Countering

Trade Based
Money
Laundering

Prepared By
Salim Thobani

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 Abbreviations

This study guide uses different abbreviations; the most commonly used ones are listed below.

ABC – Anti Bribery and Corruption

AML - Anti-Money Laundering

APG - Asia Pacific Group

BOI - Beneficial Ownership Information

CDD - Customer Due Diligence

CFT - Countering the Financing of Terrorism

EDD - Enhanced Due Diligence

FATF - Financial Action Task Force

KYC - Know Your Customer

IAF - Internal Audit

IAF - Internal Audit Function ML - Money Laundering

MLRO - Money Laundering Reporting Officer

TBML - Trade-Based Money Laundering

WB - World Bank

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 Contents

Money Laundering ................................................................................................................ 5

Stages of Money Laundering ................................................................................................... 5
1. Placement ...................................................................................................... 6
2. Layering .......................................................................................................... 6
3. Integration...................................................................................................... 7

Trade Based Money Laundering (TBML) ................................................................................ 9

Financial Action Task Force (FATF) ...................................................................................... 11

Financial Crime Risk............................................................................................................. 13

Type of Financial Crime Risk .................................................................................................. 13

High Risk Jurisdiction........................................................................................................... 14

Tax Haven Countries ........................................................................................................... 15

Risk Involved in Money Laundering ..................................................................................... 16

1. Operational Risk ........................................................................................... 16
2. Reputational Risk ......................................................................................... 17
3. Legal Risk ...................................................................................................... 18
4. Concentration Risk ....................................................................................... 19

Trade Based Money Laundering Detection .......................................................................... 19

I. Customer Due Diligence (CDD) ..................................................................... 19
II. Customer Identification Program ................................................................. 21
III. Customer Onboarding .................................................................................. 22
IV. Ultimate Beneficial Owner(UBO) .................................................................. 24

Trade Based Money Laundering (TBML) Red Flags .............................................................. 24

a. Over & Under Invoicing ................................................................................ 25
b. False Description of Goods ........................................................................... 27
c. 3rd Party Payment & Shipment .................................................................... 27
d. Short & Over Shipment................................................................................. 28
e. Shell Companies ................................................................................ 28
f. Phantom Shipments........................................................................... 30

Impact of Technology on Global Money Laundering ........................................................... 31

Role of Internal Control to combat TBML Risk ..................................................................... 33

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 Internal Audit ...................................................................................................................... 35

Role of Board of Directors and Senior Management to combat TBML Risk ......................... 35

Reference Studies ............................................................................................................... 37

References Links ................................................................................................................. 37

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 Money Laundering
Money laundering is the processing of criminal proceeds to disguise illegal

origin. This process is of critical importance, as it enables criminal to enjoy these

profits without jeopardizing their source. Illegal arms sales, smuggling, and the

activities of organized crime, including for example drug trafficking and prostitution

rings, can generate huge amounts of proceeds. Embezzlement, insider trading,

bribery and computer fraud schemes can also produce large profits and create the

incentive to “legitimize” the ill-gotten gains through money laundering.

When a criminal activity generates substantial profits, the individual or group

involved must find a way to control the funds without attracting attention to the

underlying activity or the persons involved. Criminals do this by disguising the

sources, changing the form, or moving the funds to a place where they are less

likely to attract attention.

Stages of Money Laundering

There are three stages of Money Laundering categorized as:

1. Placement
2. Layering
3. Integration

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 1. Placement

The process of placing, through deposits or other means, unlawful cash

proceeds into traditional financial institutions. At this stage cash derived from

criminal activity is infused into the financial system. The placement makes the

funds more liquid since by depositing cash into a bank account can be

transferred and manipulated easier. When criminals are in physical possession of

cash that can directly link them to predicate criminal conduct, they are at their

most vulnerable. Such criminals need to place the cash into the financial system,

usually through the use of bank accounts, in order to commence the laundering

process.

This is the first stage in the washing cycle. Money laundering is a “cash-

intensive” business, generating vast amounts of cash from illegal activities (for

example, street dealing of drugs where payment takes the form of cash in small

denominations). The Money are placed into the financial system or retail

economy or are smuggled out of the country. The aims of the launderer are to

remove the cash from the location of acquisition so as to avoid detection from the

authorities and to then transform it into other asset forms; for example: travellers’

cheques, postal orders, etc.

2. Layering

Layering is the process of separating the proceeds of criminal activity from their

origin through the use of many different techniques to layer the funds. These

include using multiple banks and accounts, having professionals act as

intermediaries and transacting through corporations and trusts, layers of complex

financial transactions, such as converting cash into traveller’s checks, money

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 orders, wire transfers, letters of credit, stocks, bonds, or purchasing valuable

assets, such as art or jewellery. All these transactions are designed to disguise the

audit trail and provide anonymity.

Layering usually involves a complex system of transactions designed to hide

the source and ownership of the funds. Once cash has been successfully placed

into the financial system, launderers can engage in an infinite number of complex

transactions and transfers designed to disguise the audit trail and thus the source

of the property and provide anonymity. One of the primary objectives of the layering

stage is to confuse any criminal investigation and place as much distance as

possible between the source of the ill-gotten gains and their present status and

appearance.

