June 24, 2019 by Jason Kohn

Global trade has quadrupled in the last 25 years, and with this growth has come the increased risk of trade-based money laundering. Criminals often use the legitimate flow of goods across borders—and the accompanying movement of funds—to relocate value from one jurisdiction to another without attracting the attention of law enforcement. As an example, imagine a criminal organization that wants to move dirty money from China to Canada, while disguising the illicit origins of that money. The organization colludes with (or sets up) an exporter in Canada and an importer in China. The exporter then contracts to ship $2 million worth of goods to China and bills the importer for the full $2 million, but, crucially, only ships goods worth $1 million. Once the bill is paid, $1 million has been transferred across borders and a paper trail makes the money seem legitimate. The process works in reverse as well: the Canadian exporter might ship $1 million worth of goods to the Chinese importer but only bill the importer $500,000. When those goods are sold on the open market, the additional $500,000 is deposited in an account in China for the benefit of the criminal organization. Besides these classic over- and under-invoicing techniques, there are other forms of trade-based money laundering, including invoicing the same shipment multiple times, shipping goods other than those invoiced, simply shipping nothing at all while issuing a fake invoice, or even more complicated schemes (see here and here for examples).

As governments have cracked down on traditional money-laundering schemes—such as cash smuggling and financial system manipulation—trade-based money laundering has become increasingly common. Indeed, the NGO Global Financial Integrity estimates that trade misinvoicing has become “the primary means for illicitly shifting funds between developing and advanced countries.” Unfortunately, trade-based money laundering is notoriously difficult to detect, in part because of the scale of global trade: it’s easy to hide millions of dollars in global trading flows worth trillions. (Catching trade-based money laundering has been likened to searching for a bad needle in a stack of needles.) Furthermore, the deceptions involved in trade-based money laundering can be quite subtle: shipping paperwork may be consistent with sales contracts and with the actual shipped goods, so the illicit value transfer will remain hidden unless investigators have a good idea of the true market value of the goods. Using hard-to-value goods, such as fashionable clothes or used cars, can make detection nearly impossible. Moreover, sophisticated criminals render these schemes even more slippery by commingling illicit and legitimate business ventures, shipping goods through third countries, routing payments through intermediaries, and taking advantage of lax customs regulations in certain jurisdictions, especially free trade zones (see here and here). In a world where few shipping containers are physically inspected (see here, here, and here), total failure to detect trade-based money laundering is “just a decimal point away.”

The international community can and should be doing more to combat trade-based money laundering, starting with the following steps:

  • First, the Financial Action Task Force (FATF) should update its 40 Recommendations to include measures specifically addressing trade-based money laundering. FATF’s 40 Recommendations represent the international gold standard in anti-money laundering (AML) policy and practice. Member states use those recommendations to assess one another’s AML architecture through a process of “mutual evaluations.” Yet the latest version of the 40 Recommendations (updated in 2018) makes no specific mention of trade-based money laundering and includes no recommendations directed at this particular problem. While FATF did publish a paper in 2008 describing trade-based money laundering and recommending certain countermeasures, this paper has not been updated, and the mutual evaluation process still does not assess member states on their implementation of the paper’s suggested measures. FATF should update the 2008 paper and then officially incorporate its contents into the 40 Recommendations and the mutual evaluation process.
  • Second, countries should do a better job sharing data in order to identify suspicious transactions. For example, the U.S. has established a Trade Transparency Unit (TTU) that collects U.S. customs and trade data and uses that data to detect and investigate suspicious transactions. The TTU model is meant to be exported, with equivalent units in different countries partnering to share data and expertise, which allows each unit to see both sides of a trade transaction, significantly increasing the likelihood of identifying trade-based money laundering. Though this program has been lauded for its effectiveness (see here, here, and here), as of 2017 the U.S. TTU has counterparts in only 14 overseas jurisdictions, and this list does not include major U.S. trading partners such as China, Canada, and Germany. The international community—and countries that are already leaders in this area, like the U.S.—should encourage other countries to establish their own TTUs and the accompanying networks for the exchange of trade data. Each additional partner will increase the efficacy of the TTU model and will ensure that transshipment (shipping from country A to B to C) does not allow money launderers to circumvent the existing TTU network.
  • Third, countries should investigate the feasibility of imposing AML compliance obligations on new industries in order to capture trade-based money laundering. Current AML regulation relies mainly on financial institutions to report suspicious transactions to law enforcement, but this bank-focused system is ill-equipped to detect trade-based money laundering. About 80% of global trade is not bank financed, which means that financial institutions typically have little information with which to identify suspicious trade transactions. For this reason, and again taking the U.S. as an example, it is unsurprising that fewer than 1% of suspicious activity reports submitted to the Financial Crimes Enforcement Network by financial institutions from 2012 to 2016 related to trade-based money laundering. In response, some have advocated expanding AML compliance obligations, like the filing of suspicious activity reports, to industries that facilitate the global supply chain, such as importers and exporters, shipping and freight companies, air couriers, etc. (see here and here). Unsurprisingly, critics caution that such a drastic and expensive regulatory intervention would slow down the global trade system, a major engine of economic growth. What’s clear is that, without more data, policymakers cannot make an informed decision. Individual countries, or perhaps FATF, should therefore investigate the costs, benefits, and feasibility of imposing enhanced AML compliance requirements on trade-facilitating industries (as has already been done for customs inspections).

Trade-based money laundering is a serious problem; it’s time the international community took more serious action in response.

