Our Island Plan

Trade-based Money Laundering

Trade-based money laundering ('TBML') is the process of disguising the proceeds of crime and moving value through the use of trade transactions, rather than financial transactions, in an attempt to legitimise their illicit origins.  In practice, this can be achieved through the misrepresentation of the price, quantity or quality of imports or exports.  Trade-based money laundering techniques vary in complexity and are frequently used in combination with other money laundering techniques to further obscure the money trail.

Further information on how this might affect business in the Island and what you can do to prevent or detect it can be found below.

What is trade-based money laundering

The Financial Action Task Force ('FATF') has identified three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising its origin and to integrate it into the formal economy. These methods involve:

  1. The use of the financial system (or by use of the informal economy - by such means as hawala)

  2. The physical movement of cash such as by the use of cash couriers and

  3. That may be described in general terms as 'trade-based money laundering'

You may be familiar with the first two of these methods as they have received considerable attention, but the third has not been subject to as much scrutiny nor has there been as much guidance provided.

TBML may be seen as the process of either (or both):

  • Disguising the proceeds of crime

  • Moving its value using the cover of real or concocted trade transactions, so as to legitimise the illicit origins of the proceeds

These processes could involve:

  1. Misrepresenting the price, quality or quantity of goods being bought and sold, transported, imported, exported or otherwise traded

  2. Creating a partly or wholly bogus trading arrangement, or trading pattern, that can be used to justify the movement of value from one place or person to another (sometimes referred to as 'phantom shipping')

  3. Diversion of the goods from their original, stated destination back into the country of origin to avoid taxes or duties, for sale on the black market or insertion into the legitimate supply chain. Sometimes referred to as 'U-Boat shipping', it has been seen in the UK in excise diversion fraud of alcoholic drinks, for example

TBML is often used in conjunction with other money laundering techniques, so as to make detection more difficult.

TBML might involve fraud by one party against another, but equally it can also depend on there being some element of collusion between the seller and buyer, given that the intention is to have in use an apparent value in excess of what would be expected from an arms’ length transaction, or for the funds involved to be transferred without being detected by the authorities. The collusion may arise because the parties are controlled by the same persons, or because one or both of the parties are attempting to evade taxes (such as in so-called 'carousel' or 'MTIC' VAT fraud) on some part of the transaction.

The International Chamber of Commerce highlighted the use of some of the techniques of TBML by otherwise legitimate businesses to avoid (or evade) taxes, or to avoid currency controls imposed in one or more of the countries involved in a transaction.

Studies undertaken by FATF have concluded that TBML represents an important channel of criminal activity, and is increasingly important given the growth in world trade. This growth, boosted by the general lowering of tariff and other barriers to trade, allied to a strengthening of AML/CFT controls throughout the formal channels of transmission of funds, appears to have had the effect of diverting an increasing flow of illicit funds into TBML. Indeed, FATF has expressed the concern that, as control is tightened in respect of other means of money laundering TBML is likely to become more attractive.

The World Bank has estimated that some $1.5 trillion is paid in bribes to corrupt customs and related organisations and individuals each year.

What can trade-based money laundering involve

TBML can be achieved by:

  1. Misrepresenting the price, quality or quantity of goods being bought and sold, transported, imported, exported or otherwise traded

  2. Creating a partly or wholly bogus trading arrangement, or trading pattern, that can be used to justify the movement of value from one place or person to another

The above can involve:

  1. False invoicing (including misdescribing the type and quality of goods or services involved)

  2. Over-invoicing (overcharging)

  3. Under-invoicing (undercharging)

  4. Double-invoicing (and multiple billing, where two or more invoices purport to involve the same goods)

  5. Wholly fictitious transactions (where no goods or services are actually involved, a.k.a. 'ghost shipping' or 'phantom shipping' or 'fictitious trades')

  6. Circular trading (as in carousel fraud, with the same goods being repeatedly 'sold' to cover transfer of value as a result)

  7. Using counterfeit goods masquerading as genuine, and priced as if the genuine articles - and the trafficking of counterfeit goods would be, of course, criminal smuggling

  8. Overstating or understating other costs (for transportation, for example, or storage, processing, packing etc)

  9. Diversion of the goods from their original stated destination. Including back into their original country of origin (the latter also known as 'U-Boat shipping')

Any one or more of these methods may be involved, and otherwise legitimate businesses could be used to transport or handle any goods involved. Alternatively, the whole transaction may be entirely false - with 'paper' parties and all the necessary documentation also being counterfeit.

