What is Trade-Based Money Laundering (TBML) and what is its relationship to organised crime?
Trade-based money laundering as a means of concealing illicit capital
Transnational crime is big business, worth as much as $2.2 trillion each year. These criminal networks need to disguise their illicit profits in order to benefit from the proceeds within the legitimate financial system. Trade-based money laundering (TBML), in its simplest form, refers to the movement and concealment of illicit monies using trade methods. However, the definition can extend to large scale fraud as well as the cross-border movement of illegal or controlled goods.
In recent years, many jurisdictions have introduced rigorous controls and regulations, and adopted novel technologies that make it more difficult and expensive to launder money through traditional financial systems. As criminals perpetually search for alternative means of ‘cleaning’ their money, international trade remains an enticing avenue for a number of reasons.
TBML is an attractive method to launder money
Firstly, the international trade has some of the most complicated regulations of any sector. International trade is governed by a range of overlapping bilateral agreements, multilateral agreements (between three or more nations) and prevailing international standards from bodies such as The World Trade Organisation (WTO), World Customs Organisation (WCO) International Civil Aviation Organisation (ICAO), International Chamber of Commerce (ICC). And increasingly over the years, we have observed a sharp increase in the implication of unilateral or multilateral trade embargoes, sanctions, and Export-Import controls on dual use goods, military items, protected wildlife, selected chemicals and precursors.
And in recent years the Financial Action Task Force (FATF), Bankers Association for Finance and Trade (BAFT), The Wolfsberg Group, the Bank of International Settlements (BIS) and an increasing number of national regulators have contributed to raising trade finance compliance standards.
Take as an example the WTO, which currently has over 160 members representing almost 99% of international trade. With major decisions being made by the membership as a whole, negotiations can be extremely difficult and complex. Sometimes the length of negotiation prevents agreements from materialising. As a result, international trade regulation has somewhat limited, patchy and complicated controls, leaving the sector exposed to a number of loopholes that criminals are all too willing to exploit.
Additionally, the value of global trade is immense, with millions of high-value transactions being carried out each day. The US Customs and Border Protection recorded that on a typical day in 2019, around 79,000 containers and $7.3 billion worth of goods entered the US through various ports. This volume of traded goods offers an opportunity for criminals to ‘hide in plain sight’ given that large transfers can easily blend in with legitimate trades. These issues are exacerbated by the paper-based nature of the international trade sector which makes it difficult to apply automation or other innovative solutions. As a result, organisations are often forced to take documentation at face value due to their limited ability to validate its authenticity.
What are some of the most common methods used in TBML?
Mispricing
Mispricing, otherwise known as under-invoicing or over-invoicing, is a common method used in TBML whereby goods are deliberately declared at an incorrect value. As a result, firms are able to transfer millions of dollars between one another while shipping goods that are worth next to nothing. This can often involve misrepresentation of quality to influence the pricing on the invoice.
Multiple-Invoicing
Multiple-Invoicing involves issuing duplicated invoices for the same shipment of goods, therefore inflating the value transfers through the finance system. Multiple-Invoicing can also be used in fraud schemes where inflated credit is generated and received for the collateral goods.
Over or under-shipment
TBML does not only refer to the transfer of funds - over or under-shipment is an instance where a seller either ships more goods than previously agreed with the importer, thereby transferring greater value to the importer, or the exporter ships fewer goods than agreed, transferring greater value to the exporter. Variations can also involve the quality of the goods declared which can likewise create value discrepancies.
Phantom Shipments
Some OCGs go a step further and invoice for shipments of goods that don’t take place or do not exist. Due to the aforementioned paper-based nature of the sector, OCGs are able to produce fraudulent documents and make it appear as though goods have been shipped, and if the process seems legitimate, money is exchanged.
What are some of the main challenges in identifying and preventing TBML?
Limited regulatory controls
It remains a challenge for financial institutions to monitor and implement controls in their trade finance businesses to efficiently combat TBML. A lack of clarity in compliance requirements and regulatory expectations persists in many jurisdictions. While standard setters such as The Financial Action Task Force (FATF) have provided significant guidance through best practices and sharing risk typologies, there still remain knowledge gaps in operationalising and implementing these requirements.