Typically, layers are created by moving Money in and out of the offshore bank

accounts of bearer share shell companies through electronic funds’ transfer (EFT).

Given that there are over 500,000 wire transfers – representing in excess of $1

trillion – electronically circling the globe daily, most of which is legitimate, there isn’t

enough information disclosed on any single wire transfer to know how clean or dirty

the money is, therefore providing an excellent way for launderers to move their

dirty money. Other forms used by launderers are complex dealings with stock,

commodity and futures brokers. Given the sheer volume of daily transactions, and

the high degree of anonymity available, the chances of transactions being traced

is insignificant.

3. Integration

It is the stage at which laundered funds are reintroduced into the legitimate

economy, appearing to have originated from a legitimate source. Integration is

the final stage of the process, whereby criminally derived property that has been

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 placed and layered is returned (integrated) to the legitimate economic and

financial system and is assimilated with all other assets in the system. Integration

of the “cleaned” money into the economy is accomplished by the launderer

making it appear to have been legally earned. By this stage, it is exceedingly

difficult to distinguish legal and illegal wealth.

Not all money laundering transactions go through this three-stage process.

The three basic stages may occur as separate and distinct phases or may occur

simultaneously or, more commonly, they may overlap. Transactions designed to

launder funds can for example be affected in one or two stages, depending on

the money laundering techniques being used. How the basic steps are used

depends on the available laundering mechanisms and requirements of the

criminal organisations.

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 Trade Based Money Laundering (TBML)
Money laundering using the trade sector has been d e t e c t e d within

various financial services as far back as the1960s. However, it i s in more recent

years that money laundering has become a more notable area of focus for risk

assessment, especially within the global banking sector, as criminals have

continued to broaden their scope of activity. Criminals and organized gangs can

now exploit nearly all forms of financial services in order to launder the proceeds

of their illicit activity, including using documentation and financial services from

the trade and shipping sector.

Despite the long history of known and established m o n e y laundering

offences, the diversification into modern trade based options for laundering is

relatively new and this has meant that the definition of TBML is still vague and

unclear. Although the name TBML includes the term ‘money laundering’ which

implies cash transactions of some kind, in reality it focuses almost exclusively on

the falsified use of documents a n d shipping information to transfer goods and

services hence the term trade based.

This is highlighted in the FATF definition, which actually doesn’t include the

term money or cash at all but instead uses the term value “the process of

disguising the proceeds of crime and moving value through the use of trade

transactions in an attempt to legitimize their illegal origins or finance their

activities.” The FATF definition has been criticized for being too vague. And

in reality most trade based money laundering activities can cover an array of

different processes and criminal defrauding activities, as the next few sections will

describe.

There has recently been an increased focus on trade-based money

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 laundering (TBML) since it has been identified as one of the newest and possibly

most complex forms of money laundering to affect the banking and regulatory

sectors, across the globe. The rapid expansion of the global trade sector, along

with the increasing development of payment technology, has provided an ideal

environment for money launderers to transfer illegally gained money, either in

cash or through goods, across the world. It is now recognized that the misuse of

the financial trade system is one of the main ways in which criminal gangs move

money and integrate it into the formal economy.

However, as mentioned earlier it is only part of an overall criminal process

and the money may h a v e originated from a variety of criminal activities which are

often referred to as predicate offences, including drug and human trafficking,

hijacking, piracy and illegal arms dealing. In the past, the focus of criminal

prosecutions was on the predicate offences only, whereas nowadays money

laundering is recognized as a crime in its own right. In addition to the cleansing

of dirty money, the transfers may also be used in order to facilitate on criminal

activity and terrorist related activities.

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 The main difficulty and challenge for banks dealing with TBML, is that

money is often placed into the bank using legitimate businesses as fronts.

Criminals then use complex systems of misrepresentation of pricing, invoicing and

shipping to merge money gained from criminal activities into legitimate business

transactions. In addition, sophisticated money laundering practices such as

TBML usually require a partnership between the criminal, who acquires the

money, and a professional launderer who is often connected or familiar with the

financial sector. All of these factors make TBML one of the more difficult techniques

to detect, which places an additional stress on the bank’s risk assessment

strategies and systems. Sanitized case studies might offer some form of support

and some of these cases appear in the next section of the review. These examples

consider some of these generic typology studies and practical cases. The cases

also seek to provide an explanation of the banking methods that were used in

the detection of the money laundering activities.

Financial Action Task Force (FATF)

The Financial Action Task Force (FATF) is an inter-governmental body

comprised of Ministers from each of the 34 member countries. The group was first

established in 1989 and aims to monitor every member country for

vulnerabilities and weaknesses in the country’s approach to addressing money

laundering and terrorist financing.

“The objectives of the FATF are to set standards and promote effective

implementation of legal, regulatory and operational measures for combating

money laundering, terrorist financing and other related threats to the integrity of the

international financial system”.

