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Trade finance is being exploited by criminal groups in order to launder funds and finance terrorist activity, according to a landmark report published by an influential financial crime monitoring body.

The warnings follow research by the Financial Action Task Force (FATF), a global standards-setting body, undertaken jointly with the Egmont Group of financial intelligence units.

The task force says in a detailed report published on December 9 that international trade networks “can attract criminals… who exploit the interconnected supply chains” in order to move illicit funds through the formal financial system, a practice known as trade-based money laundering (TBML).

It adds that following consultations with public and private sector representatives, the “exploitation of trade financing processes was a common theme”.

Open account transactions, used in around 80% of international trade, have previously been identified by US regulators as a money laundering risk because financial institutions have little visibility over the underlying trade documents.

The report echoes those concerns, saying TBML schemes “frequently involve this method because [banks] have a reduced role, meaning less oversight than for the documentary collection process”.

However, it also warns that documentary trade – such as transactions supported by letters of credit – also show vulnerabilities.

“Despite a perceived increase in role for financial institutions, it is limited as they do not necessarily verify the documents,” the task force says. “In addition, documents are not always standardised, increasing the risk of TBML exploitation through fictitious or false invoicing.”

The report includes several case studies of TBML schemes around the world.

In one example, supplied by police agency Europol, a trading network involving cars and automotive parts was found to be laundering funds on behalf of drug traffickers and tax fraudsters with ties to Mafia activity.

The perpetrators created a “fake paper trail for sales and purchases” in order to disguise the origin of those funds, and used the resulting documentation to convince a legitimate supplier to deliver large numbers of vehicles – blending illegal and legitimate trading activity to hide criminality.

The same network also exploited trading networks involving luxury items, such as watches, as well as shoes and clothing.

Another Europol example involves soft commodity trade between companies in Europe and North Africa as a means of hiding drug trafficking proceeds.

The TBML scheme, believed to have laundered more than €400mn, relied on an “underground banker” in the Netherlands who was involved in an import and export business.

The company would use drug money to fund the purchase of onions and potatoes, before selling them on to North African markets. Importers were told to pay invoices into bank accounts controlled by the traffickers.

Trade is not only exploited to launder the proceeds of crime, the report adds. The FATF says Israeli customs authorities detected a scheme whereby a terrorist group was able to transfer cash across borders through apparently legitimate goods exports.

For banks, the issue is not only exposure to illicit activity leading to financial penalties. Lawyers have previously warned that reputational damage could hamper trade finance banks’ ability to syndicate, for example, even if no enforcement action has been taken.

 

Red flags

In order to cut out TBML schemes, the report recommends that banks involved in international trade check details and data associated with those transactions rigorously, wherever possible, to identify potential red flags.

Examples given include the use of a personal email or residential address rather than one associated with a legitimate address, signs that documentation has been recycled or reused, and a lack of previous trading activity by the exporter involved.

Banks are also urged to carry out thorough due diligence on the parties involved in a transaction. Warning signs can include the rapid growth of a newly formed company, unnecessarily complex supply chains involving multiple transhipments, and unexpected changes in a company’s import or export activity.

The report cites the example of an IT company that quickly and unexpectedly “established a foothold in the acquisition and distribution of bulk pharmaceuticals”.

In terms of sectors, the report says TBML schemes can affect a wide range of different activities – including both high-value, low-volume trade such as precious metals, and low-value, high-volume trade such as second-hand textiles.

However, common themes include goods with wide pricing margins, that have extended trade cycles or that are shipped across multiple jurisdictions, or that are difficult for customs authorities to examine.

Another major concern identified by the report is third-party companies that become involved in a transaction, typically around the invoice settlement process.

Kevin Newe, assistant director at UK tax authority HM Revenue & Customs, said during a press conference at the report’s launch that since the FATF’s last report on the subject – published in 2012 – there has been a trend towards integrating criminal activity within legitimate supply chains.

“There was no need to create false invoices, or to mis-describe or mis-value goods,” he said. “We’ve seen criminals effectively buy their way in as a silent partner, into a business, and continue to use that business in a legitimate way but to clean their proceeds.”

Newe gave the example of criminal groups that were involved in exporting foodstuffs to West Africa as real-life trade that was facilitated by the proceeds of crime.

Battling that trend “is the most compelling need in the report”, he added.

 

Tackling TBML

Many of the report’s recommendations focus on improving understanding of TBML schemes, both among private sector companies such as banks and traders, and among public sector bodies such as customs authorities.

It suggests, for instance, that banks offer internal training to staff specifically focused on TBML money laundering risks. The task force praises an unnamed Dutch bank for providing TBML information and emergency contacts to all its business customers.

The report also suggests several areas where cooperation could improve, such as between financial intelligence units and non-financial companies involved in trade.

For Anton Moiseienko​, a research fellow at security-focused think tank RUSI, the report gives a “clear sense of how disjointed the current response to TBML is”.

Banks “either have no access to trade documentation or face challenges in verifying it”, while customs agencies face competing priorities and freight forwarders remain outside the scope of anti-money laundering regulations.

“The natural response is to bring these parties together, and the FATF report lists various examples of public-private partnerships,” Moiseienko​ tells GTR. “This is a good start, but the next step should be analysing how well those partnerships are actually doing in tackling TBML specifically.”

Tom Cardamone, president and chief executive of Global Financial Integrity (GFI), a think tank that tracks illicit cross-border financial flows, says it would not be a surprise to see national authorities introduce new measures in response to the report.

“While it’s hard to predict with certainty what legislatures will do in response to this study, given that TBML is a chronic problem for which governments always seem to be playing catch-up, I think it’s safe to say industry should assume some changes will be contemplated,” he tells GTR.