Trade-based money laundering: how it works and how to combat it

Published on May 19, 2023 by Malla Reddy Myla

Trade-based money laundering (TBML) is a complex and sophisticated method used by criminals to launder illicit proceeds through international trade. The United Nations Office on Drugs and Crime (UNODC) estimates that TBML accounts for 87% of all illicit financial flow worldwide and approximately USD800m-2tn is laundered internationally each year. Governments, financial institutions and businesses, therefore, face a significant challenge in combatting this.

How TBML works

TBML involves the use of trade transactions to move illicit funds across borders. It is typically conducted through a series of financial activities. At the first stage, money launderers introduce funds into the financial system through the purchase of goods or services; they subsequently conduct a series of complex trade transactions to layer the funds. Finally, they integrate the funds into the legitimate economy through the sale of goods or services. Criminals use a range of techniques to exploit weaknesses in the trade finance system; the most common techniques include the following:

Over-invoicing and under-invoicing:

Criminals may overstate the value of goods imported or exported to create a discrepancy between the value of the goods and the amount of money transferred. Conversely, they may understate the value of goods to avoid paying taxes or customs duties.

False invoicing:

Criminals may create false invoices for goods or services that were never delivered or provided. They may then use these invoices to transfer funds across borders, concealing the source of the funds.

Phantom shipments:

Criminals may create fake shipping documents for goods that were never shipped. They may then use these documents to transfer funds across borders, disguising the source of the funds.

Multiple invoicing:

Criminals may create multiple invoices for the same transaction, with each invoice showing a different value. They may then use these invoices to move funds across borders, making it difficult to trace the origin of the funds.

TBML cases highlight the scale and complexity of this issue. One example is the case of the Gupta family in South Africa. The Guptas, who are Indian nationals, used a complex network of shell companies to move millions of dollars out of South Africa. The scheme involved over-invoicing and under-invoicing goods imported and exported by companies the family owned. The funds were then transferred to companies in Dubai, Hong Kong and India, making it difficult for authorities to trace the source of the funds.

Another example is the case of the Russian Laundromat, which was uncovered in 2014. This scheme involved the use of a network of shell companies to move over USD20bn out of Russia. The scheme used false invoicing for goods and services that were never delivered or provided. The funds were then transferred to banks in Europe and other parts of the world where they were used to buy real estate and other assets.

Challenges in combatting TBML

Non-standardisation of trade data:

The absence of a common, uniform format for recording and reporting trade-related information across the countries, industries and stakeholders involved in international trade transactions can create challenges for financial institutions and regulatory authorities trying to identify potential instances of TBML. For example, trade data from different countries may use different codes or descriptions for the same goods or services, making it difficult to compare or aggregate data. Additionally, some countries may not require or provide detailed information about the parties involved in trade transactions, such as the ultimate beneficiary of the goods or services being traded.

Complexity of trade finance:

Trade finance is a complex area that involves a range of actors, including exporters, importers, banks, customs officials and insurance providers. This complexity is further compounded by the fact that each country has its own regulations and requirements for international trade, including customs procedures, tax regulations and documentation requirements, which can create challenges for financial institutions and regulatory authorities trying to identify and prevent money-laundering activity.

Limited resources:

Many financial institutions, particularly smaller institutions, have limited resources to devote to anti-money laundering and counter-financing of terrorism (AML/CFT) efforts. This can make it difficult to implement and maintain effective monitoring systems, train staff and investigate suspicious transactions.

Rapidly evolving TBML techniques:

TBML techniques are rapidly evolving, and criminals are constantly finding new ways to exploit the trade finance system. Financial institutions must stay up to date with the latest TBML trends and techniques and adapt their AML efforts accordingly.

Risk-based approach:

A risk-based approach to AML requires financial institutions to assess the risk associated with each transaction and customer. However, this approach can be challenging, as the risk associated with TBML is often difficult to quantify accurately.

Limitations of data sharing:

Information sharing is critical in combating TBML, but financial institutions may be hesitant to share information due to concerns about data privacy and confidentiality, legal and regulatory barriers to information sharing, and technical challenges related to interoperability between different systems and platforms used to store and exchange trade-related data.

Best practices to combat TBML

Know your customer (KYC):

KYC policies and procedures enable businesses and financial institutions to identify and verify the identity of their customers and assess the risk associated with them. KYC checks help identify red flags and suspicious activity and prevent customers from engaging in illicit activity.

Risk assessment:

A thorough risk assessment is essential in identifying potential money-laundering risks. The assessment should consider factors such as the type of products, customers and geographical locations involved in the transaction. Businesses should also consider the potential misuse of their products and services by criminals and assess their vulnerabilities.

Trade documentation:

Trade documentation is an important source of information in identifying TBML. Invoices, bills of lading, shipping manifests and customs declarations can provide insight on the nature and value of the goods being traded, the parties involved in the transaction and the origin and destination of the goods. Businesses should ensure their trade documentation is accurate, complete and consistent with the transaction.

Transaction monitoring:

Transaction monitoring is an effective way of detecting suspicious transactions. It involves the analysis of transactional data and identifying unusual patterns or behaviours. Businesses should use automated systems to monitor transactions; these can quickly detect anomalies and alert compliance teams.

Suspicious activity reports (SARs):

Businesses and financial institutions should have a mechanism in place to report suspicious activity to the relevant authorities. SARs are an essential tool in combating money laundering, as they provide law enforcement with valuable information on potential criminal activity.

Training and awareness:

Businesses and financial institutions should train their employees on the risks associated with TBML and the measures they can take to prevent it. Staff should be familiar with the company's policies and procedures on AML/CFT and be able to identify and report any suspicious activity.

