Trade-based money laundering predates formal finance, but as the costs of compliance rise, banks are turning their back on Asian trade in a bid to avoid sanctioning. Finbarr Bermingham reports.


Earlier this year, renowned financial crime expert John Cassara, who invented the term “trade-based money laundering” (TBML) back in the 1990s, was asked to appear in front of a congressional hearing in Washington DC. His job was to advise the US government on one of the most widespread forms of financial fraud on the planet. In his testimony, he quoted the author and scholar Raymond Baker.

“Anything that can be priced can be mispriced. False pricing is done every day, in every country, on a large percentage of import and export transactions. This is the most commonly used technique for generating and transferring dirty money,” the transcript reads.

The message is clear: if a buyer and seller are working together, then the price of a commodity is whatever they want it to be. Over or under-invoicing is one of the main ways in which TBML is conducted, which is one of the main ways in which crime is financed, and the scale on which it is happening is startling.
Baker estimates that TBML accounts for 80% of all measurable illicit financial outflows. In the US, it’s thought that between 6% and 9% of all trade is “tainted by customs fraud and trade-based money laundering”. If this amount of trade is being used to launder money in the most robust financial regulatory system in the world, then what does that mean for the rest of the planet?

In the developing world, TBML amounted to US$1.1tn in 2013, according to Global Financial Integrity (GFI – the not-for-profit research firm Baker chairs). In the 10 years to 2013, the figure was estimated to be US$7.8tn. These figures do not account for the trade and capital flows conducted through unofficial channels such as hawala in the Middle East, fei-chein in China and padala in the Philippines. The sum of these informal channels, according to World Bank estimates, is 50% larger than official financial channels.

Consider Asia, the most active trading region in the world, and also home to some of its most disparate and opaque regulatory landscapes. GFI estimated that between 2002 and 2011, US$1.08tn was taken from the Chinese economy through TBML – a staggering figure, which is almost certainly only a fraction of the true total, given the widespread use of shadow banking and other unofficial systems, as well as the perceived unreliability of China’s official data.


A corrupt bargain

Malaysia’s 1MDB scandal, the bills of exchange frauds suffered by the Agricultural Bank of China (ABC) and Citic Bank in China this year, or the huge commodity fraud in Qingdao, from which the repercussions are still being felt: there have been a massive number of financial fraud cases hitting the headlines around Asia in recent months, many of them involving trade. However, few of these are actually TBML.

“The irony is that the high-profile cases are in fact the really simple frauds or just criminal theft rather than TBML. Therefore, people and the press can relate to them more easily. The reality is that the majority of the techniques of TBML are either just too complicated to understand or indeed look so legitimate that they are conveniently ignored,” Jolyon Ellwood-Russell, partner at Simmons & Simmons, tells GTR.

“The issue is that TBML is often seen as a victimless crime, unless you are a bank – and the general public don’t have much sympathy for banks these days,”
he adds. A victimless crime it is not: TBML proceeeds often finance terrorism and other forms of crime. This is part of the reason why US authorities’ interest has been piqued.

It’s worth explaining what actually constitutes TBML and what separates it from other forms of trade-based fraud. The Financial Action Task Force (FATF) defines TBML as: “The process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illicit origins. In practice, this can be achieved through the misrepresentation of the price, quantity or quality of imports or export.”

If somebody in Beijing exports 100 units to Hong Kong, priced at US$10 each, they should arrive in Hong Kong – accounting for the costs incurred along the way – valued at roughly US$10 each. If they’re over or under-valued, this constitutes TBML: value has been transferred across the border, often to disguise criminal activity or tax evasion, sometimes as a means of capital flight or to flout capital controls (humans being human, the underlying motivation is usually greed). No matter what the intention, if the value was purposely transferred, it is TBML.

There are a number of reasons international trade is so vulnerable to TBML. “It is particularly difficult because of the magnitude of trade that moves globally each day – it’s staggering. Trying to find the percentage of that trade that’s illegitimate, that’s being used to launder money, is incredibly difficult,” Liz Confalone, policy counsel at GFI, tells GTR.

She adds: “It becomes very difficult to identify, especially if the person that’s engaged in this activity is being clever and not over or under-pricing too radically. If they’re within a normal range, it’s very difficult to tell. It’s also very difficult to tell the difference between a US$10 and US$20 shirt when you open a crate to investigate.”

Trade finance – the method through which so much of global commerce is funded – is often manipulated by those hoping to launder money. Despite TBML pre-dating formal banking systems, in recent years, various regulatory statements and crackdowns on the practice have meant banks have been forced to consider the measures they take to prevent it. Empirically and anecdotally, it’s clear that this has led to a withdrawal from non-core markets, leaving a void in trade finance markets throughout the developing world.

