Trade finance and trade-based money laundering: Appreciating the dynamics

In trade finance, the fundamental steps of research, analysis, negotiation and contracting are applied to demand and supply of goods to facilitate international trade and commerce. Trade finance process makes it possible and easier for exporters and importers to transact business through international trade. Moreover, it facilitates the introduction of third-parties to transactions to eliminate payment- and supply-related risks. The phrase, trade finance, is also used to refer to financial instruments and products utilised by companies to facilitate international trade and commerce. Undoubtedly, trade finance accounts for the enormous growth in international trade activities and values over the years.

Parties to Trade Finance

Generally, parties involved in trade finance are numerous and could include banks; trade finance companies; importers and exporters; insurers; and export credit agencies and service providers. In Ghana, the list of stakeholders could be extended to include the Ghana Revenue Authority (GRA); Ghana Free Zone Authority; Financial Intelligence Centre (FIC); Bank of Ghana (BoG); Economic and Organised Crime Office (EOCO), and others.

Trade-Based Money Laundering (TBML)

Throughout the world, millions of goods are bought and sold on daily basis. However, bulk of these transactions take place online and through banks. Further, these commercial activities are not homogeneous; they involve goods, people, documentation and currency. The versatile nature of trade finance operations for importers and exporters tends to augment risks associated with trade finance crimes such as trade-based money laundering (TBML).

One of the major nemeses of trade finance within the broader international trade system is trade-based money laundering or transactional crime. Napier (2023) described trade-based money laundering as the strategic initiatives of criminals to move and conceal illicit monies through the use of trade methods. The perpetrators ensure full or high level of efficiency and effectiveness in their movement and concealment of illicit funds on small or large scale. It sometimes manifests in cross-border movement of controlled or illegal goods.

Indeed, trade-based money laundering remains major challenge to the global economy; it undermines, strongly, the integrity of the international trade system; and poses significant threat to the global financial system. Trade-based money laundering (transactional crime) is described by experts as ‘lucrative’ business worth trillions of United States Dollars annually. Frantic efforts are made by the criminal networks to disguise their illicit profits; and this creates the enabling environment for them to derive the expected benefits from the proceeds within the legitimate financial system. Monies laundered through trade can be used to finance wide range of illicit activities such as arms smuggling, human trafficking, terrorism, drug trafficking; and many more.

Actors within the trade-based money laundering space are consistently looking for alternative methods of cleaning or legitimising their money in the global financial system. In view of this, they readily perceive international trade as an enticing avenue towards ‘rapid’ realisation of their nefarious objectives.

Stages of TBML

Activities related to trade-based money laundering are cunningly advanced in three main stages. These include placement, layering and integration stages. At the placement stage, criminals draw on their skill or cleverness to ensure proceeds of illegal activities are introduced to the mainstream and legitimate financial system. By inflating the value of goods in trade transactions and creating artificial profits, the criminals ensure these profits are transferred to foreign bank accounts.

Criminals create complex web of transactions at the layering stage; and this facilitates their separation of illicit funds from the original source. True ownership of the funds is concealed through creation of shell companies; issuance of false invoices; and mislabeling of goods.

The integration stage relates to where the perpetrators draw on their ‘ingenuity’ to reintroduce laundered funds back into the legitimate financial system. The strategies adopted and utilised by the criminals make it difficult for law enforcement agencies to effectively trace the origin of the illicit funds. This criminal activity may be executed through the purchase of high-value goods such as luxury vehicles or artworks, bank transfers, and purchase of real estate.

These illustrative challenges render meaning to the global clarion calls on governments, financial institutions and other organisations to take proactive steps and measures towards detecting and preventing trade-based money laundering before it degenerates to uncontrollable levels; and towards maintaining the sanctity and integrity of the international trade system.

