The UAE is facing growing international pressure over its attitude towards illicit financial activity. As details emerge of the trade-based money laundering risks at the heart of Dubai’s gold souks and free trade zones, banks must make difficult decisions over their appetite for risk. John Basquill reports.


April 2020 was a landmark month for the UAE’s approach to financial crime. Following an extensive on-site evaluation, the Financial Action Task Force (FATF) – a highly influential standards-setting body – issued a detailed report accusing authorities of lacklustre efforts in tackling money laundering and “minimal” implementation of international sanctions.

The task force said the country’s dependency on gold, diamond and oil trading, its proximity to conflict zones, and its network of financial and commercial free zones continue to make it an attractive destination for criminal cash.

Despite that, authorities’ effectiveness in investigating and prosecuting money laundering, penalising firms for facilitating financial crime and co-operating with counterparties in other countries were all marked as “low” – the FATF’s lowest score.

“As a major global financial centre and trading hub, it must take urgent action to effectively stop the criminal financial flows that it attracts,” the report said. Financial institutions involved in trade with the UAE were warned they face “significant” risks.

Ultimately, failure to rectify the failings identified could lead to the UAE being added to the task force’s list of high-risk jurisdictions, leaving companies with a choice between exiting the country or facing significant due diligence costs.

However, for banks that facilitate trade with the UAE – and particularly within Dubai’s gold market – there are other, more immediate risks. At a time when many financial institutions are already questioning their role in trade and commodity finance, those risks may prove greater than the rewards.


Dubai’s gold souks

The UAE is a relative newcomer to the world of gold trading. Though now one of the world’s four largest importers of gold, a recent paper by illicit trade experts Shawn Blore and Marcena Hunter points out that as recently as 1996 the country was not even among the top hundred.

The paper says that status has been achieved thanks to being “savvy enough to pursue previously untapped markets and ambitious enough to frequently cut corners to bring gold to the market”. That means much of the gold traded through the souks in Dubai – which accounts for 80% of the UAE’s gold imports and exports – is of potentially questionable origin.

“What is most problematic about the UAE’s strategy is where it gets its gold,” the paper says. “Other major gold hubs source the bulk of their gold from relatively few countries, typically either other gold hubs or other major gold-producing nations.

“By contrast, in 2016, the UAE imported gold from more than one hundred countries, mainly located in Africa, South America, or South Asia.”

Importantly, those jurisdictions tend to be more active in artisanal and small-scale gold mining (ASGM) than in traditional large-scale production. Though an important source of income for rural communities in gold-producing countries, there is a history of ASGM being exploited by authorities or armed groups in some regions – in certain cases to support human rights violations.

As a result, most gold trading hubs put in place strict rules aimed at ensuring gold does not originate from a conflict-affected or high-risk region.

Writing in an extensive study on Dubai’s involvement in illicit financial flows, published in July by foreign policy think tank the Carnegie Endowment for International Peace (CEIP), Blore and Hunter point out the situation in Dubai is very different.

“Dealers buying gold to sell in the souk require only a single document – a UAE customs form – that proves the gold was legally declared to customs officials upon arrival at an Emirati airport,” the paper says. “The form does not require information about the gold’s origin. These dealers therefore accept gold originating from any country, regardless of the production circumstances, no questions asked.”

Blore and Hunter say that analysis of 2016 data suggests that at least 46% of the UAE’s gold supply came from countries that would be red-flagged under OECD rules if their country of origin had been recorded by officials.

Instead, only transit countries are listed, so gold originating in the Democratic Republic of Congo (DRC) or South Sudan, for example, can be trafficked through ‘safe’ jurisdictions and therefore considered legitimate from a regulatory point of view.

Precise details of Dubai’s illicit gold are scarce, but there is a growing body of research devoted to the subject. For example, a July report produced by anti-corruption organisation Global Witness details the supply of gold from mines in Sudan to Kaloti, a UAE-headquartered network of entities involved in gold trading and refining.

Though Kaloti denies it has purchased conflict minerals, and is not accused of knowingly and directly doing so, the report estimates that in 2012 around 22 tonnes of gold the company imported from Sudan was connected to armed groups.

Despite reprimands from authorities – including a confidential 2015 document sourced by Global Witness in which Dubai’s Multi Commodities Centre accuses Kaloti of trading with a government-owned refinery in Sudan subject to US sanctions – the company has been permitted to continue registering new refineries and other associated organisations.

Kaloti “appears to face little pressure to introduce more responsible procedures” from the UAE government or regional trading bodies, the report concludes.

Beyond Kaloti, the report also examines the ease with which gold can be traded in Dubai’s souks with little or no attention to its origin, citing conversations between undercover Global Witness investigators and market traders.

“Several gold trading companies located inside the souk were willing to buy hand-carried gold with no questions regarding links to conflict finance and human rights abuses asked – including gold imported from countries where there are well-documented risks of links to conflict finance or human rights abuses, such as the DRC, Sudan and Uganda,” it says.

“One company even explicitly said that it did not care if the gold was smuggled, though it would pay a lower price in that case.”


