Trade-Based Money laundering accounts for “hundreds of billions” of dollars worldwide. So this article aims to describe all the components of trade-based money including its remediation.
Trade-Based Money Laundering started to raise its head in 1967 when the government of Colombia passed Decree-Law 444, which established restrictions on foreign exchange and foreign commerce. The main purpose was to curb capital flight and steady the price of the Colombian peso. As a result, Colombian exporters were unable to receive proceeds from foreign sales while Colombian importers found themselves unable to buy foreign currency from the Central bank to pay debts to foreign suppliers. What followed was a fairly predictable scenario where Colombian exporters and importers collaborated to create a large and efficient foreign exchange black market. In this black market, money could be transferred without the need for funds to move across borders. Thereby, Colombian exporter transferred foreign exchange to suppliers of Colombian importers, in turn, Colombian importers paid the exporters in Colombian pesos using domestic banking transactions.
Sounds Familiar, this exact situation of Nepal and third world countries where a various number of foreign exchange restrictions are placed to prevent the outflow of foreign exchanges. As a result, these countries economy is very fertile to foster Trade-Based Money Laundering.
Although, Trade-Based Money Laundering was initially used for a legitimate purpose later on it was exploited by criminal groups to propagate their mala fide activities.
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 legitimize their illegal origins or to finance their activities.
So, this definition simply means that TBML is one mechanism to hide the source of criminal proceeds to make it look legitimate.
When and Where
It is generally seen that there are two situations when criminal groups resort to TBML.
The first one is when Criminals want to send the criminal proceeds from the country in which they operate to the country of their residence. Consider the following example:
Source: FATF Trade-Based Money Laundering
Here, Hawaladar or Hundi Operator in the US wants to settle his dues to Pakistani Hundi Operator. So, he contacts with US Importer of Surgical goods, his ally, to import the surgical goods from a Pakistani company that has ties with Pakistani Hundi Operator. The good is exported from Pakistan to the US, however, the goods are over invoiced which includes the cost of goods as well as the outstanding balance that the US Hundi Operator owes to the Pakistani Hundi Operator. So when payment is may by a US-based importer, US Hund Operator has successfully done money laundering via trade based transactions.
The second is the time when the criminal group wants to launder the illegal proceeds generated in the country of the residence. Let’s look at the following example.
Source: FATF Trade-Based Money Laundering
Criminal Organization sells drugs in Japan, all the criminal proceeds generated from this kind of trafficking is smuggled out of Japan to France by physical means like cash courier or any other methods. This criminal organization has a shell company, Designer Clothing Store, established in France, this company will use this illegal proceeds to buy designer clothes. They will export these designer clothes to companies in Japan, again that company is a shell company owned and controlled by the criminal organization. This company in Japan, will sell the goods imported from France in Japan and transmit the funds to the criminal organization. In this way, the criminal organization has successfully laundered money through Trade-Based Transactions.
All the types of Trade-based money happening all around the world can be summarized in the following table.
Trade-Based Money Laundering Red Flags:
|Over Invoicing||By misrepresenting the price of the goods in the invoice and other documentation (stating it at above the true value) the seller gains excess value as a result of the payment.|
|Under Invoicing||By misrepresenting the price of the goods in the invoice and other documentation (stating it as below the true value) the buyer gains excess value when the payment is made.|
|Multiple Invoicing||By issuing more than one invoice for the same goods a seller can justify the receipt of multiple payments. This will be harder to detect if the colluding parties use more than one FI to facilitate the payments and or transactions.|
|Short Shipping||The seller ships less than the invoiced quantity or quality of goods thereby misrepresenting the true value of goods in the documents. The effect is similar to over-invoicing.|
|Over Shipping||The seller ships more than the invoiced quantity or quality of goods thereby misrepresenting the true value of goods in the documents. The effect is similar to under-invoicing.|
obfuscation of the
Type of Goods
|Parties may structure a transaction in a way to avoid alerting any suspicion to FIs or to other third parties that become involved. This may simply involve omitting information from the relevant documentation or deliberately disguising or falsifying it. This activity may or may not involve a degree of collusion between the parties involved and maybe for a variety of reasons or purposes.|
|Phantom Shipping||No goods are shipped and all documentation is completely falsified.|
Source: Wolfsburg Trade Finance Principles
How is trade-based money laundering is being done in Nepal?
Nepal is a land-locked, import-based economy. The majority of the goods are imported through under-invoicing thereby evading customs duties. However, Nepalese importers have to pay for the goods in full, so they send the shortfall amount to the sellers abroad via hundi.
From above, you can imagine that the presence of Hundi is prevalent in Nepal. These hawaladars/Hundiwala settle their balance amount with other hawaladars/Hundiwala located in different countries via trade-based money laundering using Nepalese importers. Hundi is not done only to transfer money for trade-based payments but also for the movement of criminal proceeds of different criminal activities as well as corruption money. Thus, most portion of the money laundering in Nepal is done through trade finance and Hundi.
Don’t believe us, how about the fact, that remittance in Nepal actually increased despite the COVID-19 situation 2020. One of the main reasons was that trade financing activities have decreased during this period, as a result, Hawaladars did not have the means to transfer money from one country to another, thereby, leading to a decline in Hundi activities. Thus, people had only the option of formal banking channels to perform remittances.