As part of their remit FATF have developed a series of recommendations,

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 the main framework on money laundering was published in 2012 with additional

publications on specialized areas and ML schemes being added. These

recommendations provide the basis for a global framework of AML standards,

which can assist and guide banks to detect money laundering type activity and to

raise red flags or alerts. As part of their ongoing role FATF has assumed a role of

monitoring individual country progress, and analyzing how they are implementing

these guidelines. The results of these findings are published as a series of annual

country reports, which also inform other countries of progress and/or areas of

concern within a specific region. These country reports can then be incorporated

into the risk assessment framework of individual banks, to check if their client’s

businesses have financial transactions or trading agreements in those areas

deemed to be at additional risk.

FATF was originally developed to address money laundering concerns

linked to the movement of cash by drug cartels. However, its remit has

expanded over time and now includes all types of money laundering and terrorist

finance risks including TBML. This has led to criticism that by trying to be all

things to all people their guidelines and material is very generic and hard to

translate into practical and working guidelines, which was also a message that

came through from this research data.

As part of their role FATF has sought to actively encourage a dynamic and

responsive risk-based approach rather than a rigid rules-based system, stating that

it is more flexible and responsive. They highlight the inherent risk within a strict

rules-based approach, which they state tends to encourage a tick box attitude

without real consideration of the actual risks. The approach suggested by FATF

has sometimes been criticized for failing to provide clearer guidance for banks

on the kinds of scenarios to expect and even whether the definition FATF
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 provides for TBML is really adequate.

Financial Crime Risk

Financial crime over the last 30 years has increasingly become of concern

to governments throughout the world. This concern arises from a variety of issues

because the impact of financial crime varies in different contexts. It is today widely

recognised that the prevalence of economically motivated crime in many societies

is a substantial threat to the development of economies and their stability.

Financial crime can be divided into two essentially different, although closely

related, types of conduct. First, there are those activities that dishonestly generate

wealth for those engaged in the conduct in question. For example, the exploitation

of insider information or the acquisition of another person’s property by deceit will

invariably be done with the intention of securing a material benefit. Alternatively, a

person may engage in deceit to secure material benefit for another.

Second, there are also financial crimes that do not involve the dishonest

taking of a benefit, but that protect a benefit that has already been obtained or to

facilitate the taking of such benefit. An example of such conduct is where someone

attempts to launder criminal proceeds of another offence in order to place the

proceeds beyond the reach of the law.

Type of Financial Crime Risk

Following are the types of financial crime risk: -

 Sanction
 Money Laundering
 Fraud
 Electronic crime
 Money laundering
 Terrorist financing
 Bribery and corruption
 Market abuse and insider dealing
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  Information security

High Risk Jurisdiction

High risk jurisdictions or countries can be best defined as those countries

having serious strategic deficiencies to counter money laundering, terrorist

financing, and financing of proliferation.

Jurisdictions under increased monitoring are actively working with FATF to

address strategic deficiencies in their regimes to counter money laundering,

terrorist financing, and proliferation financing. When FATF places a jurisdiction

under increased monitoring, it means the country has committed to resolve swiftly

the identified strategic deficiencies within agreed timeframes and is subject to

increased monitoring. This list is often externally referred to as the “grey list”.

The FATF and FATF-style regional bodies (FSRBs) continue to work with the

jurisdictions below as they report on the progress made in addressing their

strategic deficiencies. FATF calls on these jurisdictions to complete their action

plans expeditiously and within the agreed timeframes. FATF welcomes their

commitment and closely monitors their progress. FATF does not call for the

application of enhanced due diligence measures to be applied to these

jurisdictions, but encourages its members to take into account the information

presented below in their risk analysis.

Jurisdictions with strategic deficiencies

 Albania
 Barbados
 Botswana
 Burkina Faso
 Cambodia
 Cayman Islands
 Ghana
 Jamaica
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  Mauritius
 Morocco
 Myanmar
 Nicaragua
 Pakistan
 Panama
 Senegal
 Syria
 Uganda
 Yemen
 Zimbabwe

Note: -This list is updated as of February 2021, However, the list is updated

based on the FATF meeting and their review.

Tax Haven Countries

A tax haven, or “offshore financial center,” is an offshore country where

taxes are levied at a very low “effective” rate for foreign investors. Residency or

business presence is typically not required in order to benefit from their tax policies.

Additionally, tax havens share limited or no financial information with foreign tax

authorities.

Tax havens attract a generous amount of capital inflow and impose fees,

charges, and even low tax rates to generate government revenue. While high-tax

countries lose corporate tax revenue from businesses shifting profits elsewhere,

tax havens can reduce the cost of financing investment in those countries,

indirectly facilitating economic growth.

The top ten tax havens in the world are:

 Luxembourg
 Cayman Islands
 Isle of Man
 Jersey
 Ireland
 Mauritius
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  Bermuda
 Monaco
 Switzerland
 Bahamas

Luxembourg is considered to be the best tax haven in the world. According

to a report from Citizens for Tax Justice and U.S. PIRG Education Fund,

approximately 30% of U.S. Fortune 500 companies have subsidiaries in

Luxembourg. For example, Amazon funnels all of its sales in Europe through its

official European headquarters in Luxembourg.