You should bear in mind that not just 'goods' may be involved (whether real or fictitious).

Real or fictitious services could just as easily be involved. A complex laundering system may involve both real and purported movements of goods and real or imaginary 'services' (such as consultant, inspection, insurance, etc).

The laundering may be the chief or sole aim of any activity, or it may be entirely incidental, allowing the criminal to seek to clean up the proceeds at the same time as carrying out the fraud.

The Global Financial Integrity advocacy group has identified four primary reasons for misinvoicing involving developing countries:

  1. Money laundering - criminals or public officials may seek to launder the proceeds from crime or corruption

  2. Directly evading taxes and customs duties - by under-reporting the value of goods, importers are able to immediately evade substantial customs duties or other taxes

  3. Claiming tax incentives - many countries offer generous tax incentives to domestic exporters selling their goods and services abroad. Criminals may seek to abuse these tax incentives by over-reporting their exports 

  4. Dodging capital or exchange controls - many developing countries have restrictions on the amount of capital that a person or business can bring in or out of their economies. Investors attempting to break these capital controls often misinvoice trade transactions as an illegal alternative to getting money in or out of the country

Some, or all, of these may equally apply to developed countries.

Abuse of trade finance - TBML can also be taken to refer to misuse or fraud involving trade finance. Trade finance refers to where short-term financing is used to facilitate import and export activity, typically through various forms of letters of credit.

Why is it important to be aware of the risk

In the Isle of Man, the regulated sector (e.g. Trust and Corporate Service Providers ('TCSP'), legal firms and financial institutions) have an important role to play in combating TBML.

Given that the Island is an International Finance Centre, there are potential risks from TBML especially where businesses are dealing in goods globally. As well as any risk to the business or individuals concerned, the business sector and the Island as a whole could suffer serious reputational damage if it were thought that the Island was being used as a means to facilitate TBML.

In the Island it is TCSPs which are involved in international trade that may present a particular risk.

A criminal or terrorist might see using an Isle of Man TCSP to form and/or manage one or more of the components in a TBML scheme as attractive. This can be because the Island would be far from where the actual or purported movements are taking place, probably in a distant time zone, and with all the obvious difficulties of verifying the identity of goods, shipments, documents etc. In addition, they may also be attracted by possible tax advantages, as well as the air of legitimacy the use of a British corporate vehicle or address might convey.

What indicators might there be that TBML is taking place

The same sorts of doubts and suspicions that may give cause for suspicions of other types of money laundering or unlawful activity can be a factor in respect of TBML.

Various organisations have highlighted a number of indicators, or 'red flags', which may give rise to suspicions.

In essence, the best defence is to ensure that your KYC and ongoing due diligence procedures are thorough and effective - remembering that you need to be aware of all the parties involved in a transaction, whether the transaction is a viable, realistic commercial proposition, and that any checks on the transaction and the parties involved are satisfactory.

Red flag indicators

The United State Immigration and Customs Enforcement ('ICE') has identified several 'red flags' that may indicate the existence of TBML:

  • Payments to a vendor by unrelated third parties

  • False reporting (such as misclassification of commodities, or under- or over-valuation)

  • Repeated importation and exportation of the same high-value goods (the carousel fraud mentioned above)

  • Commodities being traded that do not match the business or businesses involved

  • Unusual shipping or transhipment routes

  • Packaging which is inconsistent with the commodity or shipping method (e.g. goods that require specialised transportation, such as refrigeration, lacking such requirements)

  • Double-invoicing

In the UK, the Financial Conduct Authority ('FCA') suggested the following matters, (which can be seen to have general application and not just limited to banks providing trade finance) may be indicators of TBML.

