The amount of illicit money laundered through the international trade system is estimated to total hundreds of billions or even trillions of dollars per year. As financial crime authorities increase scrutiny over both open account and documentary trade, John Basquill examines the scale of the problem facing the trade finance industry – and the technology that could help.
In April, three individuals pleaded guilty to money laundering charges in a US district court. A four-year investigation spanning the US, China, Mexico and several other countries found the trio were part of a wider conspiracy to launder millions of dollars connected to drug sales across the US.
Two of the men – Hong Kong resident Tao Liu and New York-based Jiayu Chen – were involved in selling and distributing drugs directly. Chen, a carrier for the US Postal Service, would distribute cash and deliver cocaine, while Tao was caught attempting to purchase fake US passports from state department officials who were later revealed to be undercover federal agents.
The third man, Jingyuan Li, had a more mundane role. Li, born in China but residing mainly in California and Mexico, used a seafood import and export business known as Shuoyu USA Inc to disguise the criminal origins of the cash raised through the group’s drug sales.
Officials were able to link at least US$3.8mn of Shuoyo-related business to laundered drug money, with Li using the company to purchase goods that he then shipped to China and Hong Kong for on-sale, the Department of Justice says.
Charges against the group unsealed in October last year describe the trade-related process in greater detail. Cocaine sold in the US is generally produced in Latin America, and so a portion of the proceeds are typically repatriated to the organisations involved in that process, the indictment explains.
At the same time, there is significant demand for US dollars and merchandise in China, as well as for Chinese currency in Latin America among retailers looking to import goods to sell for profit.
Organised criminal groups are increasingly turning those market dynamics to their advantage, using otherwise legitimate trade activity as a means of concealing illicit funds. In this case, the indictment says illicit cash would be used to purchase US goods, which would then be shipped to China and sold on.
Once the proceeds are collected in China, another trade takes place. Latin American companies import Chinese goods – with the help of brokers who can obtain renminbi to facilitate the purchase – and sell them on. Shuoyo, Li’s seafood business, had a role in generating currency to facilitate these transactions, it says.
Cocaine traffickers are eventually able to recover clean cash from those final sales, while the various entities involved in arranging the transactions are “compensated on the basis of their success”, the indictment says.
Several European, American and Chinese banks are named by the Department of Justice as having provided account services for the individuals involved, though none are accused of any wrongdoing.
However, the case highlights a growing concern from regulators and standards-setters around the use of trade-based money laundering (TBML) schemes, and the difficulty banks have – whether providing finance or handling payments – in detecting illicit activity couched within seemingly legitimate trade transactions.
And the issue is not limited to narcotics production. US State Department officials have warned that underground gold trading can provide criminal groups with higher and easier returns than cocaine trafficking, while the illegal wildlife trade has emerged as one of the most lucrative criminal activities worldwide.
A report produced in February last year by the US Government Accountability Office (GAO), an independent congressional watchdog, warned that the amount of illicit money being laundered through international trade was believed to be “large and growing”.
After 2013, it said, a general tightening of anti-money laundering regulations led to a move away from cash on the part of criminal groups, demonstrated by a consistent decrease in bulk cash seizures by law enforcement agencies.
Instead, the watchdog says TBML has emerged as “one of the primary means that criminal organisations use to launder illicit proceeds”, with the most common method believed to be under or over-invoicing shipments of goods.
The scale of the problem is difficult to estimate, but think tank Global Financial Integrity (GFI) suggests overall transnational crime could be worth US$2.2tn per year – much of which is facilitated by TBML.
These concerns have prompted a flurry of activity from authorities around the world, as efforts increase to stem the flow of dirty money through the global trade system.
In the US, the Drug Enforcement Agency has had budgets and head counts boosted in order to facilitate greater numbers of undercover operations “focused on the most egregious trade-based money laundering cases”.
Globally, the Financial Action Task Force (FATF), an influential standards-setting body for anti-money laundering and counter-terrorist financing, published a major report on the issue in December last year, produced jointly with the Egmont Group of financial intelligence units.
The report echoed concerns from the GAO around open account transactions, used in around four-fifths of international trade. Money laundering schemes “frequently involve this method because [banks] have a reduced role, meaning less oversight than for the documentary collection process”, it said.
But unlike the GAO report, the task force says documentary trade – such as transactions supported by letters of credit – are also vulnerable to exploitation.
“Despite a perceived increase in role for financial institutions, it is limited as they do not necessarily verify the documents,” the FATF report says. “In addition, documents are not always standardised, increasing the risk of TBML exploitation through fictitious or false invoicing.”
The task force then followed up that research with specific guidance for the financial sector. Published in March, the guidance urges lenders to identify complex corporate structures or trade flows, circular payment arrangements and inconsistencies in documentation as potential TBML red flags.
Specifically for trade finance, it warns of traders making “unconventional or overly complex use of financial products [such as] use of letters of credit for unusually long or frequently extended periods without any apparent reason, intermingling of different types of trade finance products for different segments of trade transactions”.
Late changes to payment arrangements, use of transit or “pay-through” accounts, and payments “routed in a circle” back to the country of origin are also cited as potential red flags.
Additional warnings over TBML have been published by the European Banking Authority – the EU’s top financial crime regulator – as well as Germany’s banking regulator BaFin and the UK’s Financial Conduct Authority.
Yet technology firm R3, which developed the Corda blockchain platform, says in a March paper that among regulated institutions, transaction screening and monitoring tools have generally proven “inconsistent and limited”.
