Governments worldwide are sharpening their focus on money laundering executed through international trade. Anti-money laundering obligations on entities beyond traditional financial institutions continue to expand. Companies active in international trade, regardless of where they are located, should take notice as their supply chains continue to come under greater scrutiny.
International attention on trade-based money laundering ("TBML") continues to grow. Over the past several months, the Financial Action Task Force ("FATF"), the international standard-setting body for anti-money laundering ("AML"), and the Egmont Group of Financial Intelligence Units ("FIUs"), which includes the national FIUs of many countries, provided comprehensive guidance on the subject and detailed risk indicators. National governments have also taken steps to better understand and address this issue.1 While specific obligations may not immediately follow, companies active in international trade should understand the risks posed by TBML and the potential impact on their operations.
Many companies active in international trade must simply comply with laws criminalizing financial crimes. For many jurisdictions, the crime of money laundering requires that a defendant has knowledge that the subject of a transaction is derived from the proceeds of crime.2 But, in some jurisdictions, the mere possession of assets derived from the proceeds of crime or intended to further criminal activities can create criminal liability. Regardless, even the unwitting association in a money laundering scheme will often result in reputational damage that could negatively affect both banking and trading relationships.
Very few companies active in international trade are considered "financial institutions," subject to various recordkeeping and reporting obligations that are found in laws such as the US Bank Secrecy Act. While neither the FATF/Egmont report or other national-level studies, such as the one required of the US Department of the Treasury in the NDAA of 2021, will likely result in immediate obligations on companies active in international trade, in the past, similar products from these bodies initiated policy discussions that have led to more formal action, including new international standards, guidance, strategies and even specific compliance obligations. In fact, some jurisdictions have already incorporated certain companies active in international trade (and even customs brokers and other international trade professionals, as in the case of Mexico) into their AML regimes in some way. Regardless, such companies may also expect to receive broader requests for information from their financial institutions, which will be responding to regulatory pressure to address TBML.
Trade-based Money Laundering
The global value of the merchandise exports during 2019 was nearly US$19 trillion.3 Such a volume of transactions is an attractive target for criminals to leverage to hide their illegal gains. If even two percent of trade involves the proceeds of crime,4 the global trade network could be facilitating approximately US$380 billion in illicit proceeds annually. It is no wonder why some many governments, worldwide, are concerned about trade payments as a vehicle for money laundering.
TBML is defined as "the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise [sic] their illegal origin or finance their activities."5 There is a corollary process called Trade-based Terrorist Financing ("TBTF"), which uses the same processes as TBML to finance terrorism, but the value moved can come from both legitimate and illegitimate sources. It is important to note that the aim of TBML/TBTF is the movement of money, and the movement of goods is the mechanism for obscuring the true origins or purposes of the money.
Trade payments can be conducted through a number of different processes, including through letters of credit, documentary collections, and on open account, among others. Through letters of credit and documentary collections, the financial institutions that process the payments have at least nominal access to information about the underlying trades. But approximately 80 percent of international trade is on open account, which refers to a sale where the goods are shipped and delivered before payment is due. This creates a disconnect between the information about the payment and the information about the trade that can be exploited by organized criminals and professional money launderers.
Governments rely on financial institutions' singular access to information about payments to detect and mitigate money laundering and terrorist financing, generally. However, with much of the world's trade payments processed on "open account," financial institutions no longer have access to the information that would otherwise allow them to detect anomalous or suspicious activity. When information about a payment is divorced from the underlying trade, as it often is in open account trades, a financial institution has insufficient context to determine if the payment is unreasonable or unexpected in the set of given circumstances and, therefore, suspicious.
In particular, in open account trades, financial institutions are often unable to verify the accuracy or integrity of the trade documents submitted as part of their due diligence process. Such documentation is often in different formats and languages, meaning verification must be completed manually. Even if the financial institution does not have issues from a process standpoint, the financial institution will often not have access to public customs data to verify the underlying substance of the documentation. Similarly, financial institutions are in a bad position to estimate what is a "fair price" of a traded commodity, which makes it difficult for them to detect TBML that relies on mispricing to move value up and down the supply chain.6
For these reasons, financial institutions often consider TBML/TBTF as the hardest type of money laundering activity to detect. They have reported to the FATF that TBML/TBTF is highly adaptive and can exploit any sector or commodity, making it difficult for them to prioritize resources and translate new typologies and guidance into their compliance systems.7
Outside of financial institutions, law-abiding organizations involved in the supply chain generally only see a narrow cross-section of the payments chain. But, because so few of those organizations understand the significance of TBML/TBTF or how to detect it, they may overlook red flags—even if they have the capability to detect them, which financial institutions may not have. This, results in fewer TBML/TBTF-related reports, which are of lower quality, to government agencies, who themselves have issues seeing the whole picture across different (and often competing) agencies and national borders.8
There is also the matter of the World Trade Organization ("WTO"). While the WTO has confirmed that "WTO Members are entitled to enforce policies aimed at combating under-invoicing, smuggling and money laundering, and any related problems, provided however, that measures implemented for these purposes are themselves WTO-consistent,"9 in relevant dispute settlement proceedings, the WTO has found attempts by national governments to address TBML to be unjustified under WTO laws.10 However, there appears to be new momentum at the WTO to recognize legitimate efforts to combat TBML and other types of illicit trade.