Singapore is a trading, transport and financial hub and is consequentially one of the more vulnerable jurisdictions to money laundering risks posed by trade finance. The Monetary Authority of Singapore (MAS) was one of the first regulators to introduce higher standards for financial institutions. From 2012 to 2015, MAS inspected banks’ trade finance activities. It subsequently released guidance detailing the observations made from the inspections and recommendations to identify TBML risks and consequent measures to mitigate associated threats. Ultimately, international trade being necessarily cross border will require consistent global standards, regulatory expectations and technical capabilities to address TBML risks in any meaningful way.
Information Asymmetry
There are often challenges in maintaining consistent, accurate and complete information between the physical trade-based world (i.e., the organisations that control physical shipping logistics) and the finance world (the financial system that finances a majority of these trades). Banks may be familiar with financial compliance standards such as sanctions screening, KYC and transaction monitoring, but these institutions may lack knowledge of how the physical trade world works. Some red flags that would be obvious to those familiar with physical trade may pass them by. Therefore, specialist knowledge is often required to determine whether the underlying physical trades are reasonable or feasible. A lack of cross-discipline expertise can cause disconnects between physical trade and trade finance that is being exploited by criminals.
What role can technology play in supporting the identification and prevention of TBML?
Technology has the potential to greatly enhance trade compliance, reducing TBML and disrupting criminal networks in the process. However, the first and most important step is to encourage the industry to transition away from paper-based document filing, much as we have seen the financial services sector do. Once this happens, automation and overlaying innovative technologies can be very quickly applied.
Pattern matching
Trade is extremely complex, and large complex problems often benefit the most from novel technologies. Artificial intelligence and machine learning software offer the capabilities to identify suspicious trades, much as they identify suspicious transaction behaviours within the financial services industry. Some technology providers are training their machine learning models on the relevant threat typologies and associated trade patterns, allowing the system to generate more accurate red flags and automatic alerts when inconsistencies arise. This has the potential to greatly reduce the challenges associated with information asymmetry as the trade-finance sector can rely on technology to evaluate the legitimacy of proposed trade transactions.
Supply chain transparency
For many firms, supply chain information is a highly proprietary ‘secret sauce’. Organisations may not be forthcoming with such information because they see it as a means of gaining a competitive edge. However, this must change if firms and individuals are to be certain of who they are trading with. Supply chain transparency requires companies to know what is happening upstream in the supply chain and communicate this information internally and externally. Supply chain transparency also provides greater overall resilience, as other issues such as third-party risk management, concentration risks, and disruption risks can be better managed as a whole.
Technology exists to automate this process by helping companies identify, assess and mitigate risk within their supply chains. Some focus on supply chain compliance or technology risk, others emphasise supplier’s financial health or ESG and crime track records. Ultimately, a shift to supply chain transparency through leveraging technology will serve to reduce TBML by identifying criminal networks and illicit actors more effectively, as well as improving supply chain efficiencies and reducing overall risks.
Perpetual KYC
At present, firms generate vendor and supplier profiles and conduct subsequent risk assessments at a particular point in time, and these do not necessarily evolve as the world does. Eventually, it will become imperative that organisations move toward a perpetual KYC (pKYC) model, in which periodic third-party reviews give way to event-driven and ongoing reviews.
pKYC is powered by technology and enables automation across all end-to-end periodic KYC review process steps. From a trade perspective, companies are bought and sold in supply chains frequently, some for legitimate reasons, and others for sinister ones (i.e., to use as a front/shell company to transfer illicit funds). Perpetual monitoring of companies and changes in behaviour and ownership will eventually unlock greater transparency of evolving risk. While we may be some distance away from this at present, the technology exists to facilitate the data gathering and analysis, and to move toward a more perpetual and effective model.
About the author:
BC Tan is the risk solutions director for Thomson Reuters in Asia Pacific and MENA. Prior to this appointment, he was the APAC head of Client & Third Party Risk and head of research for World-Check – a Thomson Reuters business. He designed a Trade Finance Compliance solution in 2016 to address MAS and prevailing global standards.
Tan is a specialist in transnational organised crime networks, anti-money laundering, counter-financing of terrorism, narcotics trafficking, political-criminal nexus and crime-terror nexus.
He speaks regularly at a variety of workshops and conferences on these topics for both the corporate and law enforcement/intelligence communities. He continues to contribute to several anti-money laundering and security-focused publications.
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