“My risk guys keep asking me for more staff, but at the same time, we’re being told to keep costs down. It takes almost twice as long to get a transaction approved these days, given all the KYC (know your customer) and AML (anti-money laundering) stuff. We just focus on our bigger clients in Asia now. It’s easy to get the smaller guys off our balance sheets as we bank them on an uncommitted basis,” one senior commodity banker told GTR in Hong Kong recently.

Similarly, while Carole Berndt, until recently the head of transaction banking for Asia Pacific at ANZ, says that the bank was never very “avant-garde” and always took a conservative approach to selecting clients, the recent focus on AML and TBML has made things more difficult for all banks.

She says: “Obviously it is one of the most important things we think about. In terms of risk appetite, it creates complexity and that equates to cost. As we go into new markets where the infrastructure isn’t as mature, it requires additional due diligence. That’s something we invest in heavily to make sure our systems are robust and can deal with that. But it’s a moving landscape and is changing rapidly. The AML/KYC transaction monitoring piece is pretty core.”

Some international banks have retrenched from Asia altogether, as it no longer fits within their risk profile. Banks have been pummelled with fines by the US’ Office of Foreign Assets Control (OFAC) in the past for breaching sanctions and for financing trade that funds terror. With other governments also now seeking to crack down on money laundering, the costs of due diligence are often deemed too high. This is also leading to a huge decline in correspondent banking relationships.

In February, for example, the Hong Kong Monetary Authority (HKMA) issued a guidance paper on combating TBML – recognition that the problem is real, great and growing, and that for banks, the risks are high. In May, the HKMA followed this up by announcing a crackdown on fake trade invoicing that facilitates billions of dollars in capital flight from China every year (last year a record US$674bn was estimated to have left China, according to official estimates). Reuters reported that customs inspections at Hong Kong border posts have doubled, with raids on warehouses and customs monitoring also on the rise.

In a statement issued to GTR, the HKMA said that “it is important that where banks engage in trade finance activities, effective risk-based systems and controls are in place”. Better systems equate to higher costs.

“Banks are conscious that they have not necessarily got the right controls and systems in place to combat TBML properly. All financial instructions can be quite siloed and combating TBML needs a united approach from management, the trade operations divisions and the compliance team who might not necessarily before have found a reason to mix,” says Ellwood-Russell.


The crackdown

There is no formal regulatory framework surrounding TBML. The current system is risk-based, meaning banks are expected to show that they have taken the necessary steps to make sure the transactions have been properly vetted, the counterparties are safe and there is no criminal or illicit element on the deals they finance. Many bankers, however, would prefer a rigid set of rules, telling them exactly what they can and can’t do. In the multi-jurisdictional, many-faceted world of trade and TBML however, a prescriptive method would arguably be impossible to create and enforce.

One of the main problems is a lack of understanding. A formal recommendation from FATF has not yet been forthcoming, but may help raise awareness on TBML methods and how to counter them.

“FATF has no enforcement power but it’s the peer pressure that they can impose on countries. The countries themselves need to be aware though: this is a problem. Awareness is the first step. You can’t go anywhere unless you recognise there’s a problem,” says Cassara.

On a policy level there is much that can be done. Despite the plethora of international trade agreements either signed or under discussion, there is still remarkably little customs and trade data shared between nations. A number of initiatives are underway on this front, but surely as the US attempts to simultaneously seal the TPP and clamp down on TBML, the lack of detail of the latter in the former is a missed opportunity.

“One of the things I mentioned in my testimony to Congress is that maybe in the TPP we should mandate that countries collaborate in a great trade transparency, so there would be cutting down on the abuses these agreements allow,” Cassara tells GTR.

The measures taken by the HKMA and the port authorities may be onerous on traders, but they are necessary if TBML is to be reduced. Most experts advocate the presence of specialists at customs and ports, who can focus on certain types of commodities coming through, with a view to establishing what is legitimate or otherwise. Beyond that, many of the measures seem to make common sense, but have yet to see great take-up among governments.

Cassara developed the theory of trade transparency units (TTU), through which the US and participating nations “create dedicated enforcement units to detect discrepancies or anomalies in international trade data, which may be indicative of TBML”.

Essentially, the countries create shared trade databases, which allow them to flag up suspicious transactions. To date, there are no more than a dozen participants, with India and the Philippines as the only Asian countries involved.

Other nations require pre-clearing of imports, which means bills of lading and invoices have to be filed before the article arrives at the port. This allows customs to screen things that are high risk so that when they arrive they can be investigated, or so that additional documents can be requested in advance.

Neither are exactly rocket science, but the fact that they are anomalous emphasises the lack of joined-up thinking in this area. The sad truth is too many officials around the world – Asia included – are getting fat from the proceeds of TBML to make a concerted effort to stop it. For others, the expense of clamping down seems obtrusive, despite the revenue that can be reclaimed through tax and customs charges.

Confalone says: “We have many many laws on the books and folks break them all the time. But if you can make it as difficult as possible for folks to engage in this kind of thing, you’re doing what you’re supposed to do.”