Banks’ compliance teams encounter vast numbers of false positives and have to rely on paper-based, manual processes to sift out and report any truly suspicious activity, it says.
“Banks urgently need to find solutions and take additional measures to establish whether unexpected flows are legitimate – or they risk paying for it later,” R3 says.
Documentary trade finance and digitisation
Over and under-invoicing is generally understood to be the main way documentary trade finance is exploited as a means of moving illicit funds.
Research by GFI has found an annual gap of at least US$800bn between countries’ total stated exports and the equivalent stated imports on the other side of those transactions.
Though data can be patchy, the think tank says it believes trade misinvoicing is being used to facilitate a range of crimes, including tax evasion, capital flight and payments linked to corruption – as well as laundering illicit cash.
“With paper-based trade processing, banks have to take in reams of documents, and then have armies of people reading those through, comparing them, then punching that data into some kind of screening or compliance tool,” says Colin Camp, senior director for business development at Pelican.ai, a tech firm that provides real-time compliance services to the financial sector.
“That takes time, it’s costly, and it’s potentially strewn with errors,” he tells GTR.
Camp says developments around natural language processing – the ability for a computer system to interpret and understand unformatted data, for example from invoices and shipping documents – are starting to provide a solution to that problem.
Once that documentary data is combined with other information, such as banks’ historical client data and cargo-related price points, Camp says compliance teams can “set their tolerance at a certain level, depending on the context, and anything outside of that would be flagged up as an alert”.
“It’s entirely up to the bank where they set their risk profile, but we can apply more restrictive conditions to trade in certain corridors, certain countries, certain business types or certain goods, if the bank is not interested in financing those things,” he says.
There are still limitations with that approach, particularly around the availability of data, with data sharing across different institutions – particularly internationally – giving rise to concerns over privacy and competition law issues.
“If the industry really wants to take trade-based money laundering and terrorist financing seriously, it has to work out a way of having some kind of data utility across banks,” Camp says.
But for Camp, those limitations do not seem to be deterring the trade finance sector from adopting emerging new technology now in order to fight TBML.
“When these technologies were first coming to market, there was a bit of doubt over whether an artificial intelligence (AI) tool could do what it can do now, but as AI becomes more mature and more proven, we are finding banks more accepting that this is the way to go,” he says. “Banks know they can’t just keep throwing bodies at this problem.”
The next frontier: open account
Open account trade transactions present another set of issues for financial institutions. Without oversight of the underlying documentation, identifying suspicious activity based on details of the trade itself becomes impossible.
“The bank never sees the vast majority of the goods descriptions, invoices or manifests. It’s just a payment between businesses,” says Alexon Bell, chief product officer at financial crime intelligence company Quantexa.
“At the moment, banks only need to know who their customer is – not who the importer or exporter is at either end of the trade. But to solve the problem in these cases, you have to gain an understanding of who the ultimate end parties are, that are transacting with each other.”
Bell explains that by aggregating data from corporate registries, and applying sophisticated matching tools to that data, banks can gain visibility over all counterparties involved, and not just their own customer.
“We then take that data and attach it to the information that’s within the bank, and eventually that allows you to see the directors, the shareholders, the ultimate beneficial owners and the companies’ financial status,” he tells GTR.
“Banks would previously have had only a fraction of the information they would need to detect TBML. But when you have that counterparty view, you can identify connections between different entities, and identify where relationships are potentially open to collusion.
“That possible collusion is what could allow over and under-invoicing to occur. Logically, if a company over-invoices a legitimate trader, they would probably be pretty upset – but if they’re in cahoots with each other there won’t be any complaints about it.”
Again, there remain some challenges. Not all jurisdictions offer corporate registries, and if a company does not disclose financial information, it becomes much harder to spot transactions that are out of keeping with their overall business profile.
But according to Bell, there has been a “massive uptick” in interest in financial crime-focused technology – particularly where it can help combat fraud as well as TBML.
“I think there is an appreciation now that technology is up to the task now, whereas in the past it hasn’t been at that level – and that’s among some of the biggest trade finance banks in the world,” he says.
China’s Belt and Road Initiative: a TBML risk?
Recent research from Global Initiative against Transnational Organized Crime, a Geneva-based non-government organisation, has suggested China’s Belt and Road Initiative (BRI) is “likely to have unintended consequences” in terms of criminal exploitation.
In a detailed report, Global Initiative argues that by boosting trade and infrastructure projects the BRI is opening new avenues for illicit activity.
In East Africa, for example, the report says China has identified the port of Mombasa in Kenya as the “maritime pivot” for the BRI in the region and is supporting a major expansion project.
However, with Mombasa “already being a key trafficking hub for narcotics and other illicit commodities such as wildlife”, the report says that project risks making the port “a magnet for further criminal activities”.
It cites examples of shipments of pangolin scales and ivory – rather than plastic waste and tea leaves as stated on the respective bills of lading – that are believed to have passed through the port.
“The key paths of the initiative correspond to and elongate transnational trafficking routes, with illicit goods blending in with the larger volume of trade,” the report says.
“In areas where the BRI routes do not overlap with established trafficking routes, new transport infrastructure will link the Chinese market with new trading partners, amplifying the opportunities for illicit trade.”
Global Initiative suggests that does not only present risks to commercial banks involved in facilitating BRI-related projects, but also to development banks and import-export agencies engaged in those transactions.