The Cayman Islands currently hold banking assets equal to one-fifteenth of

the world’s total $30 trillion in banking assets. In addition to having no corporate

tax, the Cayman Islands impose no direct taxes on residents, including property,

income, and payroll taxes. The Caymans are especially popular with hedge fund

managers because there is no corporate or income tax even on interest or

dividends earned on an investment. The Caymans have subsidiaries with Fortune

500 companies such as Pepsi, Marriot, and Wells Fargo.

Risk Involved in Money Laundering

There is certain risk involved in Money Laundering for financial institution and

the highest risk may involve losing the license, i.e. Financial institution are using

the best of their resources to avoid Money Laundering risk.

Following are the risks involved in Money Laundering:

1. Operational Risk

Operational risk is the risk that a firm’s internal practices, policies and systems

are not adequate to prevent a loss being incurred, either because of market

conditions or operational difficulties. Such deficiencies may arise from failure to

measure or report risk correctly, or from a lack of controls over trading staff.

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 Although operational risk is harder to define precisely compared market or credit

risk, it is considered by many to have been a contributor to some of the highly

publicized losses of recent years.

Different Organization defines Operational Risk as:

Business/operational risk relates to activities carried out within an entity, arising

from structure, systems, people, products or processes.’

CIMA Official Terminology, 2005

The risk of loss resulting from inadequate or failed internal processes, people

and systems, or from external events.’

Basel Committee on Banking Supervision, 2004

2. Reputational Risk

In recent years the role of various types of financial intermediaries has evolved

dramatically, as capital market deregulation and innovation has resulted in

intensified competition, with intermediaries in each cohort competing vigorously

with their traditional rivals as well as with players in other cohorts. Consequently,

market developments have periodically overtaken regulatory capabilities intended

to promote financial stability and fairness as well as efficiency and innovation. It is

unsurprising that these conditions would give rise to significant reputational risk

exposure for banks and other financial firms involved.

Reputational risk in banking and financial services is associated with the

possibility of loss in the going-concern value of the financial intermediary – the risk-

adjusted value of expected future earnings. Professor Walter gives a possible

working definition as follows:

“Reputational risk comprises the risk of loss in the value of a firm’s business

franchise that extends beyond event-related accounting losses and is reflected in

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 a decline in its share performance metrics. Reputation-related losses reflect

reduced expected revenues and/or higher financing and contracting costs.

Reputational risk in turn is related to the strategic positioning and execution of the

firm, conflicts of interest exploitation, individual professional conduct, compliance

and incentive systems, leadership and the prevailing corporate culture.

Reputational risk is usually the consequence of management processes rather

than discrete events, and therefore requires risk control approaches that differ

materially from operational risk.”

3. Legal Risk

Legal risks are those risks that a business organization faces that pertain to

legal matters. This type of risk is generally the result of non-compliance with laws,

rules, and regulations of the government and other statutory bodies that control

businesses. Various matters that can result in legal risk are business contracts and

agreements, assets and related litigation, matters with regards to intellectual

property rights, patents, copyrights violations, etc. Legal risk can cause both

monetary and non-monetary losses to a business. Monetary losses include loss of

business due to cancellation of orders or payment of damages to outside third

parties. Non-monetary losses include loss of reputation, goodwill, or damage to the

brand value of the business.

There are few types of legal risks as follow:

 Contract Risk
 Non- Contractual Risk
 Compliance Risk
 Regulatory Risk
 Dispute Risk

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 4. Concentration Risk

Concentration risk is a banking term describing the level of risk in a bank's

portfolio arising from concentration to a single counterparty, sector or country.

The risk arises from the observation that more concentrated portfolios are less

diverse and therefore the returns on the underlying assets are more correlated.

Following are the types of Concentration Risk.

 Credit Risk
 Country Risk
 Investment Risk
 Commodity Risk
 Political Risk

Trade Based Money Laundering Detection

This section considers the processes that banks currently use in order to

detect and assess the risks posed by TBML activity.

I. Customer Due Diligence (CDD)

The first of these measures is the customer due diligence (CDD) and

enhanced due diligence (EDD) systems, whereby client information and

background account information are gathered. Clients need to s a t i s f y a number

of criteria before the bank is willing to work with them. However, from the

information already ascertained in relation to TBML risk and in light of the newly

proposed definition of TBML for banks, there is now one important element to be

considered in the old AML system.

The increasing use of legitimate businesses as front companies is one way in

which criminal syndicates have sought to circumvent many of the risk assessment

processes. This means that initial customer due diligence checks in these

situations will show that the client documentation can be verified and be valid.

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 However, it is at the second level of checks, seeking beneficial ownership that the

bank can begin to unravel some of the deception. Other factors such as unusual

business transactions for this client and sudden changes in transaction patterns

can flag to the bank that something is amiss.

