How trade-based money laundering works and its impact on world finances

Money laundering is big business, so big, that to handle the movement of enormous sums of money, fraudsters are increasingly turning to Trade-Based Money Laundering (TBML). In developing countries, TBML and associated tax evasion contributed to almost $9 trillion in losses between 2008 and 2017. Tackling TBML is complicated by cross-jurisdiction trade, multinational companies, and globalized trade pathways.

Money laundering, used to legitimize monies from some of the most grievous crimes, is classified by the Financial Action Task Force (FATF) into three main areas:

• Use of legitimate underlying financial systems, e.g. check and wire transfers.

• The physical movement of money, e.g. cash couriers.

• The physical movement of goods through the trade system (TBML).

TBML fraudsters use certain methods to facilitate the crime:

Mispricing, also called trade misinvoicing, is a common technique used in TBML. Goods invoices are deliberately misrepresented in terms of value, type, or volume. The technique involves over or under-invoicing and can also use a system of multiple-invoicing, also known as split-invoicing.

Some TBML scams use phantom shipments – shipments of goods that don’t occur, or that don’t exist. Fake documentation is generated as if the goods will be shipped. Foreign remittances are received by the exporters as part of import/export collusion. The whole process looks legitimate, money is exchanged, but no actual goods are shipped.

This is allegedly the most common form of transactions used to facilitate TBML across borders. The seller ships more/less than the invoiced quantity or quality of goods thereby misrepresenting the true value of goods in the documents. The effect is similar to over/under invoicing.

The trick in the mechanisms used in TBML fraud is that they look legitimate. By appearing as real-world transactions and ticking the regulatory boxes, they can more easily go under the radar. Whatever mechanism is used to move money or hide funds, the ultimate outcome is to overcome structures put in place to prevent this type of fraud. Regulations and other structures attempt to prevent this type of sophisticated and highly obfuscated activity. However, some contradictions in these attempts may be thwarting the wider handling of TBML.

In a recent report, the Government Accountability Office (GAO) found that around 80% of international trade processed through financial institutions is performed using “open account” trade, i.e. one that is not financed by the bank. The GAO described this tactic as “one of the primary vulnerabilities of the US financial and trade systems”. The GAO goes on to describe how open account trade has inherent vulnerabilities – it uses standard anti-money laundering (AML) and sanction screening for payment processing. Suspicious Activity Reports (SARs) are required to be lodged with FinCEN as part of the process. This should, in theory, be enough to spot fraud. However, according to the GAO report, “Subject-matter experts and representatives of banks say a bank’s ability to identify indicators associated with TBML is limited for open-account transactions”. This contradiction is the pivot upon which TBML turns.

These mechanisms are recognized as weaknesses in trade processes and help drive TBML. The regulations themselves show this to be true. For example, in 2019, 1.15 million reports were submitted on money laundering; only 0.2% related to TBML – the figures do not add up, mismatching the actual figures for TBML-based fraud which currently stands at around 30% of all money laundering crimes. In terms of SARs, the lag time contradicts the ability to spot fraud on-the-fly. The recent FinCEN SAR leaks debacle demonstrates the issues with SARs.

The inability to spot fraud that flies under the radar of legitimate checks and measures leads to serious crimes and can ruin lives or worse. TBML laundered money leads to:

• Movement of corrupt funds: In the UK, alone, £100 billion of “dirty money” is moved each year.

• Human trafficking: At any one time there are over 40 million enslaved and 152 million in child labour around the world.

• Tax evasion: The global estimate of capital income tax evasion is around $189 billion per year – TBML may be used to help in avoiding sanction lists.

• Evasion of currency restrictions: FinCEN is aware of the use of TBML methods to evade current restrictions. FinCEN released an advisory on TBML activity involving “funnel accounts”. These are accounts where an individual or business account in one jurisdiction receives multiple cash deposits. These deposits are usually under the reporting threshold to avoid suspicion. The funds are then quickly withdrawn via a different location.

• Evasion of import duties on luxury goods: Similar to tax evasion, but luxury goods, such as watches and cars, are often also part of over or under-invoicing scams.

US Customs and Border Protection (CBP) recorded that on a typical day in 2019, around 79,000 containers and $7.3 billion worth of goods entered the US through ports of entry. This massive movement of traded goods offers fraudsters enormous opportunities to hide in plain sight. TBML is successful because it uses the very structures that have been put in place to prevent fraud: documentation, customer/invoicing processes, and open trade accounts are all twisted by fraudsters to hide or obfuscate the illegitimate movement of money. When trading partners transact, they do so without bank intervention – the trade flowing outside the normal confines of the payment system. It is this divergence of systems and processes that allows fraudsters to find a chink in the financial insitutions armour. The AML process needed to tease out the complex nature of TBML requires a smarter approach.