Posted on June 24, 2019 by Jason Kohn

Global trade has quadrupled in the last 25 years, and with this growth has come the increased risk of trade-based money laundering. Criminals often use the legitimate flow of goods across borders—and the accompanying movement of funds—to relocate value from one jurisdiction to another without attracting the attention of law enforcement. As an example, imagine a criminal organization that wants to move dirty money from China to Canada, while disguising the illicit origins of that money. The organization colludes with (or sets up) an exporter in Canada and an importer in China. The exporter then contracts to ship $2 million worth of goods to China and bills the importer for the full $2 million, but, crucially, only ships goods worth $1 million. Once the bill is paid, $1 million has been transferred across borders and a paper trail makes the money seem legitimate. The process works in reverse as well: the Canadian exporter might ship $1 million worth of goods to the Chinese importer but only bill the importer $500,000. When those goods are sold on the open market, the additional $500,000 is deposited in an account in China for the benefit of the criminal organization. Besides these classic over- and under-invoicing techniques, there are other forms of trade-based money laundering, including invoicing the same shipment multiple times, shipping goods other than those invoiced, simply shipping nothing at all while issuing a fake invoice, or even more complicated schemes (see here and here for examples).

As governments have cracked down on traditional money-laundering schemes—such as cash smuggling and financial system manipulation—trade-based money laundering has become increasingly common. Indeed, the NGO Global Financial Integrity estimates that trade misinvoicing has become “the primary means for illicitly shifting funds between developing and advanced countries.” Unfortunately, trade-based money laundering is notoriously difficult to detect, in part because of the scale of global trade: it’s easy to hide millions of dollars in global trading flows worth trillions. (Catching trade-based money laundering has been likened to searching for a bad needle in a stack of needles.) Furthermore, the deceptions involved in trade-based money laundering can be quite subtle: shipping paperwork may be consistent with sales contracts and with the actual shipped goods, so the illicit value transfer will remain hidden unless investigators have a good idea of the true market value of the goods. Using hard-to-value goods, such as fashionable clothes or used cars, can make detection nearly impossible. Moreover, sophisticated criminals render these schemes even more slippery by commingling illicit and legitimate business ventures, shipping goods through third countries, routing payments through intermediaries, and taking advantage of lax customs regulations in certain jurisdictions, especially free trade zones (see here and here). In a world where few shipping containers are physically inspected (see here, here, and here), total failure to detect trade-based money laundering is “just a decimal point away.”

The international community can and should be doing more to combat trade-based money laundering, starting with the following steps:

  • First, the Financial Action Task Force (FATF) should update its 40 Recommendations to include measures specifically addressing trade-based money laundering. FATF’s 40 Recommendations represent the international gold standard in anti-money laundering (AML) policy and practice. Member states use those recommendations to assess one another’s AML architecture through a process of “mutual evaluations.” Yet the latest version of the 40 Recommendations (updated in 2018) makes no specific mention of trade-based money laundering and includes no recommendations directed at this particular problem. While FATF did publish a paper in 2008 describing trade-based money laundering and recommending certain countermeasures, this paper has not been updated, and the mutual evaluation process still does not assess member states on their implementation of the paper’s suggested measures. FATF should update the 2008 paper and then officially incorporate its contents into the 40 Recommendations and the mutual evaluation process.
  • Second, countries should do a better job sharing data in order to identify suspicious transactions. For example, the U.S. has established a Trade Transparency Unit (TTU) that collects U.S. customs and trade data and uses that data to detect and investigate suspicious transactions. The TTU model is meant to be exported, with equivalent units in different countries partnering to share data and expertise, which allows each unit to see both sides of a trade transaction, significantly increasing the likelihood of identifying trade-based money laundering. Though this program has been lauded for its effectiveness (see here, here, and here), as of 2017 the U.S. TTU has counterparts in only 14 overseas jurisdictions, and this list does not include major U.S. trading partners such as China, Canada, and Germany. The international community—and countries that are already leaders in this area, like the U.S.—should encourage other countries to establish their own TTUs and the accompanying networks for the exchange of trade data. Each additional partner will increase the efficacy of the TTU model and will ensure that transshipment (shipping from country A to B to C) does not allow money launderers to circumvent the existing TTU network.
  • Third, countries should investigate the feasibility of imposing AML compliance obligations on new industries in order to capture trade-based money laundering. Current AML regulation relies mainly on financial institutions to report suspicious transactions to law enforcement, but this bank-focused system is ill-equipped to detect trade-based money laundering. About 80% of global trade is not bank financed, which means that financial institutions typically have little information with which to identify suspicious trade transactions. For this reason, and again taking the U.S. as an example, it is unsurprising that fewer than 1% of suspicious activity reports submitted to the Financial Crimes Enforcement Network by financial institutions from 2012 to 2016 related to trade-based money laundering. In response, some have advocated expanding AML compliance obligations, like the filing of suspicious activity reports, to industries that facilitate the global supply chain, such as importers and exporters, shipping and freight companies, air couriers, etc. (see here and here). Unsurprisingly, critics caution that such a drastic and expensive regulatory intervention would slow down the global trade system, a major engine of economic growth. What’s clear is that, without more data, policymakers cannot make an informed decision. Individual countries, or perhaps FATF, should therefore investigate the costs, benefits, and feasibility of imposing enhanced AML compliance requirements on trade-facilitating industries (as has already been done for customs inspections).

Trade-based money laundering is a serious problem; it’s time the international community took more serious action in response.

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