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Trade-based Money Laundering: The Need for an Effective Regulatory Framework

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About The Author

Clyde Darrell (Regular Contributor)

Clyde is a pupil barrister at a leading criminal set in London, specialising in white-collar fraud. He graduated from Cardiff University in 2012 having done his LLB and LLM in International Commercial Law (with a particular focus in international financial crime) receiving a distinction overall.

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If you can walk into a supermarket and are able to buy Caribbean bananas, Brazilin coffee and a bottle of South African wine, you are experiencing the effect of international trade.

International trade provides a number of benefits one of which is the ability for countries to expand their markets in order to obtain goods and services that may not have been ordinarily available. This has the effect of fostering greater competition in the market and therefore more competitive prices, which has a trickle down effect of providing a cheaper product for the consumer. It is the reason why we as the consumer have the choice between a Japanese, German or American car.

The World Trade Organization (“WTO”) estimated that in 2014 member states exported over 54 billion dollars in goods and services. But like any global market, international trade offers a plethora of opportunities for criminals to exploit. Fraud, money laundering, corruption and tax evasion are all examples of predicate crimes often underpinning international trade. In a money laundering context, the United Nations Office on Drugs Crime estimate the crimes such as money laundering comprise of 2% - 5% of the world’s GDP or approximately $3 trillion to $5 trillion per year. It therefore goes without saying that where there is an enormous trade flow, this offers a ready made environment for criminals to launder cash or move illicit funds.

In light of this, one may have expected the international community to have embarked on a coordinated, determined, all guns blazing assault on plugging the obvious avenue trade provides to criminals. Surprisingly however, since the inception of the Financial Action Task Force (“FATF”) (the international body who have commendably led the fight against money laundering) in 1989 there has been no real attempt on an international level to regulate trade-based money laundering (“TBML”).

What is Trade Based Money Laundering?

FATF identifies three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising it origins and integrating it into the formal economy. They involve:

  1. the use of the financial system;
  2. the physical movement of cash through cash couriers; and
  3. the movement of value through the trade system i.e. TMBL.

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 legitimize their illicit origins or finance their activities.                                                                                                         

There are a number of ways in which criminals move value through trade transactions:

(i) Over-invoicing - when the exporter misrepresents the price of the goods or service far above the fair market value so that additional value can be transferred to the importer.

(ii) Under-invoicing - where the goods or services are invoiced below the ‘fair market’ price so that additional value can be transferred to the exporter.

(iii) Multiple invoicing - when more than one invoice is used for the same trade transaction in order to receive multiple payments for the same goods and services.

(iv) Over and under shipments of goods and services - where goods being shipped or the services being provided are over or understated.

(x) Falsely described goods or services - where the quality or type of a good or service is misrepresented.

On the one hand, identifying the use of these techniques can be very difficult for example where the trade transaction involves multiple foreign exchange rates and diverse financing arrangements.

In other cases the use of such techniques may be blatantly obvious. For example, the 2003 International Narcotics Control Strategy Report from the US State Department identified a case where cotton dishtowels imported from Pakistan to the US for $153.72 each, underwear imported from Hungry for $739.25 a dozen, metal tweezers imported from Japan at $4,896 a unit and rockets and missile launchers exported to Israel for $52.03.

Regulating TBML: The Current Regulatory Framework

A close look at the current international framework shows that since its inception in 1989, the FATF’s entire focus has been on the first two avenues - the physical movement of currency and abuse of financial institutions. Hardly any attention was been paid to TBML. One only needs to look at the FATF’s 40 Recommendations to combat money laundering in order obtain support for this. These Recommendations are meant to set the international standard for anti-money laundering measures. They were first issued in 1990 and since then there have been revised Recommendations in 1996, 2003 and 2012. Surprisingly, none of these revisions addressed TBML.

Indeed it was only in 2006 that FATF first recognised TBML as a threat and issued its first typologies report which was later followed by a Best Practice Paper on TBML in 2008 and a report on money laundering vulnerabilities of Free Trade Zones in 2010. Since then there have been no further specific reports on TBML or any attempts to include measures in its Recommendations to prevent TBML.

Without specific TBML measures at international level, policy makers have had to adapt and apply AML strategies and regulations specific to the financial sector, to the trade sector. For obvious reasons this particular approach was and continues to be a failure. The AML strategies and regulations applied in the financial sector focus primarily on reporting requirements by financial institutions, which it is suggested will not be able to work in the same efficient way in the trading system.

Measures like Know Your Customer (“KYC”), reporting suspicious transactions to the Financial Intelligence Unit and due diligence practices, seek to combat money laundering in a banking or financial institution context. However, TBML is a distinctive form of money laundering and poses different threats to the abuse of the financial systems. The nature of the involvement of banks and financial institutions in trade transactions often means that it is difficult for them to assess risks in trade transactions and ultimately combat TBML. The trade-based systems that act as a parallel method of transferring money and value around the world such as hawala, the black market peso exchange and the use of commodities such as gold and diamonds are not captured by these financial reporting requirements and therefore pose tremendous challenges for law enforcement using current financial reporting requirements.

