Trade based money laundering – Challenges, detection and prevention

Back in 2006, Financial Action Task Force (FATF) emphasised on new measures and strategies for banks to combat money laundering and terrorist funding in its report on trade based money laundering. As per the report, FATF highlighted the fact that with new standards applied, other money laundering techniques are becoming more effective. And there’s a high possibility that trade based money laundering will grow more attractive. Moreover, very little attention is paid to combat the abuse of the international trade system currently.

Trade based money laundering has become a growing concern since the publishing of FATF report. According to the Global Financial Integrity analysis, from 2005-2014, the illicit cash flow to and from emerging and developing countries was 12-24% of their total trade. Not to forget the potential damage through the use of these funds, is more than a trillion-dollar problem. For years, regulatory authorities and international trade sector have worked together to address the rising issue. Authorities such as FATF, have issued various guidelines to assist banks in combating money laundering.

What is trade based money laundering (TBML)?

Trade based money laundering is the most sophisticated approach to make black money white by taking advantage of complex trading systems It generally involves importing and exporting goods and exploitation of cross-border trade finance. TBML is most prominent in the context where multiple parties and jurisdictions make customer due diligence (CDD) and AML screening more difficult.

Money laundering is the third-largest global industry after oil and currency, states the International Money Laundering Information Bureau (IMLIB). With the advancement in technology, criminals are becoming more sophisticated and trade based money laundering is one of the oldest yet refined forms of money laundering.

Why is Trade based money laundering done?

Crimes and money laundering are interrelated concepts that balance each other. Money laundering is done to hide and wash away dirty money generated through crimes. Individuals want to secure their illegal earnings by keeping them at lower tax jurisdiction and washing away the dirty money. Crime is not a crime unless it is proved and that’s how money laundering is done, i.e. presenting illicit money as the hard-earned money.

Money launderers use various channels and networks to bring their dirty money at a place where it’s hard to detect the source of money and trace the transactions. Moreover, these channels are adopted to ensure personal security, lower or no tax, and political stability. The leaked Panama papers highlighted different aspects that how rich and powerful people are hiding their wealth. Secondly, how companies helped their clients to dodge sanctions, launder money and evade taxes. Most of the illicit money comes from various trade based money laundering schemes.

Some recent statistics show that the illegal cash flow from Bangladeshi nationals is growing. It is because the major portion of Bangladesh’s export earnings comes from RMG export. And in order to execute RMG export order, million-dollar Back-to-back Letter of Credit (BBLC) are issued every day against export contacts and letter of credit. That’s where trade based money laundering risks arise because it makes money laundering easier than other foreign trade operations.

Three stages of trade based money laundering

Trade based money laundering, like money laundering, usually occurs in three stages. The flow goes like

• Placement: At the placement stage, the criminal transforms the illicit proceeds into some legally transferable assets; for instance, purchasing goods.
• Layering: At the layering state criminal attempts to hide the relationship between their proceedings and criminal source, for example, trading goods cross-border.
• Integration: Lastly, at the integration stage the offender re-introduces the illegally laundered money into the legitimate economy, for instance, reselling the purchased goods.

Non-documentary trades – The biggest challenge

Trade based money laundering is often hard to detect because of its nature. One of the biggest challenges that make it difficult for compliance officials to identity TBML is non-documentary trade. In a non-documentary transaction, banks get limited access to information depending upon the transaction structure and the institution’s policy. For instance, the bank may only have the name, address, and account number of the seller, and buyer’s name and account number.

In such scenarios, the trade occurs without any human intervention like a wire transfer. Banks cannot identify the underlying trade flows for international transactions in a non-documentary trade. Even in a wire transfer, very little information is available that does not suffice for the bank’s validation system. Banks only intervene if the transaction instructions are unclear or a sanction stops the transaction itself for further review.

Banks must understand their customers and their businesses using a comprehensive due-diligence assessment that may include the volume and the type of goods or services. Customer profiles can help banks to validate the flow of transactions and ensure their authenticity.

Trade based money laundering schemes

With the evolution of AML controls globally, criminals are exploiting new ways to hide their dirty money. Trade based money laundering is one of the ways to deceive regulatory authorities and move illicit funds cross-border without getting detected. Even in TBML, criminals adopt multiple schemes which include:

• Over or under-invoicing: It involves misinterpreting the price of goods sending either inflated or deflated invoices to the importer. In the case of over-invoicing, the exporter receives a greater value from the importer. Whereas, in the case of under-invoicing, the greater value is transferred to the importer.
• Multiple invoicing: It means invoicing one shipment several times. When exporter invoices multiple times for the same shipment, they receive greater values from the importer.
• Short or over shipping: This scheme involves shipping more or fewer goods than invoiced. In case of short shipping, the exporter ships fewer goods than the previously agreed contract, therefore, receiving greater value. Alternatively in over-shipping importer receive more goods, hence more worth.
• Obfuscation: It involves shipping something other than what is invoiced. For instance, exporter misinterprets on official invoice/documentation claiming the goods are of premium quality hence receiving greater value from the importer.
• Phantom shipping: In this type, the exporter ships nothing at all with false invoices and receives payment from the importer.

Scope of trade finance

Banks and financial institutions are under the continuous scrutiny of regulatory authorities because of the nature of operations. Trade finance is emerging as a significant concern for anti-money laundering (AML) enforcement authorities and compliance officers. It is difficult to detect and combat abuses within trade finance processes. Within the scope of trade finance, financial institutions provide various services that are resulting in trade based money laundering risks. These services include, but not limited to:

• Banks guarantees and document collections
• Loan services (import/export, packing, pre-shipment loans etc.)
• Financing under open account transactions
• Trust receipts and letters of credit (L/C)
• Structured trade financing
• Warehouse financing
• Import/export invoice discounting

In order to identify red flags and combat money laundering, officials need to take a fresh look at these channels to derive risk factors.

FATF report – Red flag indicators

The financial action task force has issued multiple guidelines for the banks and other sectors to combat money laundering. In its recent trade based money laundering paper, FATF presented the list of red-flag indicators for the bank trade finance departments. Detecting these red flags, banks can deter TBML activities.

These red-flag indicators include:

• Significant disparities between the descriptions of the commodity on shipment bill and the invoice.
• A notable difference between the value of goods or commodity reported on invoices and the market value of the item. For example, exporting gold
• jewellery at $500/ounce when the market price is $950/ounce.
• The goods being shipped are not in line with the exporter’s or importer’s regular business activities. For instance, cloth manufacturer exporting gold jewellery is suspicious.
• Inconsistent shipment size according to the exporter’s or importer’s regular business scale and activities. For example, a small toy exporter shipping a consignment worth $50 million when the normal business turnover is $10 million only.
• The transaction involving cash payments or receipts from third-parties that have no direct link with the transactions. Such transactions usually involve the use of shell companies.
• The commodity is shipped through one or more jurisdictions or subsidiaries that are not connected without any valid economic reason.

It all comes down to Know your client

Analyzing various trade based money laundering schemes and the red-flag indicators issued by FATF, it all comes down to one major thing, i.e. Know your customer or know your client (KYC) to combat money laundering. An effective AML compliance program makes it obligatory for banks and financial institutions to cross-link the know your client data and regular business alerts.

In trade based money laundering, the involvement of shell companies is often witnessed. For banks and financial institutions, it is important to know the business (KYB) and ultimate business owners (UBOs) to detect shell companies and any other business entities having money laundering risks associated with them.