Falsified trade invoices are responsible for a US$800bn gap each year in the value of the goods shipped around the world, creating reputation, business and compliance risks for banks that support international commerce.

Research by Global Financial Integrity (GFI), a think tank that tracks illicit cross-border financial flows, says the value gap for trade in goods totals US$8.8trn over the last ten years, and US$817.6bn for 2017.

That accounts for companies altering the value of goods on a trade invoice, typically in order to move money out of a country or evade taxes. For example, if Ecuador reports exporting bananas worth US$20mn to the US, but the US reports imports worth US$15mn, that would result in a value gap of US$5mn – a sum that has likely been transferred from Ecuador to the US.

“Logically, every dollar that leaves one country must end up in another,” the think tank says in a report published this morning. “Very often, this means that illicit financial outflows from developing countries ultimately end up in banks in developed countries like the United States and United Kingdom, as well as tax havens like Switzerland, the British Virgin Islands, or Singapore.

“This does not happen by accident. Many countries and their institutions actively facilitate – and reap enormous profits from – the inflow of massive amounts of money from developing countries.”

Illegal activity facilitated by over- or under-invoicing includes tax evasion, capital flight, corruption and money laundering, GFI says. It also results in “potentially massive revenue losses” for customs departments in developing countries.

GFI’s analysis is based on the most recent UN trade data available. The group also adjusts its figures to account for human error, different reporting conventions and other regional variations, and says it is more likely to have understated than overstated the scale of the problem.


‘An easily accessible channel for illicit activity’

The report says the problem is caused in part by a lack of knowledge of what is being shipped. Fewer than 2% of containers are searched by customs authorities, creating “an easily accessible channel for illicit activity” – and though regulated banks facilitating trade transactions are expected to adhere to anti-money laundering controls, details of the underlying trade are usually scarce.

“If you are a financial institution that provides financing for international trade transactions, and you do not have the capability to determine whether the value of the goods put in front of you is an accurate reflection of the true value of those goods, in effect you’re poking around in the dark,” says Tom Cardamone, president and chief executive of GFI.

“Our findings do indicate financial institutions that are providing financing are at risk for fraud, and I think more focus needs to be put on this issue,” he tells GTR.

“They do their due diligence – are these legitimate companies and so on – but it’s unclear to me from the banks we have spoken with whether they spend much time trying to determine the validity of the value of the products that the requester for financing has presented to them.”

William Barry, a member of Miller & Chevalier’s anti-money laundering practice, says that can result in “real and immediate liability” for regulated firms.

“For example, there have been inquiries in the past as to whether firms that are financing a deal that in some way facilitates corruption ought to have known more, or did know more,” says Barry, who is also a member of the American Bar Association’s international anti-money laundering and anti-corruption committees.

“More often, though, risk can come in the form of a government investigation or a reputational hit. There is real reputational exposure for financial institutions that find themselves sitting in the middle between two parties, one of which may be unscrupulous,” the lawyer tells GTR. “Reputational risk can translate quite quickly into loss of opportunity.”

For example, Barry says that in a deal being financed by a bank “conscientious counterparties are going to carry out due diligence on the financial institution itself”.

“What nobody wants is to go through the entire process and put together a deal that is contingent upon financing, and then find they can’t syndicate for example, because others won’t participate if that financial institution has a poor reputation related to illicit financial flow in another deal,” he says.

Though banks can request audited financial statements or evidence of the underlying trade flow, Barry says they must also avoid overloading their systems. As a result, any initial risk analysis carried out is “critical”.


Smuggling, capital flight and tax evasion

Trade misinvoicing is a global problem and applies across all types of goods, but the report finds the world’s largest value gap – US$324bn over the last decade – is in trade between China and a list of 36 advanced economies. Mexico and Russia are placed second and third, at US$63bn and US$57bn respectively.

Relative to each country’s overall trade, however, China appears lower risk. Its value gap accounts for less than 18% of its overall trade with those 36 countries, compared to 37% in the Gambia, 30% in Togo, and 27% in each of the Maldives, Malawi and Bahamas.

The largest value gaps are found in trade of electrical machinery, mineral fuels and other machinery.

The report says developing countries with underdeveloped manufacturing sectors, whose main exports are mineral resources or agricultural commodities, are particularly vulnerable.

“This situation, in which countries are highly dependent on the import of manufactured goods, creates strong incentives for trade misreporting and smuggling in which traders can make significant profits from under-invoicing imports (often the most common form of trade misinvoicing) if they can bypass import tariffs and other barriers designed to protect nascent manufacturing industries,” it says.

GFI also estimates that much trade misinvoicing activity is a means of capital flight or tax evasion. Shifting funds from developing market currencies into US dollars, British pounds, euros or Japanese yen can provide a mechanism of storing wealth that is better insulated from economic and political instability.

However, despite the scale of the problem, GFI’s Cardamone says there has been little effort on the part of governments to clamp down on fraudulent invoices.

“It’s discouraging that much more has not been done, given the amount of information that’s out there on so many developing countries and the magnitude of the value gap related to their trade transaction,” he says.

“The most basic of things governments could and should do is make invoice fraud illegal. Once you get a law in the books, it doesn’t ensure success in and of itself, but it does telegraph a government’s intent.

“The next step would be to ensure they enforce the new law. We would advocate governments creating multi-agency teams to combat a whole host of trade-related issues. Not just trade misinvoicing but tax evasion, corruption and anonymous shell companies.”

Cardamone has previously called for better information exchange between customs authorities, and that features among a string of policy recommendations set out by the report. Other suggestions include using technology to check the stated value of a shipment matches the expected price of the goods.

GFI also suggests that relevant institutions begin testing the feasibility of using distributed ledger technology, such as blockchain. For Cardamone, trade invoicing presents a “perfect opportunity” for using the technology as a means of sharing price information between customs departments in real time.

The World Economic Forum and Inter-American Development Bank currently have a pilot project underway to test distributed ledger technology, though have identified untrustworthy data entry as one of many “pain points” identified so far.