Trade-based Money Laundering: Avoiding Murky Waters

HSBC Singapore’s Jamil Ahmed calls for continued vigilance, the use of technology, and participation in public-private partnerships to mitigate trade-based money laundering risks.

Trade and the exchange of – not just objects but ideas, philosophies, religions and ideologies – have captivated people since Marco Polo first chronicled his explorations in the Orient back in the thirteenth century. Fast forward to today – global trade is the bedrock of international commerce, and its curtailment in the current pandemic has wreaked havoc on global economies.

What globalisation and the distribution of supply chains across lower cost economies have collectively contributed to economic growth, by way of job creation, the removal of trade barriers in developing nations and lower consumer prices, is now compromised with travel restrictions in place all over the globe. While most of us will agree that the role of global trade and its outcomes are largely positive, there is a murkier side to it – namely, the use of trade to transfer the proceeds of crime whilst concealing their illicit origins, otherwise known as trade-based money laundering (TBML).

The Financial Action Task Force (FATF), an inter-governmental organisation that designs and promotes standards to combat financial crime, recognises the misuse of trade as a primary mode for criminal organisations to launder illicit funds. Given the high volumes of global trade, underlying trade complexities and the technical skill sets required, TBML is often said to be a challenging area to detect and investigate.

Trade finance instruments have a long history. Existing trade finance instruments such as the ‘letter of credit’ can trace their origins back to the ancient Egyptians and Babylonians. Today, trade finance transactions remain largely reliant upon paper-based documents, many of which – such as the ‘Bill of Lading’ – were first introduced in Marco Polo’s era; and their uses and forms haven’t evolved significantly since. It is precisely this feature of trade financing that bad actors, often in collusion with others, exploit, by manipulating paper-based trade documentation to facilitate TBML by over/under invoicing and phantom shipments, or to defraud banks.

TBML risks are clearly more pronounced in jurisdictions with a heavy economic focus on trade and shipping. In 2018, Singapore’s port processed over 36 million containers or Twenty-Foot-Equivalent Units (TUEs); ranking second globally behind only Shanghai. Singapore is also one of the largest trans-shipment hubs in the world. The sheer volume of trade flow underlines the challenges faced by customs and port authorities to meaningfully inspect cargo against trade documents to identify TBML or smuggling activities.

Authorities must therefore be able to target cargo, so as to find and interdict the illicit shipments. In addition to foreign intelligence and other risk indicators, this targeting would necessarily benefit from material red flags in the financing or payment for the trade. Hence, there are expectations placed on financial institutions to flag and report those suspicion, where they exist and can be reasonably detected through controls.

Financial institutions that process trade transactions are mandated by their regulators to implement effective controls to prevent and detect suspicious activity and report these concerns to law enforcement. However, trade financing controls are often reliant upon manual in-flight red flag processing checks to identify anomalies in trade documents and raise concerns for further investigation. The manual nature of the red flag detection process depends on the skill and judgment of the trade finance processor to detect and raise these for further investigation.

How effectively these processes are in detecting red flags can ultimately be determined by the quality assurance, recruitment and training processes deployed within individual financial institutions. These factors, coupled with the relatively rapid in-flight reviews of individual transactions, often in isolation, are leading certain banks to question how successful the red flag process is or could ever be at detecting complex money laundering activity.

Whilst traditional trade finance transactions do provide transactional information which banks scrutinise, screen and review to identify nefarious activity, the bigger picture is that trade financing represents a dwindling proportion of global trade transactions. It is estimated that over 80% of international trade is conducted through ‘open account’ terms, a proportion that is expected to grow, given the costs associated with securing trade financing.

In an ‘open account’ transaction, the buyer and seller negotiate the credit terms of the transaction directly, without a financial institution acting as an intermediary or providing a trade finance solution such as a ‘letter of credit’. In an ‘open account’ transaction, a financial institution’s role is limited to processing a payment, which is often accomplished without manual intervention, via ‘straight-through-processing’ channels similar to other wire transfers. With no underlying trade finance service or product utilised, no underlying trade documents are submitted to banks for processing and hence, no red flag checks are conducted.

The deployment of distributed ledger technology involving all trade participants holds significant promise to improve transparency, strengthen risk management and introduce processing efficiencies in the trade financing world. Whilst there may be underlying complexities in designing and integrating platforms to encompass multiple trade participants, the benefits of adopting blockchain technology with its inherent consensus and immutability properties will be high, provided the right control mechanisms are effectively deployed. Furthermore, the digitisation of trade can ultimately give rise to better monitoring tools that utilise multiple data sources covering transportation, customer, transaction and goods/commodity reference price data to improve the detection of suspicious activity.

Tentative steps towards this paradigm shift have already commenced and are being explored in multiple markets including Singapore. HSBC, as a major bank founded more than 150 years ago to finance trade between Europe and Asia, has been an early backer of the use of blockchain technology in trade finance and is participating in multiple consortia to develop and promote the use of the technology.

In late 2018, HSBC completed Singapore’s first fully digitised end-to-end ‘letter of credit’ transaction and in 2019, the first ‘letter of credit’ transaction in Chinese Yuan denomination was completed. Moreover, HSBC is increasingly turning to intelligence-led and contextual monitoring systems, which look at holistic customer activity, including the payment elements of trade transactions, to address the challenges of in-flight red flag checking processes. These systems also consider key elements such as the relationship between the two parties or social links in the trade transactions, as collusion is a necessary element of a successful TBML scheme. However, there is more to do.

Whilst technology is a promising avenue, much can be accomplished through continued focus, sharing of best practice and adapting standards. TBML remains a key area of focus for regulators in many jurisdictions, and Singapore is no exception. In 2020, the Monetary Authority of Singapore (MAS) launched a series of thematic reviews across the banking industry, with a specific focus on processes and controls to mitigate TBML risks.

Upon the completion of these reviews, a best practice guidance paper is expected to be published, against which banks will be able to assess their control environment. However, the thematic review isn’t the first effort by MAS to promote good practices for mitigating TBML risks. In 2015, a similar review was completed with a guidance paper issued and in 2018, Singapore’s AML/CFT Industry Partnership (ACIP), co-chaired by CAD and MAS, also came together to publish a best practices paper on TBML controls.

It may be too early to tell to what degree emerging protectionist forces and the impacts from the COVID-19 crisis will impact the reshoring of supply chains and, consequently, trade flows over the coming years. However, one thing I am certain of is that trade will remain susceptible to illicit actors wanting to launder their ill-gotten gains. To avoid murky waters, financial institutions need to remain vigilant to these risks, explore the adoption of technological solutions to improve risk management and increasingly work with regulators in public-private partnerships to mitigate TBML risks.

Jamil Ahmed is Chief Compliance Officer at HSBC Singapore, and a member of various industry taskforces and initiatives across Singapore focusing on AML/CTF, sanctions and fraud.

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