Brief Statistics

Data accessed from the World Trade Organisation (2023) affirmed between 80% and 90% of global trade is transacted and concluded through trade finance, implying only 10% to 20% of global trade is concluded without the ‘direct intervention’ of trade finance. The global trade finance market was valued at nearly US$46.18 billion in 2022. Quite expectedly, it is projected to evolve at a compound annual growth rate (CAGR) of 4.5% to reach market valuation of US$68.62 billion by the end of 2032 (Fact.MR, n.d.).

Currently, the top-three countries leading the global trade finance market account for 42% market share. The global trade finance market share of Europe in 2022 was 26%; while North America accounted for 31% during the same period (Fact.MR, n.d.). Africa accounted for only 3% (African Development Bank, 2023), with the remaining 40% spread among Asia, Latin America and Oceania.

Though the global trade finance value in 2022 (US$46.18 billion) may appear significant, the significance of the value is stymied when juxtaposed with the global trade finance gap value during the same period. In 2022, the global trade finance gap was estimated at US$2.5 trillion, equivalent to 10% of global merchandise trade; and represented 47% or US$0.8 trillion increase over the US$1.7 trillion trade finance gap value recorded in 2020 (Asian Development Bank, 2023).

The amount of money that is laundered through trade-based activities globally, each year, is valued at US$2.2 trillion (Napier, 2023). This is equivalent to 88% of the trade finance gap value in 2022 (US$2.5 trillion); approximately 4.76 times the trade finance value in 2022 (US$46.18 billion); and nearly 3.21 times the projected trade finance value by 2032 (US$68.62 billion).

Further analysis revealed the trade finance gap in 2022 (US$2.5 trillion) was approximately 5.41 times the trade finance value in 2022 (US$46.18 billion); and equivalent to 3.64 times the projected market value by the end of 2032 (US$68.62 billion).

The huge financing gap is indicative of great untapped market potential for banks and other financial institutions in local and international trade, particularly those incorporated in Africa; as the pendulum of population socio-demographics swings in favour of the African continent to accentuate further, its single largest market potential across the globe.

Analysts attributed the widening gap in trade finance to the recent COVID-19 crisis; and related surge in rejection rates of trade financing requests. In Ghana, the situation was exacerbated by the government’s decision to embark on the debt restructuring programme; banks’ appetite for lending to businesses in the private sector was reduced by the government’s announcement on the domestic debt exchange programme (DDEP); and its subsequent implementation.

It is refreshing to state the narratives have changed; banks are making more efforts to diversify their investment portfolios with strong concentration in private sector investment to mitigate inherent investment risks. As practical demonstration of their commitments to the private sector, banks organise regular clinics for businesses in the small- and medium-sized category across the country.

Some Population Figures

Population estimates released by the United Nations (UN) in April 2023; and Worldometer in November 2023 saw India emerging as the world’s most populous country with current estimated population of over 1.434 billion; closely followed by China with estimated population of 1.426 billion. Barely a year ago, Africa’s total population (approximately 1.27 billion) was less the respective populations of China and India. Nonetheless, the narratives have changed in recent periods.

As of mid-November 2023, Africa’s total population was approximately 1.474 billion, which is more than the distinctive populations of India (1.434 billion) and China (1.426 billion) (Worldometer, 2023); and affirmed ready market for over 1.474 billion people through strategic and practical implementation of the African Continental Free Trade Area (AfCFTA) initiative throughout the continent. The commitment towards tackling the issue of trade-based money laundering would help to advance the economic prosperity of the continent as legitimate trade and related financing activities are recorded at accelerated pace.

Common TBML Methods

Perpetrators of trade-based money laundering are consistently searching for loopholes in international trade regulation; and the attendant complicated controls to execute their illicit agenda. The craftiness of criminals indulged in trade-based money laundering cannot be underestimated. Though perpetrators adopt several methods, the most common ones include multiple invoicing; under-invoicing; over-invoicing; phantom shipments; over-shipment; and under-shipment.