State Bank of Pakistan via FE Circular No 04 of 2019 instructed Authorized

Dealers to capture the following information before onboarding trade customers

not limited to perform the Customer Due Diligence for trade customers.

a. The goods/services in which the customer usually trade in and prices

thereof where available

b. Customer’s key buyers and suppliers

c. Annual volume of trade transactions of customer

d. Trade cycle of the customer

e. The countries of origin of goods in which the customer trades

f. The jurisdictions/countries of business

g. Modes of transportation for goods

h. Port(s) of loading/discharge

i. Usual mode of trade and terms of payments

j. Related business concerns (domestic as well as international) and third

parties such as shipping agents, insurance companies, inspection

companies, etc.

k. Active membership of customer with Chamber of Commerce/Trade

Association

l. Person(s) authorized to sign on behalf of customer

m. Legal structure of the customer

n. Ultimate beneficial owner of the customer/transactions along with

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 his/her stakes in the trade transactions directly or indirectly

o. Conduct of customer’s personal PKR/FCY Account

II. Customer Identification Program

The Customer Identification Program, or CIP for short, requires that financial

institutions, such as banks, take the appropriate steps to have the reasonable belief

that all customers who enter into a formal banking relationship with them are who

they say they are.

A financial institution is an entity, such as a bank, that provides financial

services, such as opening a checking account.

A customer is one who opens a new account or opens a new account on behalf

of another individual (who lacks the capacity to do so) or entity, and can be:

1. an individual

2. a corporation

3. a partnership

4. a trust

5. an estate

Financial institutions need to have procedures in place on how to verify the

identity information collected on each customer. Verification procedures should be

done within a reasonable amount of time from the opening of the account.

The procedures should allow the financial institution to verify enough of the

identity information that a reasonable belief can be formed about the true identity

of a customer. In other words, customer identity verification procedures are not

required to verify each and every piece of identity information collected – the only

requirement is to check as much identity information as needed to establish the

reasonable belief. There are two methods on how identity information can be

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 verified:

1. Using documents

2. Using non-documentary methods

III. Customer Onboarding

Client onboarding can be simply defined as the entire process through which

a user starts his journey as a customer or a client of a bank/ financial institution.

Similarly, the onboarding experience can be defined as the relationship between

the customer and the organization.

Client onboarding is the process a bank undertakes when bringing a new

business customer onboard. Onboarding new clients involves gathering vital

information on the customer and conducting identity checks to comply with KYC

regulations.

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 The State Bank of Pakistan via FE Circular No 04 of 2019 ‘Framework for

Managing risks for Trade Based Money Laundering & Terrorist Financing

instructed Authorized Dealers to perform due diligence before onboarding trade

customers, some of the important points are mentioned below:

a. Authorized Dealers (ADs) shall obtain an undertaking from new

customer, which intends to do trade business, wherein the customer

shall be required to declare the name(s) of bank(s) with which it has/had

trade business relationship along with various type of trade transactions

in which it has been dealing. Upon obtaining the said undertaking, ADs

shall verify the status of customer overdues [Export Bills, Advance

Payment Import, Advance Payment Export.

b. While onboarding proprietorship concerns for trade business, the

assessment, as noted above, shall be conducted by ADs keeping in

view the higher ML/TF risks associated with this form of business due

to factors such as minimum legal requirements in formation, registration

and winding up of the business etc.

c. ADs shall also integrate the performance of the trade clients in their risk

profile including historic and outstanding overdues [Export Bills,

Advance Payment Imports, Advance Payment Exports, Regulatory

Penalties etc.]

d. ADs shall formulate procedure whereby each of their client, based on

the risk assessment conducted at the time of onboarding with respect

to trade related activities, performance history and historic reporting of

STRs to FMU (if any), is assigned a risk rating/category in addition to

the general risk profile of the customer being maintained by the ADs

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 under AML/CFT instructions issued by SBP from time to time.

IV. Ultimate Beneficial Owner(UBO)

“Ultimate Beneficial Owner” “means a natural person who ultimately owns or

controls a company, whether directly or indirectly, through at least twenty-five

percent shares or voting rights or by exercising effective control in that company

through such other means, as may be specified.

The definition of UBO is different under the different laws, keeping in view the

unique characteristics associated with each type of legal person. For instance,

section 123A of the Companies Act, 2017 defines a UBO as “a natural person who

ultimately owns or controls a company, whether directly or indirectly, through at

least twenty-five percent shares or voting rights or by exercising effective control

in that company through such other means, as may be specified”.

Section 8 of the Limited Liability Partnership Act, 2017 (LLP Act 2017) defines

UBO as “a natural person who ultimately and effectively owns or controls a limited

liability partnership through direct or indirect rights or who shares at least one fourth

of the net profits and losses of the partnership”. Notwithstanding the above, the

threshold of ownership or control for the purpose of classification as an ultimate

beneficial owner provided in the definitions in the different laws and regulations is

the same, i.e. 25%. (Extract from: - FAQ on UBO from SECP revised Nov 2020).

