protocols. We also belong to the World Wide Web Consortium (W3C), the standards body for the World Wide Web.
The work of Identity.com as a future-oriented company is helping many businesses by giving their customers a hassle-free identity verification process. Identity.com is an open-source ecosystem providing access to on-chain and secure identity verification. Our solutions improve the user experience and reduce onboarding friction through reusable and interoperable Gateway Passes. Please get in touch for more info about how we can help you with identity verification and general KYC processes.