Financing conflict gold

For financial institutions involved in supporting UAE-based gold trade transactions, potential exposure to conflict minerals can carry several risks, says Jodi Vittori, a non-resident scholar at CEIP and a former Global Witness policy advisor.

“The US and other countries are increasingly cracking down on conflict gold and illicit gold, as are industries themselves,” Vittori tells GTR. “Beyond the UAE, countries are caring more and more about gold, and major technology companies are improving tracking of their mineral chains to minimise exposure to conflict gold. All of that could cause issues.”

A further concern is that there appear to be ties between the trading of conflict minerals and efforts to carry out trade-based money laundering – where illicit funds are integrated into the formal financial system by exploiting trade transactions, for instance by over or under-invoicing cargo.

Vittori explains that proceeds of illicit gold sales can be laundered without leaving Dubai. “You can take those proceeds, go down to various markets, purchase goods there and have them shipped back,” she says.

“That’s really where you make your money, and if you can link it with trade misinvoicing and so forth, you can make even more money out of that.”

The issue is complicated further by the use of hawala systems, which function as informal money transfer networks to facilitate the flow of value outside the formal banking system. The Global Witness report says such systems are used “extensively” by gold traders “for the purposes of trade-based money laundering”.

The risk to banks is that ultimately, those funds will re-enter the financial system with little indication that they are connected to criminal activity.

One of the most obvious direct risks to financial institutions found to have facilitated trade-based money laundering schemes is enforcement action by regulatory authorities.

Within the UAE, that prospect appears relatively unlikely. Lakshmi Kumar, policy director at Global Financial Integrity – a non-profit research organisation that advises governments on illicit fund flows – points out that in Dubai’s case, board members of the Financial Services Authority are directly appointed by the emirate’s ruling Al Maktoum family.

“This control is highly problematic, given that a well-documented risk to good governance is regulatory capture by state or private interests,” Kumar writes in the CEIP study. “When state leaders control the regulatory apparatus, this raises the risk of their being complicit in illicit financial activities and reduces the regulator’s capacity to carry out its functions without state approval.”

However, as CEIP’s Vittori points out, banks “are still linked into the international financial system, with everything that goes along with that”.

“Depending on who you move funds through and what denomination of currency you use, there are enforcement risks even if the UAE chooses not to intervene,” she says.

In cases of sanctions evasion or terrorist financing, for example, US authorities have shown significant appetite for extraterritorial intervention. In the case of UAE-based companies, American sanctions regulators imposed restrictions in June on three local entities accused of facilitating trade with an Iranian state-owned steel producer.

Even if enforcement action is not taken, trade finance banks can suffer reputational damage if they are named in connection with legally or ethically questionable transactions. Legal experts have previously warned this could have knock-on effects if other institutions become wary, affecting banks’ ability to syndicate, for example.


Risk versus reward

There are growing signs that authorities in the UAE are responding to international pressure over illicit finance risks, not least following the FATF evaluation.

In September 2020, the central bank introduced Fawri Tick, a digital tool that aggregates information about anti-money laundering and counter-terrorist financing cases from across the country’s various regulatory authorities. The same month, providers of hawala services were required to register with the central bank for the first time.

In a statement issued after a regional meeting of monetary authorities, central bank governor Abdulhamid Alahmadi vowed to ensure the country “shall continue to adhere to FATF standards in order to ensure the UAE’s financial system is sound and inclusive”.

However, for Global Financial Integrity’s Kumar, there has so far been little sign of action when it comes to trade finance. Part of that is because of the elaborate network of financial and trade free zones that make up the UAE’s regulatory landscape.

There are around 30 known free zones in Dubai alone, which account for nearly half of its total trade, generating a combined total of £118bn in 2017. The majority of trade volume and value goes through the Jebel Ali Free Zone, generating nearly a quarter of Dubai’s GDP.

Most free zones are trade-focused, though the UAE also boasts two financial free zones: the Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market.

The Dubai Financial Services Authority issued guidance related to trade-based money laundering in 2016, specifically targeted at the trade finance sector. The regulator said it had identified “several areas of potential improvement” that firms should take into consideration, including around governance, risk assessment, customer onboarding and ongoing due diligence.

But as Kumar notes, those guidelines apply only to the DIFC, and so do not cover the underlying trade transactions in question.

“This regulatory move is puzzling because the DIFC is a financial free zone, which is different from a free trade zone,” she says. “So unless trade transactions within Dubai’s free trade zones are routed through financial institutions in the DIFC, it is unclear what impact these guidelines would have on trade-based money laundering.”

Kumar tells GTR that ultimately, financial institutions are left with a decision between the perceived risks associated with supporting trade in Dubai, and the potential revenues.

“Financial institutions constantly evaluate and re-evaluate their risk factors, and we have heard that a lot of banks are already exiting commodity markets and trade finance in general, because of what they perceive to be risks,” she says.

“Financial institutions are looking at the whole portfolio of services they offer, the risks and the profitability, and whether their margins are large enough to keep that service running or to cut it off – and if compliance costs are going up, it might not be worth making that investment.”