Risks and Typologies
Any commodity could be an appropriate vehicle for TBML/TBTF, but the FATF warns that goods with (i) wide price margins, (ii) extended trade cycles—that is, spanning multiple jurisdictions, and (iii) that are difficult to examine by customs authorities, are particularly vulnerable to TBML/TBTF.11 The global disruption of supply chains by the COVID-19 pandemic has only created further opportunities for criminal groups to infiltrate
Supply chains moving lower-value goods are most at risk to end-to-end ownership by a criminal organization or professional money launderers. Costs are lower—setting up the scheme is generally cheaper and such a scheme is less likely to attract the attention of government authorities.12 When criminal organizations or professional money launderers exploit higher value products, they are more likely to do so through the penetration and subsequent misuse of established supply chains. They may buy their way into a legitimate company and then use the business and its supply chain contacts to launder the proceeds of crime.13
Many TBML/TBTF typologies rely on the witting participation of both the exporter and importer. When both sides are complicit, techniques such as over- and under-invoicing of goods and services, over- and under-shipment of goods and services, multiple invoicing of goods and services, and falsely describing goods and services are more likely to go by without challenge, as there will not be an aggrieved party that will report such inconsistencies to appropriate authorities.
What is more dangerous, however, is when legitimate companies are taken over by organized criminals and professional money launderers. Such a company may not use the most common TBML/TBTF techniques, but rather appear to maintain relatively normal operations. Companies active in international trade should be sensitive to:
- Rapid growth of newly formed companies into existing markets
- Evidence of consistent and significant cash payments, including those directed towards previously unknown third-parties
- Unnecessarily complicated and complex supply chains, involving multiple transshipments
- Previously established companies specializing in one sector that unexpectedly pivot into an entirely unrelated sector
- Companies simultaneously involved in more than one unrelated sector14
Where such information is available, significant changes in a business's beneficial ownership without acknowledgement of that change, particularly where the new beneficial owners have little experience in the industry, may also be red flags.15
Expectations for Risk Management
Although it cannot be assured, the FATF/Egmont report and the pending US Government study may be first steps to embark on further work combatting TBML/TBTF. In the past, such projects examining money laundering/terrorism financing trends and methods have become stepping-stones for policy development endeavors. Regulation of companies active in international trade would not be without precedent. For example, in Germany, the national legal framework designated "traders of goods" as reporting entities that therefore must report suspicious activity to competent authorities.
However, it is more likely that companies active in international trade will face greater expectations of transparency from their financial institution partners. This may be seen in trade-specific payments processes, where financial institutions may seek greater information about a company's beneficial owners or more substantial documentation about the trade itself to verify its integrity. Some financial institutions have even set up special mechanisms to engage in a dialogue with their customers on TBML/TBTF.16
Financial institutions may also seek representations, warranties and covenants in its corporate financing transactions. The financial institutions may seek assurances that the company has policies and procedures regarding cash transactions or for conducting due diligence of trade partners and their beneficial owners.
One of the best ways to mitigate legal or reputational risks for a company active in international trade is to increase the AML due diligence it conducts on its trading partners along the supply chain. Such due diligence would build on existing expectations to conduct due diligence for human rights and Environmental-Social-Governance ("ESG") risks.17 Even if governments have not implemented specific requirements to do so, entities in the private sector are benchmarking companies against ESG standards and could easily begin to address AML issues as well.18
Companies active in international trade may also build AML terms into their purchase and sale contracts, particularly where due diligence indicates a higher level of risk. Such terms may include restrictions on the use of cash, disclosure of beneficial owners of counterparties, and representations on the legitimate origin of goods and use of proceeds.
All companies active in international trade should understand the risks and typologies associated with TBML/TBTF. While most such companies do not have specific obligations to address TBML/TBTF yet, the expectations on such companies continue to rise, as AML stakeholders understand the value such companies hold to understanding and combatting TBML/TBTF. Companies active in international trade may consider conducting more AML-specific due diligence to mitigate its legal and reputational risks.
1 See, for example, Section 6506 of the U.S. National Defense Authorization Act of 2021 ("NDAA"), which requires the Secretary of the Treasury to draft a report and strategy on TBML. For our analysis of other AML elements of the NDAA, please see White & Case, Corporate Transparency Act and New Implications for US Special Purpose Vehicles, Wealth Structuring and Other Arrangements (Jan. 26, 2021) and White & Case, Patriot Act Subpoenas: Reinvigorated and Reaching Across Borders (Jan. 28, 2021).
2 In the US, see 18 U.S.C. §§ 1956 and 1957.
3 World Trade Organization, Merchandise exports by product group- annual (Million US dollar), Geneva, Switzerland (2020).
4 UN Office on Drugs and Crimes, Money Laundering.
5 FATF – Egmont Group, Trade-based Money Laundering: Trends and Developments, p. 11 (Dec. 2020).
6 Ibid, pp. 41-42.
7 Ibid, p. 41.
8 Ibid, p. 38.
9 Panel Report, Colombia – Indicative Prices and Restrictions on Points of Entry, WTO Doc. WT/DS366/R, adopted May 20, 2009, p. 197.
10 See also, Panel Report, Argentina – Measures Related to Trade in Goods and Services, WTO Doc. WT/DS453/R, adopted May 9, 2016.
11 FATF – Egmont Group, p. 20.
14 Ibid, p. 25.
15 Additionally, the FATF and Egmont published a much more detailed list of risk factors/red flags. See Trade-Based Money Laundering: Risk Factors (March 2021).
16 Trade-based Money Laundering: Trends and Developments, p. 44.
17 See, White & Case, The Emerging Landscape of US Forced Labor Enforcement in Global Supply Chains (Dec. 2020), White & Case, Increased human rights supply chain scrutiny with UK and EU legislative proposals (Oct. 13, 2020) and White & Case, ESG Disclosure Trends in SEC Filings (Aug. 13, 2020).
18 See White & Case, How your human rights and ESG benchmarking scores may be improved, Jan. 9, 2020.