Duplicate invoices may be issued for the same shipment of goods to increase the value transferred through the finance system. Alternatively, inflated credit may be generated and received for goods that are collateralised. These unacceptable trade practices are referred to as multiple invoicing. Further, money may be laundered by illicit traders through the intentional act of under-invoicing or over-invoicing; or both.

Both under-invoicing and over-invoicing are otherwise called mispricing; and involve deliberate declaration of goods at an incorrect value (lower or higher than the actual value). Under mispricing, quality may be misrepresented to influence pricing on the invoice; and facilitate transfer of significant amount of money between two companies. The value of goods shipped or traded under this method may be low compared to the payment involved.

Invoices may be prepared and issued for shipment of goods that do not eventually take place; or for goods that turn out not to exist. These phantom shipments are often encouraged by the paper-based nature of the international trade sector which enables parties to a trade to produce fraudulent documents to affirm legitimacy, shipment of goods; and for money to exchange ‘hands.’

It is sometimes possible for exporters to ship fewer goods than initially agreed to importers; and this helps to transfer greater value to the exporters. Conversely, exporters would transfer more goods than originally agreed to importers if the intent is to transfer greater value to the latter. These under-shipment and over-shipment strategies are indicative of the fact that trade-based money laundering is advanced not only through the transfer of funds, but also through shipment of goods (under-declaration and over-declaration of shipped goods).

In addition to the foregoing, shipments may be routed through multiple unconnected subsidiaries or several countries without tangible explanation or reason. Moreover, payment plans may be inconsistent with the level of risk associated with the transaction; while payments for large consignments or shipments may be effected by third parties with no apparent connection to the transaction. Either of these transactions could raise red flag for trade-based money laundering.

Challenges

The World Trade Organisation has current membership of over 160 countries, representing nearly 99% of international trade. Given the large membership size, negotiations become extremely difficult and complex when consensus views of all members are needed; or sought in a given situation. In certain cases, the length of negotiations prevents members from reaching an agreement; and criminals latch on the inherent vulnerabilities to exploit the system.

 

Further, extensive reliance on paperwork makes the application of automation and other innovative solutions in the international trade sector quite difficult. Due to its paper-based nature and limited ability to validate and authenticate documents upon receipt, companies involved in international trade are impelled to take documentation at its face value (which may be at variance with the actual value.

In many jurisdictions, businesses are grappling with issues related to clarity in regulatory expectations and compliance requirements; and these, in addition to monitoring and implementation control challenges, affect their efficiency and effectiveness in combating trade-based money laundering.

The Financial Action Task Force (FATF) is on record to have provided significant guidance to member countries by sharing risk typologies; and best practices. However, there is knowledge gap in effective operationalisation and implementation of these requirements by many member countries; further, there are challenges to effective implementation by institutions and organisations incorporated in those countries.

Another worrying trend is many organisations’ perception of supply chain information as highly proprietary; and thus, reluctant to share with other companies, so they become abreast of current happenings and strategic ways of counteracting the activities of criminals in trade-based money laundering. These ‘reluctant’ organisations perceive the supply chain information at their disposal as unique means of gaining competitive advantage; or gaining an edge over other businesses in their immediate industry, economy; and in the ever-changing and dynamic global business environment. Unfortunately, this ‘organisational behaviour’ does not augur well for the collective fight against trade-finance sector related crimes.

Without conscious efforts of trade-finance sector orgainisations to leverage technology to ensure transition towards supply chain transparency, it may be quite herculean to improve deficiencies associated with supply chain; and reduce overall risks. Further, it may be difficult to effectively identify illicit actors; halt criminal networks; and reduce trade-based money laundering to appreciable levels.

Illicit financial flow remains a major threat to both the international trade and global financial systems; perpetrators of these criminal activities employ adept tactics and strategies towards achieving their objectives. To illustrate, available statistics from the United States Customs and Border Protection (as cited in Napier, 2023) affirmed on a typical day in 2019, about 79,000 containers; and US$7.3 billion worth of goods entered the United States of America through various ports.

