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Zoe Allen

Finance professional with extensive experience in Anti-Money Laundering (AML)

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November 13, 2023

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Blog / Trade-Based Money Laundering: What Is It and Why It Matters

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Trade-Based Money Laundering: What Is It and Why It Matters

The Global Financial Integrity reported that over USD 1 trillion are siphoned from developing countries every year due to crime, corruption, and tax evasion – a significant portion of which is subjected to laundering processes. This shows how money laundering, which is the process of disguising the real source of funds that have been obtained illegally, can damage the financial system to the core. For criminals, this is essential since it enables them to spend their illicit gains without calling attention to their source of funds. The UNODC encourages countries to develop policies to combat money laundering and funding of terrorism through its Global Program. They also keep an eye on associated matters, inform the public, and work in tandem with the UN and other international organizations. Money laundering is defined as follows in Article 3.1 of the UN Vienna 1988 Convention:

“the act of changing or moving assets, with the knowledge that they come from illegal activities, with the intent to hide their unlawful origin or to aid someone involved in such activities to avoid legal repercussions.”

On a related note, the FATF describes trade-based money laundering (TBML) as a tactic used by terrorist financiers and other perpetrators to conceal the source of funds and smoothly incorporate them into the legal economy. The international commerce system is full of opportunity for such malicious acts because of its vastness and complexity. TBML usually entails changing trade details such as the cost, quantity, or quality of items. Even though it’s important to illicit activity, other money laundering strategies frequently take center stage. However, TBML is expected to become a more popular option for people with nefarious intentions as a result of the growth in international trade and the tightening of existing anti-money laundering regulations.

It’s very important to now understand how TBLM is done, so let’s study various mechanisms.

The Mechanics of TBML

Invoice Manipulation:

Intentionally changing the price of an item or service on an invoice to either transfer more money (over-invoicing) or less money (under-invoicing) than the actual worth of the trade transaction is known as over-invoicing and under-invoicing. Bharti Airtel, an Indian telecom corporation, was charged with inflating the cost of imported equipment in the early 2000s. The business reportedly exaggerated the value of capital goods imports from different countries in order to obtain more bank financing and claim more equipment depreciation, which reduced tax obligations.

Multiple Invoicing:

China’s anti-corruption authority discovered in 2015 that certain Chinese companies were disguising financial outflows with several invoices. This was carried out in order to bypass China’s capital controls and transfer funds outside of the country, particularly during a period when there were apprehensions about the slowing of the economy. Consequently, this strategy entails sending out several invoices for a single trade transaction, which is basically “double-billing” or even “triple-billing” in order to transfer money that is greater than the transaction value.

Over-shipping and Under-shipping:

Using this strategy, a different amount of items is sent than what is listed on the shipping paperwork or invoice. Sending more items than stated is known as over-shipping, and sending less goods than declared is known as under-shipping. To have a better understanding of this, consider the situation from the beginning of the 2010s when it was discovered that importers from Venezuela were part of a system in which they would overcharge the government for foreign exchange by inflating the worth of the items they were importing (over-invoicing). Then, though, they would undership or occasionally not ship any items at all, they would keep the difference for themselves.

Phantom Shipping:

In the notorious “Russian Laundromat” case, which came to light in 2014, a network of around 21 shell businesses gave each other fictitious loans that were supported by fake guarantees. Then, to create the impression of genuine commerce, they shipped fake items and invoices across international borders. An estimated $20 billion was removed from Russia under this plan. This clarifies that, although trade transaction documentation is generated, no actual products are dispatched or received in phantom shipment. Only paper is used in this transaction.

TBML Techniques involve invoice manipulation, multiple invoicing, over-shipping, phantom shipping which are crucial techniques.

It is crucial to know why TBML is such an important subset of money laundering and why having its knowledge even matters. So let’s study its gravity.

Why TBML Matters

Volume and Complexity:

Global trade refers to the flow of goods and services beyond national boundaries. The sheer volume of transactions and the minute details of each trade (product specs, pricing, shipping details, etc.) make it challenging to monitor every one of them. The World Trade Organization (WTO) reports that global merchandise exports reached a value of $18.89 trillion in 2019. In addition, an International Chamber of Commerce (ICC) research noted that up to 27 parties and 40 papers may be involved in a single international commerce transaction. As evident from the stats, because of its size and complexity, TBML is a favored technique of money laundering for it gives criminals plenty of opportunity to conceal illegal cash within lawful transactions.

Economic Impact:

Significant economic obstacles are presented by trade-based money laundering (TBML), especially for countries that lose income as a result of trade misinvoicing. Insufficient TBML control systems at financial institutions expose them to regulatory enforcements, which can result in correspondent bank partners de-risking the institution, raising transaction costs and restricting financial flows. This affects income collection for the public sector as well as private sector opportunities.

Criminal Financing:

TBML has the ability to finance further unlawful operations in addition to concealing illegitimate gains. This covers the drug trade, where money needs to be laundered from sales; terrorism, where finances are needed for operations and logistics; and smuggling, where products are carried across borders without the necessary documents or detection. According to estimates from the United Nations Office on Drugs and Crime (UNODC), the world drug trade brings in between $400 billion and $700 billion a year. It is thought that trade-based techniques are used to launder a substantial amount of these revenues. Therefore, by stopping TBML, law enforcement may also target the money source of these other illegal businesses.