A practice that is so widespread will never be stopped completely, but awareness, transparency and collaboration will help ensure trade continues, finance still flows, but that the connection to crime can be limited.


The genesis of TBML
John Cassara is a retired US intelligence officer who countered money laundering and terrorist financing for 26 years. He is the creator of the term “trade-based money laundering” and spoke to GTR on the release of his new book on the topic.


GTR: You had a long career in law enforcement: what initially sparked your interest in trade-based money laundering (TBML)?

Cassara: I’ve been interested in TBML for probably 20 years. I believe that I coined the phrase in the 1990s. I was assigned to the US Embassy in Rome as a customs agent and we were doing a number of investigations. At the time the US government, particularly the drug enforcement administration, equated international money laundering with the proceeds of narcotics, and that’s true.

But being in customs, I was concerned about customs fraud issues that are also predicate offences for money laundering. So I coined the term TBML and started writing about it and I think that was the genesis of it.


GTR: You also developed the theory of trade transparency units (TTUs) which have been adopted by the US government. How did that come about?

Cassara: That happened right after 9-11 and I was very concerned about terror finance. I was working at the Financial Crimes Enforcement Network (Fincen) and was searching for ways of transparency in underground financial systems, such as hawala [an informal value transfer system commonly used in the Arabic world] and fei-chien [the Chinese equivalent] – the systems our criminal adversaries use.

I knew from my experience in the Middle East that historically and culturally they all use trade to provide counter-valuation or ways to balance the books between brokers. Knowing that, I came up with this idea that every country in the world has a customs service that tracks what goes in and out. Some do it better than others; they all do it for security reasons but most importantly for revenue.

It’s a very straightforward process: if one country uses its targeted trade data and compares the same transaction with its counterparty country it can spot the anomalies. For example, in the US if you’re tracking, say, 1,000 widgets and each one is worth US$100. When they get into Mexico you should have 1,000 widgets and roughly the price per unit should be US$100 per widget. But what if they’re not? What if they arrive in Mexico at US$50 or US$1,000? You’ve then got over and under-invoicing and the sending of value in the form of widgets. When you do this, it is striking: you can see it immediately.


GTR: What are the major barriers to the roll-out of these TTUs?

Cassara: Funding is a major issue. There are co-ordination issues. A lot of these are dependent on customs-to-customs agreements, so legally you have to be able to share information. But the one thing I’d like to emphasise is that these are not fishing expeditions: these are targeted investigations on specific transactions.

The thing that fascinates me is that it makes so much sense, but there are a lot of countries out there that frankly don’t care about money laundering and terror finance. But they are all interested in increasing their revenue and this is a huge revenue enhancer.

I’m an American who was in law enforcement for 25 years, but this doesn’t have to be US-centric: any group of countries, or trading groups, can set up their own TTUs. The concept is so simple. You don’t need American software: if trading partners wanted to create their own regional TTUs then so be it, I think it would be great.


GTR: In your book you talk a lot about the ancient value transfer system of fei-chien in China, similar to hawala in the Middle East. How does one go about regulating something like that?

Cassara: I can tell you what does not work: the counter measures that the west and governments in the Middle East such as the UAE and Afghanistan have used to counteract hawala. They make them register with their financial intelligence unit (FIU), but they don’t register, nor do they report suspicious behaviour. Because these systems are ancient, they’re based on trust, they’re family-oriented, and they’re not going to betray confidence. That’s the stupidity of political battles being fought in countries. They’re completely ineffective.

That’s one more reason to look at trade transparency. Again, historically and culturally these systems use trade [to transfer value]. They use other things as well: banks, couriers, cyber and the internet…. But it still comes back to trade. By systematically examining some of these suspect networks it could be the backdoor into spotting underground finance in the guise of fei-chien. You also need informants, and these things are hard to come by.


GTR: In certain parts of Asia, with its vast, sprawling populations and systemic corruption, is there the political will for anti-TBML measures?

Cassara: I think that’s an interesting discussion to have. There are a number of elites that benefit from the status quo: they like these opportunities to get their money out of the country. Even though they officially clamp down on it, I think the big party bosses, their family members and the mega-rich, don’t want to clamp down because it lets them buy their properties overseas, to educate their kids overseas, to get economic citizenship in foreign countries. It basically is a safety valve.


GTR: Have you noticed in recent years that there’s much more awareness of the penalties around these things?

Cassara: Yes, over the last two to four years there’s been a lot more international attention paid to TBML. I think the interesting thing is going to be how the industry responds to all this. I understand extremely well how onerous AML reporting requirements are for the financial community. I can only imagine the reluctance of the trading industry: they don’t want to get drawn into this, but I have a feeling it’s coming.


GTR: The main deterrent will probably be financial penalties, would you agree?

Cassara: I think so. We went through of this in the 1990s with the black market peso exchange and a lot of companies were caught up in this. We have the expression “wilful blindness”, they kind of knew what was going on but they didn’t ask a lot of questions. I think the same thing is going on now with TBML.