The large volume and value of traded goods at issue could be a blend of legitimate with illicit trades. Thus, large trade volumes and values afford criminals the opportunity to hide in plain sight; and execute their trading activities, sometimes in a grand style.

Though banks may be strongly familiar with financial compliance standards such as transaction monitoring, sanctions screening and know-your-customer (KYC) standards, they may lack good knowledge in physical trade operations. This knowledge gap makes it difficult for bank staff to detect red flags that would otherwise be obvious to those familiar with physical trade. The banks’ limited knowledge in this regard could present opportunities for criminals to perpetuate their money laundering activities through trade, using banks to introduce illicit funds to the legitimate financial system.

In the recent case of Ghana in which the Financial Action Task Force placed the country on its Grey List, banks operating in Ghana were saddled with the challenge of de-risking, even after Ghana’s name had been expunged from the Grey List of FATF. Foreign banks were reluctant to transact with their counterparts in Ghana for fear of being sanctioned or fined by their regional bodies and FATF.

The foreign banks’ decision to distance themselves or withdraw their correspondence services from their counterparts in the country impacted adversely on the banks’ ability to process international transaction requests (from their customers). These transaction inhibitions had revenue implications for banks operating in Ghana since fees to be derived from such transactions were limited; and this affected the total revenues from operations for many banks during the period.

Further, customers who needed to effect payment through the banks within specified periods to ensure timely shipment and delivery of their goods; and in most cases avoid late payments and their attendant penalties were denied those ‘timely’ bank transactional services. Given that Ghana remains an import-led economy, undue delays in the delivery of goods could affect aggregate supply in the market, even if aggregate demand remained constant or the same during the FATF-sanction period.

Ceteris paribus, the shortage in aggregate supply with aggregate demand remaining constant would induce upward adjustment of prices; and consistent price increase over a given period would trigger inflation within the economy. In effect, the detrimental impacts of Ghana’s placement on the Grey List of FATF owing to perceived surge in activities related to trade-based money laundering were economically monumental to individuals and businesses; financial institutions including banks; and the country as a whole.

Challenges associated with the effective combat of trade-based money laundering could be summarised as follows: lack of data and information sharing; inadequate technology in many countries and organisations; complexities of trade transactions; limited knowledge and awareness; difficulty in prosecuting trade-based money laundering; and weaknesses inherent in anti-money laundering regulations.

FATF and Sanctions

The Financial Action Task Force remains the watchdog for global money laundering and terrorism financing. With current membership of over two hundred (200) countries and territories, FATF is responsible for setting international standards towards prevention of illicit financing activities with devastating socio-economic impact on the wider society.

Trade-based money laundering could have dire implications for a country’s financial system. To illustrate, Ghana was recently placed on the Grey List of the Financial Action Task Force due to reported incidents of money laundering; and potential use of the country as transit for financing terrorism activities in neighbouring countries.

Ghana’s placement on the Grey List of the Financial Action Task Force affected international correspondence of banks incorporated in the country since their international counterparts in various global regions including Europe were circumspect; and mindful of the financial consequences, including punitive measures in the form of hefty fines for transacting with banks operating in a country that is on the Grey List of FATF.

Strategically Rolled-Out Measures

Series of meetings between Officials of the Financial Action Task Force and their counterparts in Ghana; banks and Ghanaian officials’ commitments to addressing concerns raised by FATF; meeting deadlines for submission of documentations; and practical manifestation of the country’s control over money laundering in all forms, including trade-based money laundering proved satisfactory; and were enough evidence for FATF to remove Ghana from its Grey List.

In recent periods, many countries across the globe have resorted to the adoption of new technologies that render money laundering through financial systems more difficult and expensive. Further, these countries have taken proactive and reactive steps towards introducing regulations and controls that are characteristically rigorous.

