TBML was defined by the FATF in 2006 as ‘the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimize their illicit origins.’ TBML and terrorist financing (TBML/FT) refer to the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illegal origin or finance their activities.”
The crime involves a number of schemes in order to complicate the documentation of legitimate trade transactions; such actions may include moving illicit goods, falsifying documents, misrepresenting financial transactions, and under- or over-invoicing the value of goods. The primary role of banks in international trade is to provide financing, risk mitigation and settlement of payment for cross-border transactions. A number of international entities and National regulators including the Financial Action Task Force (FATF), the UK Financial Conduct Authority (FCA) and the Wolfsberg Group have all drawn attention to the misuse of Trade Finance as one of the ways that criminal organizations and terrorist financiers move money to disguise its origins and integrate it into the legitimate economy.
Key characteristics of Global trade that makes it more vulnerable for Money Laundering
- Cross border transactions provide opportunities to take advantage of differences in legal systems of various jurisdictions.
- TBML necessarily requires intermingling of the trade sector with the finance sector. Criminals take advantage of vulnerabilities of both the sectors. Merely having an AML regime for the finance sector becomes inadequate unless such a regime effectively covers the corresponding trade sector.
- International trade is denominated in terms of internationally acceptable currencies. Trade becomes exposed to the vulnerabilities of the foreign exchange market.
- The long supply chain necessary for international trade make the trade more vulnerable to TBML. This chain of manufacturer, trader, consigner, consignee, notifying party, financier shipper, insurer and freight forwarder broaden the scope for abuse of the system by the criminals because of all the vulnerabilities that exist.
The dilemma for regulators and policy makers
The dilemma which is faced by policy makers is the requirement to balance the needs of a free, fair and predictable trade regime with the needs for regulation of trade so as to prevent its abuse. For context, the WTO Statistical Review of 2020 stated that the volume of the global trade in world merchandise (i.e. goods) trade stood at USD 19.05 trillion while the value of global trade for commercial services stood at USD 5.898 trillion, which indicates the potential for absorption and movement of funds of criminal origin through international trade and the need to study TBML.
To further understand scope and red flag indicators of TBML, we need to differentiate between – trade that is bank intermediated and trade that is not bank intermediated.
Various types of trade and nontrade transactions that banks undertake are as under along with set of rules and framework governing them:
- Documentary trade governed by ICC rules
- Open accounts bank intermediated transactions – Governed by Deal specific and Lender Specific Policy .
- Non bank Intermediated transactions – Governed broadly by Country Exchange Regulations.
Trade can be intermediated through various modes such as open account settlement , collection documents, trade credit products, letter of credit & advance payment .Bank intermediated trade means the trade wherein bank is having an access to underlying trade documents and is in a position to ask for further documents if required under its regular due diligence. In instances where trade is bank-intermediated, the bank may provide financing and/or risk mitigation. Financing occurs in a variety of forms including transaction types such as documentary (e.g., letters of credit, collections, guarantees) and non-documentary (e.g., trade loans, receivables/payables financing). In documentary transactions, the bank handles or processes documentation such as bills of lading, invoices, packing lists, etc.
In non-documentary transactions, the bank may have access to only a portion of documentation based on the structure of the transaction and policy of the institution. For example, pre-shipment financing occurs before shipping documents and invoices are produced.
For non-bank intermediated transactions, the bank only handles the transfer of funds without seeing any underlying documents that identify the payment as being trade related.- Processing a wire transfer to settle an open account transaction.
In 2017, Wolfsberg estimated that approximately 80% of global trade was transacted using open account settlement. Banks receive underlying documentation for the approximate 20% of global trade out of which a portion is s documentary trade and a portion of non-documentary bank-intermediated trade. This adds to the dilemma of bankers on how to detect a potential TBML activity if the same is being undertaken through Open Account Settlement.
Given the above differentiation of bank intermediated and non-intermediated transactions and the lesser scope of banks to handle underlying documents in 80% of trade transactions, it is generally perceived that bank won’t be able to see any red flag indicators
However, Bankers Association for Finance and Trade (BAFT) in its guidance note for the year 2017 has mapped different red flag indicators to payments transactions, Open account Trade Payments & Documentary Trade Payments as under:
Learning from the Paradox:
More than US$3.07 quadrillion in payments are made annually. By comparison, World Trade Organization (WTO) estimates roughly $16 trillion of trade transactions occur each year. Accordingly, approximately 0.52% of the value of all payments represent trade settlement. Given that at least 80% of trade is open account, only about 0.1% of the value of payments made reflect settlement of documentary trade. All of the AML monitoring and controls put in place in a bank’s trade services department are there to identify and intercept roughly 0.1% (or less) of illicit funds flow.
