Trade Based Financial Crime and Managing the Compliance Risk (2024)

According to the WTO Trade Volume Index 2022, world trade volumes have grown between 4% - 6% annually since 1995, and the total value of annual trade currently stands at around USD 31.0 trillion.

This vast and still growing volume of trade, alongside a lack of transparency and opportunities for obfuscation, is extremely attractive to criminal organisations. Criminals use the enormity and complexity of trade to carry out and to hide illegal activities. It is not surprising that Trade Based Money Laundering (TBML) is considered to be one of the most complex and widely used methods of money laundering.

When firms become involved in the financing of trade, they become exposed to a vast range of money laundering and financial crime risks which need to be identified, assessed, mitigated and monitored.

Criminals abuse trade not just for the purposes of laundering the proceeds of crime, but also to commit many of the crimes that create these illegal proceeds. These may include arms smuggling, dealing in weapons of mass destruction, terrorism, tax evasion, drug smuggling, illegal trafficking, sanctions busting, fraud, and many others. For this reason, it is useful from a compliance perspective to think in terms of Trade Based Financial Crime (TBFC).

It is important to understand that the involvement of criminals in trade is not limited to the trades themselves, but increasingly includes the taking over of critical infrastructure. To take one example, recently Europol exposed the partial takeover of the ports of Amsterdam, Rotterdam and Antwerp by organised criminal gangs. Using threats and corruption, criminals have succeeded in misappropriating container reference codes. Europol estimates that at least two hundred tons of cocaine has been trafficked using this method. Infrastructural takeovers such as this increase the compliance challenge and bring more criminals into trade supply chains.

For firms, ensuring compliance throughout a trade is challenging. Firms rarely see the goods that are being shipped, they must rely on having sight of relevant documentation, including financial, trade, commercial and government documents. A single trade can quite easily have over 100 documents all of which may need to be reviewed, not least to identify inconsistencies, deviations, illegalities, or other red flags.

Firms may support or finance trades in several ways, the most common is through open account trades. Such trades involve a buyer and seller trading without bank intermediation and settling their trade directly through their bank accounts. In an open account trade, a firm’s compliance activity is typically limited to standard transaction and account checks.

However, when firms actively provide finance, or are involved in collections, risk to the firm rises and greater compliance activities are needed. The many different types of finance that a firm can offer create variable risk profiles. For example, bills of exchange or drafts, documentary letters of credit, or default instruments such as standby letters of credit, guarantees or avalising.

The role of a firm in a trade can vary. For example, issuing or advising on a letter of credit, confirming a financial instrument, acting in a collections capacity, or providing default cover. The role the firm plays in a trade may create different risk and compliance implications, different CDD approaches and a range of third parties from customers, through correspondent banking relationships and a variety of third parties. This creates significant compliance challenges throughout the lifecycle of a trade.

There are many different TBFC typologies. The most common methods include mispricing, obfuscation regarding the type of goods or services, over, under or multiple invoicing and even phantom shipping. More complex typologies are common, many of which are based on the format of the Colombian Black Market Peso Exchange Model.

To manage the compliance risks of trade transactions it is important to have a compliance framework for trade which is likely to include:

• A business-wide risk assessment of trade risk, including proliferation financing risk, which at a business level considers and assesses the compliance risk attaching to customers, financial instruments issued, the firm’s role, common jurisdictions involved and any other relevant factors.
• Risk-based, comprehensive, and proportionate policies and procedures covering all aspects of trade in which the firm is involved.
• Clear understanding of the roles of the three lines of defence, such as which line is responsible for what compliance activities and when.
• Published typologies and red flags relating to the specific trades, customers, jurisdictions, and other risks that reflect the firm’s trade finance business.
• Appropriate management information including trade statistics, system generated and manual alerts, high risk customers and transactions, trends, and suspicious activities identified.
• Timely, appropriate training tailored to the firm and, for example, to front line, to operations and to compliance.

Day to day management of compliance risks in trade finance requires all relevant staff to be continually aware of and alert to indicators or red flags that might signal that the trade is being used for illicit purposes. This requires frontline and compliance staff to be asking the right questions throughout a trade. For example:

• What is the purpose of the trade, the goods or services involved, and the vessels used in transportation?
• Are all parties involved in the transaction identified, how and why are they involved, are they connected and what type and level of CDD checks should be carried out?
• To what extent does the trade in question fit within the customer’s business model and usual practice?
• Is there a valid business reason for the trade, the goods or services being traded, and the counterparties involved?
• What goods or services are being provided, are they high risk goods or services – for example Dual Use Goods – and is their end destination and the end user identified and appropriate?
• Is any pricing consistent with known market prices, or any other third party reference?
• Is this trade in anyway indicative of known TBFC typologies, or is there any indication that the trade may not have a valid business purpose?
• Does the transaction appear to be overly complex?

The above list is of course only indicative and not exhaustive.

Managing trade finance compliance risk requires a good understanding of trade generally and specifically; working knowledge of risk typologies, models, and case studies; and perhaps above all an understanding that substance trumps form – what is really happening, why, how and does it make sense?

For in-depth training on this topic, our Trade Based Money Laundering and Correspondent Banking Risk course may be suitable for you. Get in touch to discover your TBFC training options with us.

Bruce has been working in financial services for nearly 40 years, 25 of these as a learning professional focusing on compliance for a wide range of financial services companies, mainly through the analysis, design, creation and implementation of global training programmes for Tier 1 Banks and FTSE 100 companies. He has been Global Head of Compliance Learning for such firms three times and has provided compliance learning consultancy to similar companies many times.

Bruce has also provided compliance training and consultancy in other fields such as real estate, industrial supply chains, charities, payment services providers, gambling and casinos and many others.

A former Director of Training for CISI, Bruce has extensive experience of compliance and financial services-related qualifications and qualified as a Chartered Accountant with Price Waterhouse (as it was then known).

Bruce provides excellent training events on compliance, with a specific focus on financial crime, including all aspects of anti-money laundering, anti-bribery and corruption, fraud and sanctions.