Since the Patriot Act was signed into US law in 2001, the financial regulatory environment has changed forever. Since then, massive new regulations have been added creating a complex web of compliance rules and recommendations.
What government regulators want is total transparency and reporting of financial transactions when they’re suspicious. Ultimately regulators hope to quash illicit financial operations and tax evasion. However, the world of industry and trade are complex. Their infrastructures is made up of multiple financial instruments and payment networks that facilitate a massive flow of capital. They’re also continuously growing in diversity and complexity and outpacing regulatory updates. Of all the channels through which money laundering takes place, the most difficult to detect is trade-based money laundering (TBML).
A 2016 survey by PwC estimates the size of global money laundering transactions annually between 2% to 5% of the global GDP, which adds up to an estimate of $1 to $2 trillion. Trade-based fraud makes one of the most powerful trends in money laundering and terrorist financing today. Financial criminals rely on the intricate web of trade processes and the complexity of multiple ownership layers to avoid detection. The transnational nature and complexity of financial trade transactions makes it even harder to identify and investigate TBML. All this offers criminals a good cover and ample time to launder massive amounts of money.
The bulk of TBML exploits the insufficient resources at the disposal of compliance officers, especially when it comes to logistics and commodities. This makes TBML a choice vehicle for laundering and commingling illicit wealth with legitimate capital. With banks financing 20% of global trade transactions and the volume of these transactions increasing, it’s becoming even more challenging for banks to mitigate risks.
Billions of dollars could be slapped on financial institutions that do not comply with standard AML compliance recommendations and procedures, even when indirectly involved in the scheme. Businesses also suffer from severe reputational damage when indicted and publicly exposed. According to Rob Wainwright, former Executive Director of Europol (Served from April 2009 to May 2018), trade-based money laundering is not only effective for commingling illicit proceeds, but also for transferring them to foreign markets.
How TBML works?
Usually money launderers apply different techniques and in some cases, this depends on the method used in trade finance, where a bank may finance a trade transaction using:
- Letters of credit: In this case, the bank will have full information about the transaction, including the parties to the contract, as well as the full set of documents exchanged among banks.
- Trade facilities/loans: In this case, the bank may not have full information and documentation.
- Another case is when only part of the wire transfer is related to the trade transaction.
How to detect TBML?
The known red flags that indicate a potential TBML, according to the U.S. Department of Homeland Security — Immigration and Customs Enforcement (ICE), are:
- Payments to a vendor by unrelated third parties.
- False reporting, such as commodity misclassification, commodity over- or under-valuation.
- Repeated importation and exportation of the same high-value commodity, known as carousel transactions.
- Trading commodities that do not match the business involved.
- Unusual shipping routes or transshipment points.
- Packaging inconsistent with the commodity or shipping method.
- Double invoicing.
How to fight TBML?
If we go back to AML/CTF and KYC principles, we realize that customer due diligence is a crucial part when dealing with any new or pre-existing customer.
Customer due diligence (CDD) has to be at the onboarding stage and resume on an-on-going basis. Many banks are following de-risking strategies, which exclude many risky business jurisdictions from their services.
The first step to mitigate TBML risks is to obtain all the necessary customer and financial information, and to be able to verify it. Naturally, a proper effective KYC program does this step as it detects any suspicious and unusual trade finance or any other transaction. The fight also entails fully understanding the scenarios and methods money launderers use or have in the case of trade related transactions.