More focus on countering trade-based money laundering

Trade-based money laundering (TBML) is gaining popularity as a money laundering method. Important reasons for this are the continued growth in global trade, the focus on ‘money-based laundering’ in preventing and combating money laundering, and the complexity of recognizing it. Intentional over- or undervaluation of goods is one of the most commonly used TBML techniques.

The regulator also expects banks to investigate this form of money laundering properly. In this article, we provide insight into recognizing TBML activity. We address the role, scope, and approach of banks in countering TBML. We believe that an integrated and risk-based approach in the CDD program and proper training are essential. Just like establishing best practices for assessing the valuation of goods.

TBML in practice – what it is and how to recognize it

Definition according to the FATF

The Financial Action Task Force (FATF) has an essential role in protecting the global financial system against money laundering. The FATF has issued recommendations that serve as an international standard for combating money laundering. Among other things, the FATF also establishes money laundering typologies.

The FATF states that, for TBML to exist, there must be at least the following three characteristics of money laundering:

1. It involves criminal value/proceeds to be laundered.
2. There is an intention to move this criminal value, usually to another jurisdiction.
3. By moving this criminal value, a legitimate origin must be assumed.

How it works

In practice, TBML can be achieved by misrepresenting the price, quantity or quality of imports or exports. TBML techniques vary in complexity and are often used in conjunction with other money laundering techniques to further cover the money trail (in the layering phase). In practice, there may be a collusion between the importer and exporter.

An example of under-invoicing:
People who want to launder can move money to another country by, for example, using their illicit funds to buy high-value products and then exporting them at a price below market value to a foreign partner in crime. The exporter can thus move his assets to the importer. The importing partner then resells goods at their actual value to receive an additional profit. To give the transactions a legitimate feel, the parties may use a financial institution for trade financing, which often entails letters of credit.

Case Study: Black Market Peso Exchange

The Black Market Peso Exchange (BMPE) is an example of a complex TBML method, widely used by drug traffickers in South America to launder drug dollars. In the early 1950s, Colombian importers created the BMPE to evade unfavorable exchange rates for U.S. dollars and government levies on imported consumer goods purchased with U.S. dollars. From the 1970s onwards, these are mostly Colombian drug cartels that use the BMPE method to convert dollars from drug sales to pesos in Colombia. In this form of BMPE, the peso brokers “exchange” drug dollars for legal pesos upon premium payment. The peso broker is based, for example, in Colombia, with an agent in the U.S.

How does it work?

Although BMPE primarily originated in South America in relation to the U.S., there is evidence that BMPE is not exclusively limited to this region. More recently, a similar scheme may also occur in Europe. *

*Source: Criminaliteitsbeeldanalyse Witwassen 2012 [Money Laundering Crime Analysis 2012], Melvin Soudijn and Theo Akse, National Police Services Agency.

What methods of TBML are there?

There are several basic typologies of TBML. The Wolfsberg Group distinguishes between:

1. over-invoicing or under-invoicing of goods and services,
2. multiple invoicing of goods and services,
3. ghost shipping or phantom shipping of goods and/or raw materials,
4. over-shipping or short-shipping,
5. false description of goods and services.

How do you recognize TMBL activity?

U.S. Immigration and Customs Enforcement (ICE) has defined several red flags:

• Incorrect pricing of goods and/or raw materials.
• Payments made to a supplier by unrelated third parties.
• Incorrect reporting, such as misclassification of raw materials.
• Repeated imports and exports of the same high-value item, also known as carousel transactions.
• Goods traded that do not fit with the company’s regular operations.
• Unusual shipping routes or transfer points.
• Packaging that is not consistent with the goods or shipping method.

Role, scope and approach of banks in countering TBML

Role of banks

The main parties that play a role in countering TBML activities are customs, police units, and banks. In this regard, the banks’ part can be related to providing trade finance products, such as letters of credit. Banks – for these products as for other products and services – need to check both their clients and counterparties against the sanctions and other screening lists. As part of their robust CDD program, they must also conduct risk-based checks on, for example, client export patterns, required shipping documents, and the final destination of the goods. They are also required to invest in software to recognize transaction patterns and assign value to goods.