Trade Based Money Laundering (TBML) Red Flags

A red flag is a warning or indicator, suggesting that there is a potential

problem or threat with a company's stock, financial statements, or news reports.

A red flag for one investor may not be for another.

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 Trade Finance is the financing for trade activity in both domestic and

international markets. Trade-based money laundering (further referred to as

“TBML”) is the process by which criminals use a legitimate trade to disguise their

criminal proceeds from unscrupulous sources.

Regulatory bodies around the globe are stepping up scrutiny on TBML and

banks are increasingly obliged to take more stringent action to ensure they are not

facilitating any illicit transactions. The Monetary Authority of Singapore (MAS), the

Hong Kong Monetary Authority (HKMA) and the Financial Conduct Authority (FCA)

in the UK are some of the global regulators that have issued guidelines and red

flag checks around trade finance, echoing those issued by the International

Chamber of Commerce (ICC), Bankers Association for Finance and Trade (BAFT)

and the Wolfsberg Group. These red flag checks define the key attributes in trade

finance transactions that indicate a high risk for TBML and are now seen as the

global standard for due diligence for which financial institutions must screen and

monitor.

State Bank of Pakistan issued a comprehensive Framework for managing

TBML & TF risk via FE Circular No 04 of 2019 dated: - 14th October 2019 which

shown a serious effort by the regulator to encounter the risk of TBML.

a. Over & Under Invoicing

One of the main forms of TBML activity is to either over estimate or under

estimate the price of invoices. Case studies described in the FATF report highlight

how banks may be involved in facilitating TBML transactions by not having the

relevant documentation to fully understand the transaction process or realizing

the full value of the shipments. In these scenarios although business checks

and assessments were undertaken within the banks, the use of false shipping

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 documentation and falsified documents by the client effectively rendered standard

risk assessment systems null and void.

This falsification and over invoicing process can be used in either direction

depending on where the money needed to be transferred. From this it can be

seen that trade-based money laundering is a complex mini financial system of its

own, which involves a number of partners, transactions and goods. The challenge

for the banking sector is to develop a system that will unravel those elements that

are relevant to their work as a financial institution; rather than considering

themselves as an extra arm of law enforcement.

For the banking sector generally and especially for global banks involved in

international transfers, there are a number of points that n e e d to be

acknowledged when implementing the current AML requirements. The main

point is to be clear how TBML affects banking business and therefore establish

what the benefits are to addressing and improving AML compliance within the

banking structure. In other words, the f inanc ial sector needs to develop its own

understanding and definition of TBML as it applies to their work.

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 b. False Description of Goods

Customers involved in TBML activities can also present other business

documentation such as invoices, packing list etc. to the bank that has been altered,

forged or acquired illegally. The nature of the forged document will depend on the

transaction that they wish to undertake and the underlying purpose of the criminal

activity; therefore, understanding the nature of the business may give some clues

as to the nature of the crime.

c. 3rd Party Payment & Shipment

This is also a new area of risk assessment and links into the increased focus

on beneficial ownership of companies and transactions.848 It has become

increasingly evident through FIU reports and media coverage of banking cases,

that many clients are hiding their trading activity through the use of third-party

businesses and people. Illicit financial flows from developing countries into the

western economies often involve politically exposed persons (PEP). These

PEPs know that they will be checked through enhanced due diligent systems

and so they use third party members and friends to hide the source of the

money. Sometimes criminal organizations will also approach legitimate business

owners for them to undertake financial transactions on their behalf and avoid

CDD checks. This means that the bank CDD process also needs to incorporate

the analysis of key beneficiaries within the business and to verify ownership

information. It is often through this process that suspicious client behavior may

come to the fore, as the client becomes uncomfortable with the process. The FATF

indicators include:

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  The transaction involves the use of front (or shell) companies.

 The transaction involves the receipt of cash (or other payments) from

third party entities that have no apparent connection with the

transaction.

d. Short & Over Shipment

A short shipment is when cargo is listed on a shipping list but not included in a

shipment, or not received by the recipient. Notably, when the quantity received is

less than the quantity listed.

An over shipment is when the quantity received is more than the quantity listed.

These can occur for a number of causes, and the term can refer both to actually

shipping incorrectly, or to what the recipient reports on receipt, which may be for

another cause.

Usually, over shipment occur due to sampling goods included, However, the

weight or the quantity may not be unusual or highly differ due to inclusion of

sampling goods in Cargo. Such difference may not count as the red flag after

proper investigation.

e. Shell Companies
Shell companies are non-public entities that are formed to protect or hide

another company’s assets. Existing only on paper, shell companies typically have

no physical premises, employees, revenue, or significant assets, but may hold

bank accounts or investments. Shell companies are not inherently illegal: they can

be formed quickly and relatively inexpensively in the legitimate financial system

and used as vehicles to raise funds, hold stocks, or act as limited liability trustees.