Singapore is described as financial, trading and transport hub. However, this economic superlative increases the country’s vulnerability to trade-based money laundering. Mindful of the financial and economic repercussions of money laundering risks to the country, the Monetary Authority of Singapore (MAS) introduced higher standards for financial institutions in its jurisdiction. Quite remarkably, the Monetary Authority of Singapore remains one of the first regulators to introduce higher standards on trade-based money laundering for financial institutions.

The Monetary Authority of Singapore was consistent in its inspection of banks’ trade finance activities during financial years 2012 through 2015; and subsequently released Guidance for the financial institutions in its jurisdiction. Content of the Guidance included detailed observations gleaned from the inspections (in 2012 through 2015); recommendations to ease identification of risks related to trade-based money laundering; and measures that would ensure practical mitigation of the perceived threats.

Recommendations

Discussion in the preceding section revealed and underscored a common thread. That is, there are pertinent issues that trade-based money laundering could rein in the Ghanaian economy; and trigger in the broader global economy if the necessary steps and remedial measures are not taken to nib the potential threats in the bud. The preceding discussion affirmed the potential of trade-based money laundering to undermining the integrity of the international trade system; and posing enormous threat to the global financial system. To avert further catastrophic effects of trade-based money laundering on the global economy, the following recommendations are proffered.

Global bodies such as the Bank of International Settlement (BIS); Wolfberg Group; Bankers’ Association for Finance and Trade (BAFT); increasing number of national regulatory bodies; and Financial Action Task Force are noted for their vast contribution to the higher compliance standards in trade finance in recent years. On this note, these global bodies are encouraged to keep the pace of higher compliance standards to reduce the extent to which criminals perceive and rely on trade-based money laundering to transfer illicit funds into the legitimate financial system.

Transparency in supply chain is needed to adequately inform participating businesses of happenings at various stages of trade, that is, from final production through delivery. Organisations could effectively rely on communicated supply chain information to make internal and external business decisions. The socio-economic benefits of supply chain transparency to firms are manifold. For instance, it has the potential to assure significant improvements in overall resilience through efficiency in the management of disruption risks, third-party risk and concentration risks.

The risk mitigation efforts of trade-finance sector organisations would be improved considerably if novel technologies are automated to facilitate the process of identification, assessment and prevention of risks inherent in supply chains.

International trade is touted as the global sector with the most complicated regulations (Napier, 2023). This notwithstanding, activities in the sector thrive on a range of overlapping multilateral and bilateral agreements; and prevailing international standards from bodies such as the International Chamber of Commerce (ICC); International Civil Aviation Organisation (ICAO); World Customs Organisation (WCO); and World Trade Organisation (WTO). More importantly, these global bodies need to ensure the world consistently observes sharp surge in export-import controls on dual use goods; selected chemicals and precursors; and protected wildlife.

Further, there is the need for more sanctions; and increasing embargoes on unilateral and multilateral trades that are not transacted and concluded in tandem with international best practices and standards. By its simplest definition, international trade connotes exchange of goods across borders. Thus, the ability to ensure holistic and meaningful resolution of challenges or risks associated with trade-based money laundering would be predicated on consistent technical capabilities of countries and financial institutions, supported by consistent global standards and regulatory expectations.

Maintenance of complete, consistent and accurate information between actors in the finance world and those in the physical trade-based world is needed to effectively advance the combat of trade-based money laundering. Stated in different terms, the information asymmetry inherent in the correspondence between actors within the financial system that provides the needed finance for most local and international trades; and organisations (actors) that are in-charge of the physical shipping logistics should be bridged to support early detection and prevention of trade-based money laundering activities.

Based on the foregoing submission, it suffices to state some specialist would often be needed to determine the reasonableness or feasibility underlying physical trades prior to approval and payment. Stated differently, cross-discipline expertise would be needed to create positive connections between trade finance and physical trade to avert the extent of exploitations suffered at the hands of criminals through trade-based money laundering activities.

