The misuse of the trade system, in a scheme known as trade-based money laundering is one of the principal methods by which money launderers move money for the purpose of disguising its origins and integrating it into the formal economy.
Trade-based money laundering can take place on both a domestic and an international level, but it is the international trade system, with its greater complexities and vulnerabilities, that provides the best opportunities for money launderers. The enormous volume of trade transactions, which are able to act as a barrier and obscure individual illicit transactions, and the commingling of legitimate with illegitimate funds, creates an inherent trade-off between disrupting genuine business and detecting illicit transactions.
Different jurisdictional standards, legal systems and due diligence requirements may result in some jurisdictions to have less stringent controls than others. The long supply chain broadens the scope for abuse of the international trade system. The journey from manufacturer to consumer is generally a very long process that involves traders, consigners, consignees, financiers, shippers, insurers, freight forwarders and possibly other parties.
Examining cargo movements between two countries may prove to be difficult due to the limited resources generally assigned to customs agencies and also due to the lack of information sharing between different jurisdictions. Financial institutions may lack the expertise to make meaningful determinations about product pricing.
Various products are not traded in public markets and their unit pricing is not publicly available and in cases where goods are traded in the open market, prices mentioned on the contract of purchase or sale may not reflect the real price of the goods. This is because traders tend to be reluctant to reveal this to financial institutions in order to safeguard the competitive sensitivity of such information.
Also, in this day and age, the majority of international trade is carried out under open-account terms. Albeit riskier, open-account transactions are considered as cost effective. Under such terms, trade finance instruments are not used. The exporter and importer enter into an agreement and a clean payment is made through the financial system soon after the goods reach their destination. Unless credit is provided to one of the parties involved in the trade, the financial institution will not be aware of the transaction. Nonetheless, depending on the risk appetite of the financial institution, the transaction may be flagged by the transaction-monitoring tools.
The misuse of the trade system to obscure the illegal movement of funds, usually includes methods to misrepresent the price, quality or quantity of goods. Collusion between seller and buyer is usually present when using these techniques, as the intention is to obtain excess value through a transaction between two parties.
The misuse of the trade system usually includes methods to misrepresent the price, quality or quantity of goods
In certain cases, collusion may arise because the parties involved in the trade may be controlled by the same person or group of persons. For criminals looking to launder illicit funds through trade-based money laundering, the payment is the most important piece of the puzzle. The trade transaction is used as an additional cover to avoid detection and to mask the movement of illicit funds.
Excess value can be transferred from one party to another in a variety of ways using different techniques, some of them simple and others that are more complex because they are combined with other money-laundering techniques. Although there are several trade-based money-laundering techniques, the aim is always the same, leveraging the natural flow of goods in exchange for payment and moving value from one location to another without arousing suspicion.
Over-invoicing of goods is committed when the importer transfers excess value to the exporter because the price of the goods is inflated. Under-invoicing of goods is the opposite of over-invoicing, the exporter transfers excess value to the importer by shipping goods of greater value than the amount stated on the invoice.
Another technique involves issuing multiple invoices. In this case, multiple payments are made for the same shipment. The exporter transfers excess value to the importer by shipping more goods or goods of a higher quality in a technique known as over- shipment of goods.
On the other hand, under- or short-shipment occurs when the exporter ships less goods or goods of a lower quality. Deliberate obfuscation entails omitting information from the relevant documentation or deliberately disguising or falsifying it. Another technique is phantom shipping. In this case, no goods are shipped and all documentation is completely falsified.
The primary role of financial institutions in international trade is to provide financing and settlement of cross-border transactions. Checking the goods being shipped does not fall within their remit. Asking customers to provide supporting documentation for every trade transaction is not feasible and would disrupt legitimate business. And, determining whether one of the mentioned techniques was used in the trade is not easy and cannot be based on the trade documentation provided by the customer itself.
However, financial institutions play a key role in detecting financial crime and protecting the integrity of the financial system. Detecting trade-based money laundering can prove to be a challenging task, nevertheless certain red flags cannot be ignored.
Financial institutions need to know their customers and understand their operations. Customer due diligence measures at onboarding stage are crucial as they will allow the institution to understand expected volumes and values, trade flows, location of counterparties and types of goods and services involved, and the risks posed by the customer.
Ongoing monitoring of the business relationship is also important as it will allow the institution to validate that the transaction flows are consistent with the business profile of the customer.
Any views, assumptions or opinions expressed in this article are those of the author. Issued by Bank of Valletta plc, a public limited company regulated by the MFSA and licensed to carry out the business of banking and investment services in terms of the Banking Act (Cap. 371 of the Laws of Malta) and the Investment Services Act (Cap. 370 of the Laws of Malta).
Josef Galea, AFC Head of Quality Assurance & Testing Unit, Bank of Valletta.