Scope

However, there is a limit to what banks can do because they are not involved in all their customers’ commercial transactions. Often, banks only provide financial products in 20% of trade transactions. In 80% of cases, trade finance products are not provided, so information about the underlying trade transaction is missing. These are the so-called ‘open account transactions.’ If banks are already involved, they have no real possibility to view or examine the goods physically. Between exports and imports, many different parties all see only a part of the trade transaction and the underlying goods. They all have a part of the solution to the puzzle. If, in a utopian case, there were full collaboration and information sharing, all parties could solve the puzzle together. In practice, this is not the case. This makes it very difficult for each link to recognize TBML. Nevertheless, the regulator does expect a proper investigation into the matter.

Integrated approach in CDD program is crucial

TMBL deserves an integrated approach. To effectively combat TBML, it is important to add the “trade dimension” to every aspect of existing traditional CDD programs. A common pitfall we observe in practice is that countering TBML is implemented as a separate process rather than integrated into the main CDD program. We believe that countering TBML should be reflected in all aspects of the CDD program. For example, adding a client’s trading profile in the CDD files and investigating the existence and integrity of the counterparties with which the client trades.

Researching TBML

Tracking goods and money flow

In research into TBML, the factors “in, out, or through” play an important role in the flow of goods:
In: Goods come in, does the money stay here?
Out: Goods go out, does the money stay here?
Through: Goods pass through (transfer), where is the money?

In addition to the flow of goods, it is certainly important to track the flow of money. Is the direction in which the money is moving logical? Do the prices of imports or exports make sense? It immediately brings up a difficulty because how do you determine the value of a good? Especially for non-regular goods or commodities that are not traded on a regular market, the original value or market value is difficult to determine—for example, vases from China, ceramic tiles from Italy, or art. Therefore, the question is whether the price at which the good is traded is too high, too low, or in line with the market.

Over- or undervaluation of goods common form TBML

Illicit trade invoicing, or intentional over- or undervaluation of goods is one of the most commonly used forms of TBML. In 2014 only, the volume of illicit financial flows for developed countries was estimated between $2 and $3.5 trillion. Of this, an average of 87 percent concerned fraudulent trade invoicing. **

**Source: Illicit financial flows to and from developing countries: 2005-2014, Global Financial Integrity, April 2017, https://www.gfintegrity.org/wp-content/uploads/2017/05/GFI-IFF-Report-2017_final.pdf.

Best practices for assessing the valuation of goods

Regulators expect bank personnel to perform “reasonable” price checks while processing commercial transactions. The dilemma here is that bank personnel are usually not qualified to assess the actual valuation of goods. To solve this in a practical and good way, the following best practices can be implemented:

• Risk-based policies/procedures to guide staff. You can implement reasonable price controls by defining sources from which these prices can be extracted. You can also define acceptable price variation thresholds (for example, plus/minus 20 percent) and formulate clear escalation paths when thresholds are exceeded. The entries can vary between different goods/commodities.
• Price control by independent teams based on risk-based policies. This could include samples or value thresholds on related parties, commodities, customers, and higher risk countries.
• Price controls for commodities, where market prices are generally available, with established price variation thresholds.
• Price controls for commodities where market prices are generally unavailable. Here, identifying any significant, material, apparently unusual, or apparent price deviations plays an important role.
• Implementing an internal pricing system. Appropriate guidelines for selecting reference prices for goods/commodities can be established and reviewed periodically. In addition to market sources, you can obtain input from the valuation of trade transactions involving similar goods/commodities in the current period (internal data analysis). You can also obtain inputs through clients/third parties of reliable integrity.

Conclusion

The regulator, also in the Netherlands, expects banks to do proper research on trade-based money laundering in addition to research on money-based money laundering. In our opinion, the best way to do this is to integrate TBML into the CDD program by adding the trade dimension. We also believe that providing training to one’s own staff on TBML indicators and research is a must. Also, the valuation of goods is a crucial component in TBML research. Formulating best practices for valuation can add much value. We are happy to help you, anytime.