“To truly make a difference in mitigating TBML, we must look beyond documentary trade, and beyond banks.”
Major Typologies of Trade Based Money Laundering
Asia Pacific Group has grouped the typologies of TBML such as over or under invoicing, phantom shipping, short shipping, multiple invoicing etc into four broad categories based on reporting of various cases by various countries . The broad categories reveal the identified pattern in which majority of TBML activity has been detected so far.
- Jurisdiction :
- The commodity is shipped to or from a jurisdiction designated as ‘high risk’for MLactivities or sensitive / non-co-operative jurisdictions.
- The commodity is transhippedthrough one or more such high risk / sensitivejurisdictions for no apparent economic reason.
- Presence of Free Trade Zones / Special Economic Zonesalso affects the sensitiveness of a jurisdiction as far as TBML is concerned.
FTZs are also emerging as being especially vulnerable to TBML. FATF (2010: 4) defines FTZs as ‘designated areas within countries that offer a free trade environment with a minimum level of regulation’. In the said report, FATF noted that most zone authorities operate separate company formation services from those that exist in the rest of the jurisdiction and market the ease of setting up a legal entity in an FTZ to attract business.. As a result, it is simpler for legal entities to set up the firms/companies in FTZs and hide the name(s) of the true beneficial owners. This lack of transparency has allowed companies located in FTZs to create layers of transactions that are difficult (if not impossible) for law enforcement agencies to follow (FATF 2010). It also reported that ‘goods introduced in a FTZ’ are generally not subject to the usual customs controls, with goods undergoing ‘various economic operations, such as transshipment, assembly, manufacturing, processing, warehousing’.
FinCEN has identified TBML red flags that are specific to FTZs. In its 2010 report, FinCEN (2010: 4) signaled that a number of red flags seen in conjunction with shipments of high dollar merchandise (such as electronics, auto parts and precious metals and gems) to duty free trade zones could be an indication of a trade-based money laundering activity.
These include :
- Third-party payments for goods or services made by an intermediary (either an individual or an entity) apparently unrelated to the seller or purchaser of goods. This may be done to obscure the true origin of the funds;
- Amended letters of credit without reasonable justification;
- A customer’s inability to produce appropriate documentation (ie invoices) to support a requested transaction;
- Significant discrepancies between the descriptions of the goods on the transport document (ie bill of lading), the invoice, or other documents (i.e. certificate of origin, packing list etc) (FinCEN 2010).
- d) Circuitous route of shipment and/or circuitous route of financial transaction or Orderor the goods is placed by firms or individuals from foreign countries other than thejurisdiction of the stated end-user.
- e) Transaction involves shipment of goods inconsistent with normal geographic tradepatterns of the jurisdiction.
2. Goods Involved :
Most of the jurisdictions have responded to state that no definite pattern of goods involved in TBML is identifiable. This is probably due to the vulnerability of almost all trade transactions for TBML, however , Global trade in services provide greater opportunities for ML than trade in merchandise because fraud particularly in regard to valuation of services is more difficult to detect and prove.Some goods are found to be more vulnerable to be used in TBML activity such as consumer goods, textiles, garments, engineering goods, electronics goods, illicit tobacco products, leather goods, luxury cars, precious metals, counterfeit products, diamonds, metal scraps.
- Where significant discrepancies appear between the description, quality and quantity of the goods on the documents such as bills of lading, invoices etc and the actual goods shipped. The misrepresentation may also be in relation to or type / grade of goods. For example, a relatively inexpensive good is supplied but it is invoiced as being more expensive, of different quality or even as an entirely different item so the documentation does not accurately record what is actually supplied.
- Significant discrepancies appear between the valueof the commodity reported on the Invoice and the commodity’s fair market value. This is done either in conjunction with mis-declaration of the description / quality / grade of goods or without it. This is also often associated with mis-declaration of the jurisdiction of origin .
- Consignment size or type of commodity being shipped appears inconsistent with the scale or capacity of the exporter or importer having regard to their regular business activitiesor the shipment does not make economic sense i.e. there is no reasonable explanation for the client’s financial investment into the shipment.
3. Pattern of corporate structures
To adduce information about the types of corporate structures i.e. Companies, Partnership
Firms, Proprietorship, Offshore Companies etc. used by criminal syndicates in TBML Bogus
registered companies (behave like true consignor / consignees of goods) and offshore companies located in tax havens have been reported as corporate structure misused by criminal syndicates. The use of offshore companies is also associated with complex schemes and methodologies utilized by established criminal enterprises. Red flags with regard to corporate structures are as under:
- The transaction involves the use of front or shell companies. Both shell and front companies can be used to facilitate TBML but in different ways. As FATF (2010: 20) explained TBML and other ML schemes rely on the ability of the perpetrator of the crime to distance themselves from the illicit proceeds. Shell companies enable illicit actors to create a network of legal entities around the world. By contrast, a front company has real business whose legitimate operations are used as a cover for ML and other criminal activity. In many ways, front companies present a much more significant TBML threat than shell companies.
