Trade Based Money Laundering: Risks

April 21, 2020

Trade Based Money Laundering: Risks and Implications

(Published in the Financial Express in 2019)   

Dr. Shah Md Ahsan Habib[1]

Trade-based money laundering (TBML) activity is widely recognized as one of the most common manifestations of international money laundering, and has emerged as an issue of growing interest amongst the policy makers of both developed and developing countries. It involves the exploitation of the international trade system for the purpose of transferring value and obscuring the true origins of illicit wealth which may vary in complexity but typically involve misrepresentation of the price, quantity, or quality of imports or exports. Banks may willingly or unwillingly be implicated in TBML schemes when such institutions are used to settle, facilitate, or finance international trade transactions.

Trade based money laundering is a critical area of malpractice which can be practiced through the misrepresentation of the price, quantity or quality of imports or exports, and the techniques involved are: over- and under-invoicing of goods and services; multiple invoicing of goods and services; over- and under-shipments of goods and services; falsely described goods and services etc. In many cases, this can also involve abuse of the financial system through fraudulent transactions involving a range of money transmission instruments, such as wire transfers.

Growing risks and challenges in global trade services are relevant for risks of TBML as well.  Key challenges commonly include trade finance gap, information gap, document rejection, court injunction, disruption in correspondent banking relationship, sanction and financial crime especially trade based money laundering. The challenges and concerns are impacting trade services by banks. The most recent International Chamber of Commerce (ICC) survey shows that nearly in 30 percent instances the request of trade finance were rejected as a result of money laundering or terrorist financing-related concerns. In the same survey, nearly 80 percent of respondents agree (or strongly agree) that money laundering related requirement is a barrier to servicing trade financing needs. Regulatory and policy concerns on TBML have brought notable changes in terms of greater know-your customer (KYC) requirements; increased efforts on price verification of tradable; struggling correspondent banking relationship; and increased compliance and reporting requirement and costs. With the increased regulatory requirements on banking services, the less regulated portion of banking i.e. the shadow banking also came under scanner of the policy maker and the regulatory authorities both in developed and developing countries.   

Increased KYC due diligence requirements have significant impediments on trade financing activities. As a result of the regulatory burden and uncertainty, there are instances, when banks avoid entering into some transactions altogether. Practically, the KYC tactics needed to properly vet against TBML require more extensive analysis, including more precisely knowing the business of clients. Broadly, it is also about third party policies, screening and processes of also know customer’s customer (KYCC) to mitigate risks. In regards to pricing of tradable, it is suggested to collect information from a bank’s business clients about the product range and pricing during the due diligence process. One can also research online to check the accuracy of the data. After the completion of gathering research, one can check transactions against that data to ensure they are in line with expectations. Banks generally are not in a position to make meaningful determinations about the legitimacy of unit pricing due to the lack of relevant business information, such as the terms of a business relationship, volume discounting or the specific quality of the goods involved. Further, many products are not traded in public markets and there are no publicly available market prices. Even where goods are publicly traded, the exiting prices may not reflect the agreed price used in any contract of sale or purchase and these details are usually not available to the banks involved due to the competitive sensitivity of such information.

Correspondent banking is mainly being threatened by an overenthusiastic interpretation and enforcement of rules aimed at preventing money-laundering and terrorist financing. The number of linkages between banks has been declining in recent years, largely because the industry has been trying to avoid risk prone services especially when business opportunities are low. The impact of the de-risking has now been rebounded to some extent, as the development institutions like Word Bank, IMF etc. are now working almost on same tune to redefine correspondent banking business with an expectation to bridge the gap between uncertainty in regulator expectation and compliance program of global correspondent banks.

As a whole the changes have brought in greater compliance and reporting requirements for banks. Increasing compliance requirement and reporting in trade services has pulling the overall costs of offering trade services in all global economies. The most recent ICC survey identified, capital adequacy requirements have made trade finance business more expensive and have translated directly into balance sheet constraints on the business. Regulatory requirements designed to mitigate the risk of financial crimes and money laundering has resulted in unintended consequences particularly in emerging markets.

One critical concern is that detection of TBML is relatively difficult since volumes of trade flows are massive and because TBML can take complicated forms. Monitoring trade transaction is the key to handle TBML, and probably KYC is the most critical component of any anti-money laundering program, especially one looking to control TBML. A comprehensive KYC arrangement offers foundational understanding of the activity and partnerships the customer should be reasonably expected to engage in; and for TBML specially, expanding beyond just KYC to understand trading partners, vessels, products being shipped is necessary to effectively identify TBML.  The responsibilities of banks in setting up right control mechanisms and monitoring arrangements are particularly crucial where reliance on documentary trade is very high. 

Greater capacity building and more effective cooperation on information sharing is especially necessary for the prevention of TBML. Financial Action Task Force (FATF) has published two separate guidance papers to address concerns related to TBML. Several other international organizations are working to support emerging economies to address TBML. As a global trade platform working to link emerging market banks with international banks, IFC (International Finance Corporation) recently prepared a guideline for the benefit of emerging market banks those involved with trade finance. Certain red flags are identified and used as the danger or warning signs for the banks and other stakeholders as part of the process of identifying TBML. Certain other key relevant documents include: a consolidated sets of red flag from three key documents titled Trade based money laundering by FATF published in 2006; Best Practices on Trade Based Money Laundering by FATF published in 2008; and APG (Asia Pacific Group on Money Laundering) Typology Report on Trade Based Money Laundering published in 2012. These documents might be particularly helpful to the policy makers, regulatory agencies and banks that are attempting to address TBML.

[1] Professor and Director (Training), BIBM ([email protected]).

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