Transactions

  • Lack business sense or commercial strategy; are inconsistent with the customer’s stated business strategy

  • Deviate from the normal pattern of trading

  • Involve parties sharing the same address, or provide only a registered agent’s address

  • Involve excessive or aggressive pressure from the client

  • Involve an apparent reluctance to provide clear answers to routine questions

  • Use structures that appear unnecessarily complex and/or designed to obscure the true nature of a transaction

  • Have an unusual number of intermediaries

  • Involve one or more of the parties being a shell company

  • Involve unexplained changes to payment instructions

  • Include requests to pay a third party

  • Involve the use of cash

  • Involve unusually favourable payment terms, or has an unusual trigger point for payment

  • Does not make economic sense (e.g. the container is too large)

Documents

  • Where shipment locations, shipping terms or descriptions of goods are inconsistent (for example, when compared to any Letter of Credit)

  • With significant discrepancies between descriptions of the goods on bills of lading or airwaybills and the actual goods said to have been shipped

  • With unauthorised amendments to documents

  • Where Bills of Lading are consigned 'to be advised between applicant and beneficiary' or the like

  • Including future-dated Bills of Lading

  • Where the Letter of Credit etc contains non-standard clauses

Research carried out by Dutch police noted the use of cash being a significant factor, which characterised TBML schemes. A number of cases showed goods being paid for in cash, in one example the buyer paid with no less than 3,750 €20 banknotes. Normally cash payments would only constitute a small proportion of the expenditure of companies, and such large cash transactions should automatically trigger suspicions.

What can I do to prevent or detect TBML

Everyone in the supply chain - exporters, importers, freight forwarders and carriers - as well as tax and customs authorities and law enforcement have a role to play. In addition, those that facilitate trade in other ways - such as a TCSP that helps to form and/or administer a trading company also have an important role.

In theory, all those involved in the supply chain (in its widest sense) should implement AML/CFT preventive measures, including having a requirement to employ customer due diligence and KYC, have a suitable compliance officer and a reporting system for suspicions, as well as maintaining adequate internal records of checks and controls. A procedure for reporting any suspicions to the appropriate authority should be in place.

To improve supply chain security your business could apply to become an Authorised Economic Operator (AEO) and only use third party suppliers and partners that are themselves AEO-certified. The AEO certification standards are designed to operate under the SAFE framework developed by the World Customs Organisation. The AEO programme may use other names in different countries, such as C-TPAT in the USA. AEO certification may also have other benefits, such as guarantee waivers and reduced customs compliance requirements.

In practice, whilst the move towards improving the security of the international supply chain - though chiefly for revenue and anti-terrorism purposes (such as by adoption of trusted traders or authorised economic operator programmes) go some way to help, it remains the case that of those businesses mentioned above many may not be subject to a formal AML/CFT control regime.

A TCSP administering a company should know what that business is doing and should have a means of assessing the credibility and viability of the client’s business and manage the business using a risk-based approach depending on the level of control and information you have.

In 2013, the FCA highlighted good practice in UK banks, such as:

  • Having clear roles and responsibilities for managing financial crime risks in trade finance

  • Requiring staff to identify customers and transactions that represented the greatest risk

  • Requiring staff to screen all relevant parties in a transaction

  • Having detailed guidance available for staff on what might be potentially suspicious transactions (including lists of 'red flags')

  • Encouraging processing teams to escalate any suspicions for investigation as soon as possible

In addition, the FCA considered that having independent expertise from outside the trade finance business (e.g. the compliance department) involved in decisions and possible reporting of suspicions in a Suspicious Activity Report was best practice. Whilst a smaller TCSP may not have the separate sections that the FCA envisaged for UK banks, the principle of obtaining information, advice or assistance from as wide a spectrum as possible remains a good one.

Transaction laundering

This is the term describing situations where legitimate merchants set up a scheme to process payments (usually involving credit or debit cards) for illegal goods on behalf of another merchant (aka merchant account laundering, factoring or undisclosed aggregation). A merchant sets up an online store and receives approval of a bank or payments provider to process orders, then sets up additional websites to sell other, illegal goods with payments being routed via the legitimate online store.

What do I do if I have suspicions

As with any suspicion of money laundering in general, you should follow your internal reporting procedures.

If need be, you should make every reasonable effort to verify independently the transaction or party that is giving rise to the suspicion. You should, of course, have undertaken the normal KYC and ongoing due diligence procedures for your client and their activities. These could be reviewed and/or repeated, again using alternative or independent sources, if possible.

If suspicions remain, a Suspicious Activity Report should be made to the Financial Intelligence Unit ('FIU').

Reports should be made using the online reporting system, THEMIS; however, if you do not have access to this reporting system, you should use the appropriate form on the FIU website.

Financial Intelligence Unit contact details 

Telephone: +44 1624 686000

Email: fiu@gov.im

Note: The FIU does not take reports of crime - please report the matter to your local Police station or contact the Economic Crime Unit. 

Further Information

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