Collaboration and information sharing:

Businesses and financial institutions should share information and intelligence with each other and with the relevant authorities to identify and track illicit activity. Collaboration can also enable businesses to gain insight on the latest TBML trends and techniques.

Key regulators and their role in combating TBML

Financial Crimes Enforcement Network (FinCEN):

The FinCEN is a regulatory agency of the US Department of the Treasury. It is responsible for administering and enforcing the Bank Secrecy Act (BSA), which requires financial institutions to implement AML programmes and report suspicious activity to the authorities. The FinCEN plays a critical role in combating TBML by collecting and analysing data on suspicious transactions, issuing guidance on TBML and imposing penalties on institutions that fail to comply with AML regulations.

European Banking Authority (EBA):

The EBA is a regulatory agency of the European Union (EU). It is responsible for developing and maintaining the EU’s AML/CFT framework, which includes the Fourth Anti-Money Laundering Directive (AMLD4) and the Fifth Anti-Money Laundering Directive (AMLD5). The EBA provides guidance on TBML to financial institutions and conducts regular assessments of national AML/CFT regimes to ensure they are effective in preventing TBML.

Financial Action Task Force (FATF):

The FATF is an inter-governmental organisation that sets global standards for AML, counter-terrorist financing (CTF) and proliferation financing. The FATF has developed a set of recommendations, known as the FATF Recommendations, to assist countries in their efforts to combat money laundering and terrorist financing. The recommendations include specific guidance on TBML, encouraging countries to adopt a risk-based approach to TBML and enhance cooperation between law enforcement agencies, customs authorities and financial institutions to combat this type of financial crime.

Monetary Authority of Singapore (MAS):

The MAS is the central bank of Singapore and the primary regulator of financial institutions in the country. It has developed a comprehensive framework for AML/CFT that includes specific guidance on TBML. The MAS conducts regular supervisory reviews of financial institutions to ensure they comply with AML/CFT regulations and are effective in preventing TBML.

Hong Kong Monetary Authority (HKMA):

The HKMA is the central bank of Hong Kong and the primary regulator of financial institutions in the territory. It has developed a comprehensive AML/CFT framework that includes specific guidance on TBML. The HKMA conducts regular supervisory reviews of financial institutions to ensure they comply with AML/CFT regulations and are effective in preventing TBML.

Wolfsberg Group:

An association of international banks that focuses on developing and promoting best practices in the areas of AML, CTF and sanctions compliance. The group has developed guidance on TBML, providing practical recommendations for financial institutions to identify and mitigate risks associated with TBML. The guidance covers areas such as customer due diligence, transaction monitoring and risk assessment, and it is regularly updated to reflect changes in the TBML landscape.

The role of technology in combating TBML

The role of technology in combatting TBML has become increasingly important in recent years as financial institutions and regulatory authorities have recognised the need for more sophisticated and automated solutions to address the evolving nature of financial crime.

Technologies such as artificial intelligence (AI) and vessel-tracking systems such as the automatic identification system (AIS) can be powerful tools in combating TBML. By leveraging these technologies, financial institutions and regulatory authorities can gain greater visibility on international trade transactions and identify potential TBML activity more quickly and accurately.

One way AI technology can help combat TBML is by analysing large volumes of trade data and identifying patterns and anomalies that may indicate potential TBML activity. For example, AI can be trained to look for transactions involving high-risk countries, unusual pricing structures or repeated transactions with the same counterparty. AI algorithms can also be trained to learn from historical data and improve their accuracy over time, making them more effective in identifying suspicious activity.

AIS tracking systems can be used to track the movement of vessels and their cargoes across borders, providing greater visibility on international trade transactions. By monitoring vessel movements and comparing them to trade data, financial institutions and regulatory authorities can identify anomalies or discrepancies that may indicate potential TBML activity. For example, if a vessel deviates from its intended route or if the cargo on board does not match the reported destination, this may be a red flag for potential TBML activity.

Combining AI technology and vessel-tracking systems can further enhance the detection and prevention of TBML. By integrating vessel-tracking data with trade data and other sources of information, AI algorithms can identify suspicious activity more effectively and provide alerts to financial institutions and regulatory authorities in real time.

In addition to identifying potential TBML activity, AI technology and vessel-tracking systems can help financial institutions and regulatory authorities conduct risk assessments more effectively. By analysing trade data and vessel movements, these technologies can identify high-risk counterparties, routes and commodities, enabling financial institutions and regulatory authorities to allocate resources more effectively and prioritise their TBML prevention efforts.

Another important technology for combatting TBML is blockchain. Blockchain technology provides a secure and transparent ledger of all transactions, which can be used to track the movement of goods and funds across borders. By leveraging blockchain technology, financial institutions and regulatory authorities can gain greater visibility on international trade transactions and identify potential TBML activity more quickly and accurately.

In addition to AI and blockchain, technologies such as machine learning, data analytics and network visualisation can be used to combat TBML. These technologies can help financial institutions and regulatory authorities identify complex transaction networks, visualise the flow of funds across borders and detect suspicious activity more effectively.

How Acuity Knowledge Partners can help

We provide secure systems and have designated workplaces to ensure we mitigate risk and work is handled with the outmost confidentiality.

Our employees are equipped with end-to-end product knowledge and are experienced in examining and screening digital documents. We ensure minimal handling of physical documents, reducing the potential for data breaches and document-handling costs.

Our subject-matter experts help standardise and streamline legacy processes and bridge process and knowledge gaps.

We provide all types of data services, including data analysis and reports across the trade finance data spectrum.

Our support enables clients to focus more on front- and middle-office services, the development of business strategies for expansion and technological adoption, without disrupting their day-to-day business.

References:

• www.mas.gov.sg

• www.hkma.gov.hk

• www.fatf-gafi.org

• www.wolfsberg-principles.com

• www.unodc.org

---

---