We have an excellent article explaining what is hundi, how do hawaladars operate in detail. Just Click Here to read that article.
Problems in Detecting Trade-Based Money Laundering
These are some reason why detecting TBML is difficult:
- It is not feasible to make determinations price of goods on the basis of external data sources; most products are not traded in public markets and therefore there are no publicly available market prices.
- Lack of relevant business information, such as the terms of a business relationship, volume discounts, or the specific quality of the goods involved.
- Presence of dual-use items like software, technology, raw materials, which may have both civil and military applications. Identification of dual-use goods in a trade transaction is challenging given their possible complex and technical nature. For eg. telecommunications equipment can be used in building telecommunication infrastructure or building explosives for nefarious purposes.
The solution to the Problem?
The solution to this problem is simple, you need to focus on what drives Trade Base Money Laundering, it is Foreign Exchange. Foreign Exchange is not only the driving force behind Trade-Based Money Laundering but also Remittance, Wire Transfers, and all those transactions that you can imagine which involves cross border money transfers.
There is a motto in anti-money laundering, follow the money. If you could establish the source, destination, and purpose of foreign exchange then you have successfully traced the money, if there is any doubt regarding any of these components, then it means it needs further investigation.
Now, let’s look at some of the control measures that help us to establish the flow of money:
- Proper KYC/CDD: Almost all of Trade-Based Money Laundering activities is done through Shell companies and complex organization structure to hide beneficial owner. Therefore, proper KYC/CDD procedures should be applied to identify the ultimate beneficial owner, business model, the principal counterparties, the countries where the counterparties are located, and the goods or services that are exchanged, as well as the expected annual transaction volumes and flows.
- Customer Screening: The screening of all the parties in the trade-related transactions should be done before carrying out any kind of wire transfer or remittance activities. Ensure that the full name and address of the applicant and beneficiary are included in the wire messages so that appropriate customer screening can be done.
- Enhanced Customer Due Diligence (ECDD): ECDD may be required where the countries, products, or customers involved are deemed to be High Risk, or where the goods are seen as being high risk or of a dual-use nature.
- Report SAR(Suspicious Activity Report): If any trade-related transaction is found to be suspicious it should be reported immediately to AML/CFT or Compliance Department.
Let’s not forget Remittance:
Remittance is also the movement of Foreign Exchange from one country to another, so it is susceptible to money laundering as Trade-Based Money Laundering. The controls mentioned above are also applicable to Remittance also. However, there are some red flags that need to be watched out for:
- Multiple Remittance received by the same person.
- Multiple Remittances send by the same person.
- Where customer declares payment is coming from a certain place in abroad but it is received from a local place.
- Payment received from High-Risk Countries (High-Risk country list is given below)
Sanction and High-Risk Countries:
Sanctioned Countries are those countries against whom the political and economic trade restrictions are put in place with the aim of maintaining or restoring international peace and security.
- Economic Sanctions: Economic sanctions are a way to financially isolate a target because of their involvement in Human Right violation, nuclear arms proliferation. Increasingly, countries are using economic sanctions instead of military force as an instrument of foreign policy. Sanctions can generally fall into one of the following categories:
- Targeted Sanctions: They are aimed at specifically named individuals, such as key leaders in a country or territory, named terrorists, significant narcotics traffickers, and proliferators of weapons of mass destruction. These sanctions often include the freezing of assets and travel bans where possible. E.g., Venezuela’s president and some high officials sanctioned by CANADA, US Treasury.
- Sectoral Sanctions: They are aimed at key sectors of an economy to prohibit a very specific subset of financial dealings within those sectors to impede future growth. For e.g., Sectoral sanctions apply to specific entities in Russia’s financial, energy, and defense sectors. U.S. persons are restricted from engaging in specific transactions with these entities.
- Comprehensive Sanctions — They generally prohibit all direct or indirect import/export, financing, or facilitating against most goods, technology, and services. These are often aimed at regimes responsible for gross human rights violations, and nuclear proliferation. E.g., NorthKorea, IRAN
- Embargoes: A trade embargo refers to banning exports or imports of certain goods. For example, a strategic embargo prevents the exchange of military goods with a country, while an oil embargo prohibits only the trade of oil. In the 1940s, the U.S. froze all Japanese imports and exports resulting in a huge trade loss to Japan. The embargo also included the hot commodity oil, which hit the Japanese economy hard at the time.
- Non-proliferation Designations Against weapon of mass destruction(NPWMD): This term refers to the prevention of proliferation of nuclear, chemical, and biological weapons, as well as their means of delivery
Black List Countries: Also known as Non-Cooperative Countries or Territories (NCCTs). These are the countries that are presumed to support terrorism financing and money laundering activities.
High-Risk Countries: They are so-called ‘greylist’ contains countries where strategic AML/CFT deficiencies have been identified and which have committed themselves at the political level to implement an action plan in order to overcome these deficiencies.
|Black Listed Countries||High-Risk Countries||High-Risk Countries|
Any entities dealing with the counterparties belonging to these High-Risk Countries should exercise caution. We recommend you perform Enhanced Customer Due Diligence. The list of countries usually updates from time to time. Please click here to get the latest list of high-risk countries.
This is all that we have conjure about Trade-Based Money Launder. If you have found this article useful, please share this with others, also if you want to add something, you can put your ideas in the comment section below.
Thank you for reading.