Misuse of the trading system, in a scheme known as trade-based money laundering, is one of the primary methods by which money launderers move money in an attempt to disguise its origins and integrating it into the formal economy.
Trade-based money laundering can take place both domestically and internationally, but it is the international trading system, with its greatest complexities and vulnerabilities, that offers the greatest opportunities for money launderers. The huge volume of business transactions, which can act as a barrier and mask individual illicit transactions, and the mixing of legitimate funds with illegitimate funds, creates an inherent trade-off between disrupting genuine business and detecting illicit transactions.
Differing jurisdictional standards, legal systems and due diligence requirements may result in some jurisdictions having less stringent controls than others. The long supply chain widens the scope for abuse of the international trading system. The journey from manufacturer to consumer is usually a very long process involving traders, shippers, consignees, financiers, shippers, insurers, freight forwarders and possibly other parties.
Examining cargo movements between two countries can be difficult due to the limited resources usually allocated to customs agencies and also due to the lack of information sharing between different jurisdictions. Financial institutions may lack the expertise to make meaningful decisions on product pricing.
Various products are not traded on public markets and their unit price is not publicly available and in cases where the goods are traded on the open market, the prices mentioned on the contract of purchase or sale may not reflect the actual price of the goods. Indeed, merchants tend to be reluctant to reveal it to financial institutions in order to preserve the competitive sensitivity of this information.
Moreover, nowadays, the majority of international trade is carried out on an open account. Although riskier, open account trades are considered profitable. Under these conditions, trade finance instruments are not used. The exporter and importer enter into an agreement and a net payment is made through the financial system shortly after the goods arrive at their destination. Unless credit is provided to one of the parties involved in the transaction, the financial institution will not be aware of the transaction. However, depending on the risk appetite of the financial institution, the transaction may be flagged by transaction monitoring tools.
Misuse of the trading system to conceal illegal movement of funds generally includes methods to distort 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.
Misuse of the trading system usually includes methods to distort the price, quality or quantity of goods
In some cases, collusion may arise because the parties involved in the trade may be controlled by the same person or group of people. For criminals looking to launder illicit funds through trade-based money laundering, payment is the most important piece of the puzzle. The business transaction is used as an additional cover to avoid detection and mask the movement of illicit funds.
Excess value can be transferred from one party to another in various ways using different techniques, some simple and some more complex in combination with other money laundering techniques. Although there are several trade-based money laundering techniques, the goal is always the same, to take advantage of the natural flow of goods in exchange for payment and move value from one place to another without to arouse suspicions.
Overinvoicing of goods is committed when the importer transfers the 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 the excess value to the importer by shipping goods worth more than the amount stated on the invoice.
Another technique is to issue multiple invoices. In this case, several payments are made for the same shipment. The exporter transfers the excess value to the importer by shipping more goods or better quality goods in a technique known as overshipping goods.
On the other hand, undershipment or shortage occurs when the exporter ships less goods or inferior quality goods. Deliberate obfuscation involves omitting information from relevant documentation or deliberately disguising or falsifying it. Another technique is ghost shipping. In this case, no goods are shipped and all documentation is completely falsified.
The main role of financial institutions in international trade is to provide financing and settlement of cross-border transactions. The control of the goods sent is not within their remit. Requiring customers to provide supporting documentation for every business transaction is not feasible and would disrupt legitimate business. And, determining whether any of the mentioned techniques have been used in commerce is not easy and cannot be based on the commercial documentation provided by the customer himself.
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 be a difficult task, but some red flags cannot be ignored.
Financial institutions must know their customers and understand their operations. Customer due diligence measures at the 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, as well as the risks posed by the client.
Continuous monitoring of the business relationship is also important because it will allow the institution to validate that transaction flows are consistent with the client’s business profile.
All views, assumptions or opinions expressed in this article are those of the author. Issued by Bank of Valletta plc, a limited company regulated by the MFSA and authorized to carry on banking and investment services business under the Banking Act (Cap. 371 of the Laws of Malta) and the Banking Services Act investment (Cap 370 of the Laws of Malta).
Josef Galea, AFC Head of Quality Assurance and Testing Unit, Bank of Valletta.
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