However, shell companies are also frequently misused for illegal purposes and, in

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 particular, as part of money laundering schemes. In most jurisdictions, shell

companies can be set up by registered agents in a manner which

obscures ultimate beneficial ownership (UBO). Effectively, this means that

shell companies can be established with a degree of anonymity and then used to

hide illegal funds, evade sanctions, and avoid the AML measures that firms use to

detect suspicious financial activity.

In 2016, the Panama Papers exposed the extent to which shell companies

were being used to launder money in jurisdictions around the world. The AML

threat posed by shell companies is significant: the leaked documents revealed that

shell companies had been set up in a variety of low regulation jurisdictions such as

the British Virgin Island and the Cayman Islands, with many of those enterprises

linked to prominent political officials and their families. Responding to the leak,

global tax authorities were able to recover around $500 million and pursue a

number of criminal prosecutions against firms and individuals involved.

In the United States, some estimates suggest that the misuse of shell

companies costs the country around $70 billion per year. Given the scale of the

threat to the legitimate financial system, it is important that firms understand the

AML risk that shell companies pose and are able to detect customers that are

attempting to use them to launder money.

The anonymity associated with shell companies and the deliberate efforts

by criminals to avoid regulatory scrutiny can make AML compliance challenging.

Accordingly, AML compliance teams should be familiar with red flag

characteristics that indicate when a shell company may be being used to launder

money. Those red flags include:

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  Difficulties in obtaining information about the originators or beneficiaries

of transactions or transfers.

 A company that exhibits transaction activity inconsistent with its

business profile, including unusually high volumes of transactions or

sporadic bursts of transactions.

 Payments that have no clear or stated purpose or that do not involve

any discernible goods or services.

 Multiple high-value transfers between known shell companies.

 Payments that are only identifiable via reference to a contract or

invoice.

 Transactions involving goods and services that do not match the profile

of the companies sending or receiving them.

 Transactions that involve two separate companies registered to the

same address or companies that provide only the address of their

registered agent.

 A single company sending wire transfers to an unusually large number

of beneficiaries.

 Transactions that frequently involve beneficiaries in high-risk

jurisdictions or off-shore financial destinations.

f. Phantom Shipments

Phantom shipment usually called as ghost shipment, where upon submission

of trade documents actual shipment does not occurred.

This is an interesting concept, where the buyers and sellers collude with each other

and orchestrate a scheme where fake invoice and other shipping documents travel

alone with no merchandise associated with it.

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 Seller sends the invoices to the buyer for the goods which are not dispatched and

in some cases the goods doesn’t even exist. The buyer who receives no goods

makes the payments for the goods which were never received.

Impact of Technology on Global Money Laundering

There are many advantages of living in a globalized community with access

to advanced technology and communication systems. In business and financial

terms one of the main advantages is the increase with which business can be

conducted, supported by faster and less cumbersome means to ship and transfer

goods and faster mechanisms through which to receive or make payments. There

is however also a downside to this phenomenon and that is witnessed through

the increase in multi-national organized crime groups, who can quickly and

effortlessly move illicit goods and their financial gains across the globe at the

click of a button. In the words of Arnone & Borlini (2010) ‘The multi-faceted

process of globalization has created new opportunities for transnational economic

crime’.

This growth in transnational crime can be witnessed in the projected

estimates for global money laundering (ML) activity. These figures show that
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 money laundering activity accounts for approximately 2-5% of the world’s GDP with

50% of all money laundering activity occurring through the US banking sector. 4In

addition to the financial impact that money laundering has on the banking sector,

ML also has a severe economic impact on countries across the world, this is

due to the nature of both its direct and indirect effects. These indirect effects can

include increasing the political instability of countries due to the supply of arms

to rebel and insurgent groups; or increasing illegal drug supplies into communities.

The removal of money from weakened economies through illicit financial flows can

also destroy community infrastructure by depleting governments of structural

funds. ML can destroy the local economic structure by destabilizing legitimate

businesses and providing access to cheaper cash or credit for those businesses

supporting the criminal organizations. The social and political impact of money

laundering means that international responses have been called for in order to

address the scale of the problem.

Organizations such as the FATF have tried to address some of the concerns

by producing a series of guidelines that focus on each of the various aspects of

money laundering including best practices on TBML and also virtual currency

threats. This has resulted in a number of agreed standards for AML compliance

that banks across the globe must adhere to, and which countries have agreed to

monitor and supervise. The challenge to the banking sector is to try and turn these

generic guidelines into working policies that can be administered practically within

each specific local banking context. Unfortunately, many of the guidelines have

been developed to focus on simple money laundering techniques in isolation,

whereas research would suggest that schemes like TBML, mix and match money

laundering techniques. This means that AML red flags also need to become

broader.
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 Despite the increased regulation and reporting procedures, criminals

involved in laundering money have become increasingly more complex in their

exploitation of financial products, as a way to launder the proceeds of their illicit

activity. As a result of these evolving techniques the industries and agencies that

respond to money laundering (ML) activity have seen a continued increase in the

growth of illicit funds entering the global economy. Within the area of financial

crime, ML is now recognized as possibly the biggest major problem, and

constitutes the third largest ‘business’ in the world.

