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African economies are losing around US$50bn through illicit financial flows (IFFs) each year, with much of the damage rooted in trade misinvoicing of commodity exports, claims a new report from the United Nations Conference on Trade and Development (UNCTAD).

Research from UNCTAD finds that IFFs – broadly defined as cross-border exchanges of value, monetary or otherwise, which are illegally earned, transferred or used – are draining Africa of vital funding, with money flowing out of the continent to support tax evasion and money laundering schemes.

Particularly damaging for African countries is the underinvoicing of extractive commodity exports, UNCTAD says.

According to its report, which focuses on extra-continental African exports in eight select commodity groups such as gold and platinum, this type of IFF drained the continent of at least US$40bn in tax and other revenue in 2015.

Drawing on the latest available UN Comtrade data, UNCTAD used the “country-trade gap” method to compare the recorded value of exports from African countries with the corresponding value of imports in destination markets.

As an example, if a firm in South Africa reports gold exports of US$10mn to Switzerland, but the buyer in Switzerland reports imports worth US$20mn, that would result in an export invoice gap of US$10mn. In this scenario, commodities leave the country but half of the corresponding financial flows stay in foreign accounts.

UNCTAD says such positive trade invoice gaps – if persistent over a long period of time – could suggest that the exporting firm has understated the value of their exports to conceal funds abroad, such as in tax havens.

Extractive commodities are acutely susceptible to these export underinvoicing risks, the report finds, with gold accounting for 77% of the total. Platinum (6%) and diamond (12%) were two other main contributors.

This, UNCTAD says, is because high-value and low-weight commodities such as gold and diamonds are particularly susceptible to smuggling, with greater risk of ties to corruption and illicit arms trafficking.

Failing to spot IFFs such as these could be damaging and potentially costly for banks, says Duarte Pedreira, head of emerging and frontier markets at Crown Agents Bank.

He tells GTR: “From a compliance point of view, if a bank fails to identify trade misinvoicing, you may be facilitating financial crime and money laundering. It creates big reputational risks as well, which banks needs to look into.”

He adds: “It’s absolutely critical that banks use benchmarks such as pricing guides and conduct research over the internet. For example, if you get an invoice for a barrel of oil at US$10, and the going price is US$40, you know something is wrong.”

But Pedreira says African banks have come on in “leaps and bounds” from a compliance point of view and are creating state-of-the-art compliance, anti-money laundering and anti-financial crime systems.

“They really take things seriously in that part of the world,” he adds.

 

No “hard evidence”

Rick Rowden, a senior economist at US-based thinktank Global Financial Integrity (GFI), which focuses on IFFs, says that there are obvious difficulties in trying to measure trade misinvoicing.

While GFI uses a slightly different methodology, he says that “all everybody is doing is just making estimates”.

“You’re dealing with activity that people are going out of their way to try to hide, it’s not formal public data…. This is illicit activity that economists are having to make guesses about, as they try to measure the scale of the problem,” Rowden tells GTR.

Paul Akiwumi, UNCTAD’s director for Africa and least developed countries also says there are limitations to the report and its estimated figures, which offer no “hard evidence”.

He adds: “The partner country trade gap methodology applied by UNCTAD uses macro trade data to identify large and persistent gaps in the recorded trade between two trade partners. But the absence of comprehensive transaction-level data precludes definitive measurements of the share of illicit activities in these macro gaps.

“In other words, though illicit behaviour may explain part of the statistical gap, other factors also play an important part.”

These other factors potentially include mismatches in the way trade partners classify and record flows of a product, such as gold.

Meanwhile there are “inevitably blind spots” in international merchandise trade statistics, given goods move through complex global value chains, Akiwumi says. “They include the many transactions that may occur between the time a shipment is recorded as an export by its country of origin and as an import in its destination market.”

For example, since the 2000s, there has been a glaring gap in copper trade figures between Zambia and Switzerland.

Zambia has reported Switzerland as the destination for more than half of its copper exports, while Switzerland has reported no imports of copper from Zambia.

While this might suggest trade misinvoicing is taking place, Akiwumi notes it could alternatively be explained by the fact that Swiss-headquartered trading company Glencore bought the Mopani copper mine in the African country in 2000.

In the time since, copper trade between the two countries has shot up, while the potential for data blind spots has grown too.

UNCTAD’s Akiwumi adds that when Zambian authorities lack information about a shipment’s final destination, they may indicate Switzerland because Glencore’s name is on the export permit.

After export, however, the shipment may change hands many times, be stored for some time in a bonded warehouse or be refined and re-exported from a special export zone, before being recorded as an import at its final destination.

“Not all the transactions before the final import are captured by international trade statistics, making it difficult to calculate how these blind spots — versus illicit behaviour — contribute to the data gap in the Zambia-Switzerland copper trade,” Akiwumi adds.

 

Curbing misinvoicing

Given the difficulties in analysing patchy data, UNCTAD suggests policymakers use large, persistent trade gaps as “red flags” for further investigation.

At the same time, GFI notes in a March 2020 report looking at trade-related IFFs in developing countries that authorities can, and should, do more to tackle trade misinvoicing.

Potentially the biggest step governments could take to help customs authorities, GFI says, would be to criminalise trade misinvoicing and set out clear penalties for breaches.

Among a raft of other recommendations, GFI adds that customs authorities should also be given greater law enforcement capacities, and that governments could consider creating multi-agency teams to address financial crimes.

This would require eliminating silos between relevant agencies, such as customs, financial intelligence units, revenue authority, and law enforcement, the report notes.

For its part, UNCTAD is working to rollout a mineral tracking system it piloted in Zambia in 2016.

Designed by the UN body in partnership with the Zambian Revenue Authority, the Mineral Output Statistical Evaluation System (MOSES) works to track copper and other minerals as they travel from mines to borders.

MOSES also allows mining companies to submit their monthly mineral production reports electronically instead of travelling to the capital Lusaka to file them in person.

In Zambia, UNCTAD says the system helped recover around US$1mn in unpaid export dues from mining companies in one year.

Such a figure is dwarfed by UNCTAD’s estimated cost of IFFs in the country, however, with trade misinvoicing, the under-declaration of exports, and other fraudulent trade practices, draining the southern African nation of roughly US$12.5bn in the period from 2013 to 2015.