- Numerous sole proprietorship businesses/private limited companiesset up by seemingly unrelated people (proxies) are found to be controlled by the same group of people. For the setting up of such businesses false addresses are registered.
- Trade transaction reveals links between representatives of companies exchanging goods i.e. same owners or management. TBML requires collusion between traders at both ends of the import/export chain. Related party transactions, including transfer pricing, rely on mutual agreements between the parties, rather than free market forces. As the FATF (2006: 5) pointed out, over or under-invoicing of goods and services requires collusion between the exporter and importer. Although there is a higher risk of related party transactions being used for fraud and for TBML, dealings between related parties are not necessarily illegal.
- Transfer pricing is a related party transaction that is commonly used by transnational corporation as part of their financial and tax planning strategy. Similar strategies are also employed in relation to import duties and value added tax. FATF (2006: 3) made it clear though that in the case of transfer pricing, the reference to over- and under-invoicing relates to the legitimate allocation of income between related parties, rather than customs fraud. However, possibility of TBML originating in transfer pricing cannot be ruled-out.
4. Predicate offences of TBML
A predicate offence is a crime that is a component of a more serious crime. For example, producing unlawful funds is the primary offence and money laundering is the predicate offence. The term “predicate offence” is usually used to describe money laundering or terrorist financing activities.
15% of the jurisdictions have reported that tax evasion is the predominant predicate offencein TBML cases whereas 10% of the jurisdictions have reported customs offences as themain predicate offence. Other responses indicate that predicate offences are often related tocommercial fraud, IPR, Narcotics, human trafficking, terrorist financing, embezzlement,corruption, organized crime (racketeering), dealing in banned goods, conducting illegalbusiness, speculation etc. One Reporting jurisdiction indicated that ML is considered to bean autonomous offence and there is no need to prove the existence or nature of the predicateoffence in order to prosecute hence as a consequence, there is no systemic link between MLcases and other crimes.
- Common steps taken by many countries include:-
- Data Mining of existing customers
- Site visits to high transacting customers
- Cross border wire transfer remittances – Analysis such as [ Many to one, One to Many, top Remitters, top Beneficiaries]
- Effective coordination of all financial crime compliance functions within the country – Cyber security, tax department, customs.
- Artificial Intelligence enabling the bank’s systems to simulate intelligent behaviour and make well informed decisions with little or no human intervention
- Example of USA – TRADE TRANSPARENCY UNITS
“In 2004, US (HSI) initiated TTU to dismantle Transnational Criminal Organisations (TCOs) . TTU partners with customs and financial agencies around the world to detect trade discrepancies and violations. TTU focused on sharing of information by sharing IE declaration of US with counterpart IE declaration value thereby enhancing level of transparency.”
- Adopting a Risk Based Approach as per Wolfsberg Guidance and creating well equipped and evolving three lines of defence as under:
First line of defense Front office staff
Front Office Staff should have good knowledge of their customers, including, but not limited to, the customer’s business, its trading profile across different geographies, sources of raw materials, manufacturing locations, location of their suppliers and customers, and where appropriate, identify key suppliers and customers, in order to assess the TBML risks posed by these customers and their transactions.
Second line of defense: The Compliance team at Controlling officers
The compliance team should have trade finance expertise to review, assess and provide feedback on the TBML red flags identified by the front office and trade processing teams. The Compliance team should perform assurance testing on a regular basis to ensure timely identification of ineffective TBML controls. Information on trade transactions or TBML related escalations, controls weaknesses and remedial action plans, together with other issues noted by Compliance should be regularly reported to senior management for effective oversight.
Third line of defense – Internal Audit
As the third and last line of defense, internal audit, should conduct a holistic assessment of the Bank’s framework to combat TBML, including the assessment of adequacy of policies and procedures and effectiveness of testing of relevant controls. Internal audit should design a TBML focused test plan and ensure that the staff performing the testing have requisite trade finance and AML/CFT skill.
The key finding to above dissection of TBML remain as greater awareness about all aspects of the trade process, including how different financing processes are managed, would likely increase opportunities to detect and successfully disrupt Trade Based Money Laundering. At the same time a risk-based approach support by strong system based checks is required so that a balance between a need to encourage legitimate trade and regulate the illegitimate trade is achieved. Employee training is must as in all the three defenses of TBML, people play a key role and better updated and equipped they are would go a long way in adding to robust Anti TBML regime.