Role of Internal Control to combat TBML Risk

The cost of running a compliance function for anti-money laundering and

countering the financing of terrorism (AML/CFT) in an organization is far less than

the price it may pay for noncompliance. Because of increased regulatory focus,

penalties levied affect the bottom line and become a going-concern issue with

license suspensions or cancellations. Given the social, economic, and political

ramifications of money laundering and terrorism financing, it is becoming more

difficult for organizations to consciously ignore AML/CFT compliance. The next 10

years could witness enhanced regulatory compliance across jurisdictions, so

internal audit's role in ensuring strict AML/CFT compliance assumes greater

importance.

AML internal controls include those policies, procedures, and processes

designed to mitigate the risks of money laundering and support compliance with

AML regulations. A compliant internal controls program will be appropriate for the

specific organization, and based on its specific risks. Thus, larger or more exposed

organizations may have more sophisticated or detailed programs, but ALL financial

entities will aim to address the same types of issues. For examples, the program

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 will:

 Use the risk assessment process to identify the products, services,

customers, third parties, and locations that are more vulnerable to

money laundering.

 Assign responsibility for AML compliance to an appropriate person who

will keep senior management and the Board informed.

 Implement risk-based Customer Due Diligence (CDD) policies to help

identify vulnerable accounts.

 Identify reportable transactions, and comply with mandating reporting

requirements.

 Provide dual control and segregation of duties as appropriate.

 Train and supervise employees as needed to be aware of and

compliant with AML regulations.

 Report and maintain records as required.

Role of Internal Audit to combat TBML Risk

There are various roles and responsibilities of the internal audit. The Internal

Audit teams within the banks are responsible for ascertaining the effectiveness and

efficiency of the AML framework of the bank. This would specifically include

checking the adequacy of policies, procedures, and system support to detect

suspicious and potential money laundering transactions, and the subsequent

monitoring and reporting to regulators, FMU, and senior management. The

effectiveness and efficiency of the AML framework of the bank is the responsibility

of the Internal Audit and Internal Control teams. This would specifically include

 Checking the adequacy: It is the responsibility of Internal Audit teams

to check the adequacy of policies, procedures, and system support to

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 detect suspicious and potential money laundering transaction

 Monitoring and Reporting: It is the responsibility of the Internal Audit

and Control teams to monitor suspicious accounts and transactions.

These teams are also responsible for reporting such suspicious

transactions to the regulators, FIU-IND and senior management

SBP via FE Circular No 04 of 2019 ‘Framework for Mnaging Risks of Trade

Based Money Laundering & Terrorist Financing defines the role of Internal Audit to

combat TBML Risk as:

Internal Audit
Internal Audit Departments of Authorized Dealers (ADs) shall periodically

review (at least once in two years) the robustness of bank’s system and controls

with respect to compliance with the provisions of this framework. The audit report

prepared by the Internal Audit Department shall be submitted to the risk

management committee of the bank’s Board of Directors for review and taking

necessary action in accordance with the recommendations of the report.

Role of Board of Directors and Senior Management to combat TBML

Risk

Organization’s Board of Directors and senior management are responsible

for creating a “culture of compliance” through performance of these tasks. An

important support for this culture will be regular internal and external audits that

lead to evaluations of AML compliance performance.

SBP via FE Circular No 04 of 2019 ‘Framework for Managing Risks of Trade

Based Money Laundering & Terrorist Financing defines the role of Board and

Senior Management to combat TBML Risk as:

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 Board and Senior Management Oversight

Authorized Dealers (ADs) shall enhance the oversight role of their Board of

Directors and senior management in the areas of ML/TF risks associated with trade

transactions. In this respect, ADs shall institute clear policies and procedures

defining therein responsibilities of their Board of Directors or its Sub-Committees

and senior management with specific focus on the following:

a. Development and implementation of Customer Risk Profiling

Framework and Transaction Monitoring System for managing ML/TF

risks.

b. Implementation of technology-based solutions.

c. Periodical review of AD’s distinct risk profile.

d. Review of reports, which provide useful insight into the internal controls,

to gauge their adequacy to mitigate ML/TF risks.

e. Development and implementation of price verification policy including

level of acceptable price variance.

f. Granting of status of AD to branches.

g. Regular training of officers engaged in processing of trade business to

enhance their skill set for dealing with ML/TF risks emanating from

trade transactions.

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 Reference Studies
The Wolfsburg Group, ICC and BAFT Trade Finance Principles 2019 amendment
FATF-GAFI Trade Based Money Laundering 23rd June 2006
FATF-GAFI Best Practices on Trade Based Money Landenberg- 20TH June 2008
Guidelines on the implementation of the UN Security Council resolution concerning targeted
financial sanctions on proliferation financing issued by MOFA on September 2020.

FE Circular No 04 of 2019 ‘Framework for Managing Risk of Trade Based Money Laundering and
Terrorist Financing
AML/CFT/CPF Regulations for Sate Bank of Pakistan’s Regulated Entities (SBP-REs) Updated up to
January 27, 2021

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