In other cases, the nature of finance arrangement may make identifying or combating TBML impossible. Take for example trade finance. It is standard practice for parties in international trade transactions to take into account their required payment method. In many trade transactions a basic documentary letter of credit (‘L/C’) payment scheme - often described as “the lifeblood of international commerce” - is used. Here the issuing of the L/C involves three parties: the buyer, the seller and the issuing bank. Apart from the contract the bank has with the buyer and seller, banks are limited in their involvement. The banks are usually not privy to any other contracts between for example buyer and seller. This is referred to as the ‘autonomy of credit’ where the L/C transaction is separate from the buyer and sellers underlying contract. Where negotiations are carried out only between the buyer and the seller, the transaction is thought to be carried out under “Open Account Terms”. Approximately 80% of such transactions are carried out in this way.

Indeed the majority of international trade transactions do not involve financial institutions except for confirming finance and transferring payments at the conclusion of the transaction. It therefore becomes very difficult for banks or other financial institutions to effectively monitor, detect and report suspicious transactions outside of their involvement.

But why has there been a lack of engagement in dealing with this form of money laundering. It could be argued that one of the reasons is because there is a current absence of reliable data on the economic and social effects TBML has had on developed and developing countries. In the absence of this it is nearly impossible for regulatory authorities and law enforcements agencies to respond and devise systemic and constructive strategies and controls to combat TBML. Most jurisdictions do not even separately monitor and maintain statistics on TBML and do not even distinguish between TBML and other forms of Money Laundering.

A Way Forward?

Because the nature of international trade means that transactions can be dynamic with goods and services exchanging various hands in a long supply chain, the system is without doubt more vulnerable to money laundering abuse. Going forward, in order to properly combat TBML, the international community including FATF needs to implement a specific FATF Recommendation for trading and to impose it on all traders i.e. those further along the trade supply chain who are more directly involved and are thus best suited to prevent the abuse of the international trading system.

Admittedly, imposing requirements on “traders” may result in a compliance burden from having to incur huge financial set up costs of the appropriate systems (customer due diligence, ongoing AML/CFT staff training, AML/CFT reporting and internal procedures). In theory, these stakeholders would be less sophisticated in dealing with financial crime and less likely to be effectively regulated than your typical bank or financial institution, which may lead to difficulty in implementing and ensuring compliance. There are however ways around this.

The United States of America are one of a few developed countries who recognise a difference between TBML and other forms of money laundering and have established Trade Transparency Units (TTU’s) to exchange and analyse the import/export and financial data between the United States and its foreign trading partners. This enables them to detect suspicious TBML transactions by identifying any documentation and financial irregularities.

The US government have so far been quite successful in using TTUs for detecting blatant documentary fraud and monitoring other reporting discrepancies between two cooperating countries customs authorities. For example a recent case involving a TBML scheme in operation was The Angel Toy Company, based in Irvine, California, who laundered Colombian and Mexican drug money through purchases of toys manufactured in and exported from China to other less developed countries. Through a TTU based in Washington, US customs were able to investigate the company, which led to them being found out as international criminals big on laundering drug money. This led to prosecutors beginning an investigation where two company officers pleaded guilty to charges of structuring currency transactions to avoid reporting requirements

This US government sponsored TTU consists of a network of eight Latin American countries – Argentina, Brazil, Paraguay, Mexico, Columbia, Panama, Ecuador and Guatemala who all cooperate in trade information sharing. If other countries agree to participate this would help extend the scope and implementation of the initiative, which may prove a significant tool to detecting and preventing TBML.

Such a system would therefore not place an undue burden on “traders” as it would be mainly administered by the countries themselves. Indeed a similar approach has been adopted with member countries of the Organisation for Economic Co-operation and Development when it comes to their bottom line and tackling tax evasion in the form of tax sharing agreements. If the fight against ML is as serious as many countries and international organisations have us believe, then there is no reason why developed countries, the IMF, World Bank, United Nations and OECD cannot come forward to provide technical and financial support in order to help implement bear the costs of such initiatives.

Conclusion

TBML has been overlooked in policymaking for too long. In the TBML world you are only limited by your imagination. As such, in order to combat TBML there needs to be a stronger commitment from FATF by way of developing and incorporating more specific TBML rules and regulations into its Recommendations. FATF’s report on TBML and Best Practice report were timely reminders of the uphill task we face in dealing with TBML but are simply not enough. International trade will continue to provide an opportunity for criminals to launder proceeds. A failure to plug this regulatory gap on a priority basis will seriously endanger and undermine the trade system and the continued fight against money laundering.

Further Reading

John A. Cassara, Trade-Based Money Laundering: The Next Frontier in International Money Laundering Enforcement, 2015 (Wiley and SAS Business Series), available on Amazon.

Samuel Rubenfeld, Fighting Trade-Based Money Laundering, Risk & Compliance Journal (2015)

Economist, Uncontained, (2014).

Ross S. Delston and Stephen C. Walls, Strengthening Our Security: A New International Standard on Trade-Based Money Laundering Is Needed Now, 44 Case W. Res. J. Int'l L. 737 (2012).

United States Department of the Treasury Financial Crimes Enforcement Network, ‘Informal Value Transfer Systems’.

WTO statistics.

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Tagged: Banking & Finance, Criminal Law, International Law

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