Reputation Risks:

Financial institutions are essential to international commerce because they process payments, offer trade finance, and offer other associated services. Even if these institutions are unintentionally implicated in TBML, their reputations might suffer greatly. This may lead to a decline in consumer confidence, fines from authorities, and potentially legal repercussions. Strong reputations provide stock performance that is 2.5 times better than the overall market, according to the RepTrak. Furthermore, a one-point increase in reputation corresponds to a 2.6% increase in market value, or a gain of $1 billion on average. On the other hand, a crisis related to reputation, such as being involved in money laundering, might result in large financial losses. For instance, in past cases, banks involved in money laundering scandals have seen their stock prices drop by significant percentages following the revelation of their involvement.

Challenges of TBML include large volume, economic impact, criminal financing, reputation risks which make it a huge issue.

To get a practical idea, let’s have a look at Wachovia Bank and the Casas de Cambio Scheme.

Case Studies

Wachovia Bank and the Casas de Cambio Scheme

Execution of TBML:

A major TBML fraud included Wachovia Bank, a well-known U.S. banking institution that is now a part of Wells Fargo, in the mid-2000s. A network of “Casas de Cambio” (money exchange houses) was utilized by drug gangs in South America and Mexico to launder their illegal profits. At these exchange houses, they would deposit drug revenues in large quantities. After that, the funds would be moved to Wachovia accounts and exchanged into US currency.

Implications:

  • Billions of dollars in drug money were laundered via Wachovia accounts over a number of years.
  • The plan affected the stability of the American financial system in addition to anti-money laundering initiatives. It brought attention to the financial system’s weaknesses.

Uncovering the Scheme:

Wachovia experienced suspicion, which prompted internal inquiries. The bank’s anti-money laundering procedures were determined to be insufficient. The bank’s role in the TBML scam was the subject of a thorough investigation by US law enforcement organizations, such as the Department of Justice and the Drug Enforcement Administration (DEA). Federal prosecutors and Wachovia struck a deal in 2010. It was decided that the bank would forfeit $110 million and pay a $50 million punishment for not having an efficient anti-money laundering program. The settlement also mandated corrective measures to strengthen the bank’s anti-money laundering procedures.

FATF specially highlights the importance of countering TBML and has provided best practices so that countries can hedge themselves against its harms.

Best Practices

Enhanced Due Diligence (EDD):

EDD becomes essential in the context of TBML when working with customers from sectors or areas that are recognized to have a high risk of money laundering. This might apply to industries such as luxury products, precious metals, or areas with a track record of financial impropriety. The Financial Action Task Force (FATF) claims that the trade in precious metals, particularly when the metals are easily converted into currency, can be used to transfer illegal funds over international boundaries. In order to make sure they are not unintentionally supporting illegal activity, institutions may therefore better understand the nature of their clients’ transactions and evaluate the risks involved by deploying EDD.

Automated Detection Systems:

When we discuss sanction screening, these technologies are designed to identify businesses or persons on sanction lists, rather than trade transactions. Manual inspections might be time-consuming and prone to errors because of the large volume of transactions and the changing nature of sanction lists. For example, updates to the Specially Designated Nationals (SDN) list maintained by OFAC may occur more than once in a single month. Automated methods reduce the chance of oversight by swiftly cross-referencing transactions with updated sanction lists to ensure compliance.

Training and Awareness:

Staff members can stay informed on the most recent TBML tactics, warning signs, and legal requirements by attending regular training sessions.  For example, banks with strong training and awareness programs reported fewer instances of non-compliance with Anti-Money Laundering (AML) legislation, according to a survey conducted by the Association of Certified Anti-Money Laundering Specialists (ACAMS). Therefore, organizations may guarantee that their frontline employees—those who interact directly with transactions and clients—are watchful and can quickly report suspicious activity by establishing an awareness culture.

International Collaboration:

TBML frequently entails cross-border transactions because trading is an international activity. Countries can assure a consistent strategy to combat TBML, expedite investigations, and bridge information gaps by increasing international collaboration. These collaborations have the potential to result in enhanced enforcement measures and deterrents for possible violators.

Public-Private Partnerships:

Governments are in charge of regulations and have intelligence, but the private sector is aware of consumer behavior and market dynamics. Together, they may jointly design tactics, exchange vital information, and produce ground-breaking remedies to stop TBML. The World Economic Forum (WEF) has released a study that highlights the necessity of public-private collaborations in the fight against financial crimes. These collaborations can result in more comprehensive and successful strategies by utilizing the advantages of both industries.

Trade-Based Money Laundering (TBML) is a constantly changing danger to international trade, highlighting the significance of staying ahead of the curve through continuous learning, technical development, and international collaboration. Using strategies including duplicate invoicing, invoice manipulation, and phantom shipping, TBML takes advantage of the complex and expansive structure of global commerce, which exceeded $19 trillion in 2019. This type of money laundering damages the economy, provides funding for more illegal activity, and damages financial institutions’ reputations. Institutions must use automated detection systems, training, Enhanced Due Diligence (EDD), international cooperation, public-private partnerships, and training to successfully combat TBML. In order to achieve a robust and transparent global financial system in the always changing realm of financial crime, try AML Watcher. Contact us to stay ahead of evolving schemes in money laundering and hedge yourself from the risks of financial crimes.

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