Banks and other institutions in the financial sector are noted for strong utilisation of technology in their day-to-day operations; and effective utilisation of technology in international banking transactions. However, the same cannot be said about actors in the main physical trade space, with excessive reliance on paper-based document filing. Indeed, technology has the potential to cause a surge in trade compliance; disrupt criminal networks; and reduce trade-based money laundering. However, achieving this feat would mean the international trade sector transitioning from its overreliance on paper-based document filing to integral use of technology. This would ensure rapid application of automation and overlay of innovative technologies to support early detection and prevention of trade-based money laundering.

New technologies are needed to address the complex challenges introduced by the extremely complex international trade. Developed software for machine learning and artificial intelligence (AI) should be used to identify suspicious activities in the international trade space; and suspicious transaction behaviours within the global financial sector. The machine learning models could be tailored to train on relevant threat typologies and related trade patterns to allow the system to generate more automatic alerts and accurate red flags, when inconsistencies are experienced. Machine learning and artificial intelligence technology could be relied on by the trade-finance sector actors to reduce information asymmetry challenges; and improve evaluation and legitimacy of proposed trade sanctions.

Higher data ‘surveillance’ in trade-based organisations; and within banks and other financial institutions is needed to minimise the socio-economic effects of money laundering. Many trade-finance sector organisations generate profiles for vendors and suppliers; and conduct periodic risk assessment. However, the frequency of their risk assessments does evolve at the pace of global transformation; and this tends to give criminal networks some edge in the international trade and finance space. To cope with the global pace, it remains imperative for trade-finance organisations (particularly banks) to transition towards adoption and implementation of the perpetual know-your-customer (pKYC) model, which emphasises event-driven and ongoing reviews to the ‘neglect’ of periodic third-party reviews.

 

Application of the perpetual know-your-customer model would enable automation across all end-to-end periodic process steps in know-your-customer reviews. This model would be powered by technology. Banks and other organisations involved in trade finance could unlock greater transparency of evolving risk through perpetual monitoring of customers’ (vendors and suppliers’) profiles.

Further Recommended Measures

The writer recently moderated panel discussion on a topic related to the phenomenon under discussion. The Panelists comprised compliance experts drawn from selected universal banks in the country. Each panelist underscored the financial, economic and social harm that trade-based money laundering inflicts; and could potentially inflict, going forward, on the national and global financial systems; and the urgent need for the necessary remedial measures to be outlined and implemented to facilitate early detection and prevention through concerted efforts. In view of the foregoing, the ensuing recommendations were offered.

To effectively stem the tide, the panelists were unanimous in their call for strategic training of bank staff; and staff of other financial institutions in how to effectively detect and prevent trade-based money laundering since it is unique area in banking and finance; and the criminals are technically sophisticated and technologically savvy in their handling of the (trade-based) money laundering operations.

It remains imperative for the Bank of Ghana to consider periodic issuance of directives and guidelines to inform local banks’ internal operations; and transactions with foreign banks. The periodic guidelines could ‘insure’ the going concern of local banks; and affirm sustainable relations with foreign banks; while controlling the activities of trade-based money laundering that are channeled through the financial system.

Finally, the panelists identified due diligence; seamless flow of useful information among member banks and other financial institutions; regular training and guidance by BoG; and ‘public’ sharing of success stories on crime prevention strategies by regulatory agencies and financial institutions as useful to equipping all financial institutions with the requisite information and tools to effectively detect and combat trade-based money laundering activities.

Indeed, the collective fight against trade-based money laundering would be sustained and improved considerably if the level of transparency in international trade is increased; information asymmetry among trade-finance sector organisations is improved; anti-money laundering regulations are strengthened; trade-finance sector companies are technologically equipped to ensure early detection and prevention; and cross-border trade co-operation among law enforcement agencies are enhanced, amongst others.

The writer would like to acknowledge Mrs. Abena Asare-Menako (Societe Generale (SG), Ghana; and Messrs. Isaac Brown (Absa Bank), Vincent Osam (Standard Chartered Bank) and Philip Odoom (United Bank for Africa (UBA), Ghana) for their valuable contribution to this publication.

 

 

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