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How high risk is trade finance?

International Compliance Association

AML , Big Compliance Conversation , TBML

Ask any AML professional about the methods that pose a high-risk of money laundering and trade finance will be at the top of the list.

 

To those on the outside, trade finance has a misconception as being almost akin to the dark arts: powerful, likely to be misused and not very well understood.

 

But what is trade finance and is it really as high-risk as it is often perceived?

 

 

What is trade finance?

 

In order to understand the risk, let’s first take a look at what trade finance is: ‘the provision of finance and services by financial institutions for the movement of goods and services between two points, either within a country or cross-border’.[1] 

 

At the simplest level, trade involves exchanging goods and services between buyers and suppliers. But in this world of global trade, often the buyers and suppliers aren’t in the same country, the same time zone or may not even be speaking the same language.

 

Consider the ideal situation if you were selling goods: you would want to send the payment after you have received the goods. But if you were buying goods, you would want to receive the goods before you make the payment.  

 

What happens if you’re not sure whether you trust the other party? You wouldn’t want to risk being out of pocket. This is where the important role of banks and trade finance comes into play. At a simple level, they provide different products and services that can help address the lack of trust.

 

What are trade finance products?

 

These trade finance products account for around 20% of global trade. Trade finance is a service, which includes a multitude of standard trade finance products, including Documentary Credits and Documentary Bills for Collection.

 

These products can provide assurance that payment will be made when the required terms are met.

 

As the name suggests, there can be a number of documents associated with these products, including invoices and transport documents. Banks will have access to documentation which can be reviewed for any red flags or inconsistencies to help identify potential financial crime. The level of information available to the bank will depend on the role the bank is playing the operation and the product used. But the more information the bank has, the greater the opportunity to identify suspicious behaviour.

 

All AML professionals know that criminals will look for any opportunity to exploit legitimate products to launder the proceeds of crime, and trade finance products are not immune. Money launderers can adopt methods to misrepresent the price, quality or quantity of goods and use fraudulent documentation in order to launder the proceeds of crime or for terrorist financing. With controls in place such as screening and monitoring, banks can identify unusual activity such as discrepancies between the money being sent and the description of the goods.

 

What about the other 80%?

 

If trade finance products make up 20% of global trade, how is the remaining 80% financed? It is done through something called ‘open account’.

 

If the buyer and seller trust each other enough to agree on the terms of contract themselves, goods are delivered and a payment is made without any need for extra assurances. Banks may only get involved to send the payment, which means that they may not even be aware of the underlying reasons for that payment. This means that often the controls in place to manage the risk are AML and sanctions screening.

 

Knowing where the risks lie

 

Trade-based money laundering (TBML) is a serious financial crime threat and money launderers will use different methods to misuse trade to move value around the world. There are a number of definitions of TBML, including this helpful definition from FATF[2]: ‘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’.

 

It is important however to recognise that TBML is a broad subject, with the misuse of trade finance just one aspect. TBML encompasses a wide range of different risk factors, and for those not working within the industry it can seem daunting to try and understand.

 

The UK National Risk Assessment of Money Laundering and Terrorist Financing[3] identified abuse of open account third-party payment systems to be the most common form of TBML in the UK.

 

So how high-risk is trade finance? Unfortunately, there is no clear-cut answer, it depends on a multitude of factors, including the nuances of the product, who the customer is, the involvement of third parties and the different jurisdictions involved.

 

In order to ensure that we are best placed to combat the risk, we need to make sure that the risk is understood. A key aspect is recognising that not all trade finance products represent the same levels of risk. 

 

This ICA Insight article has provided a high-level overview of the role of trade finance and its money laundering vulnerabilities. If you would like further information on TBML, take a look at our specialist certificate. 

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The huge volumes of international trade and associated transactions (which increases the scope for suspect trade transactions to be camouflaged) offer opportunities for facilitating large-scale money laundering.  And criminals are able to distance themselves from the activity due to the complexity of the money trail, making oversight and enforcement difficult.

The amounts criminals are laundering through trade-based money laundering is estimated at hundreds of billions of dollars per year.

The ICA Specialist Certificate in Trade-Based Money Laundering (TBML) explores the anti-money laundering and counterterrorist financing risks that exist within the international trade environment, giving you or your teams the skills and tools to manage this risk effectively.

This article forms part of the #BigCompConvo - Join us as we explore and debate the latest challenges and issues facing you and regulatory and financial crime compliance professionals all over the world. If you’d like to contribute an article as part of the Big Compliance Conversation get in touch with us at contributions@int-comp.org

 

References

[1] The Wolfsberg Group, ICC and BAFT, Trade Finance Principals

[2] http://www.fatf-gafi.org/media/fatf/documents/reports/Trade%20Based%20Money%20Laundering.pdf

[3] https://www.gov.uk/government/publications/national-risk-assessment-of-money-laundering-and-terrorist-financing-2017


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