Mitigating Risks in Trade Finance. The 2011 International Conference on Financial Crime and Terrorist Financing

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1 Mitigating Risks in Trade Finance September 19, 2011 The 2011 International Conference on Financial Crime and Terrorist Financing Patrick J. McArdle

2 Disclaimer The views that I express are my own and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System. 2

3 Movement of Dirty Money According to FATF, there are three main methods by which criminal organizations and terrorist financiers launder money: The movement of value through the financial system (e.g., wire transfers, cash deposits and withdrawals, etc.) The physical movement of cash (e.g., couriers, bulk cash smuggling, etc.) The movement of value through the trade system (e.g., false documentation, false declarations, etc.) 3

4 What is Trade-Based Money Laundering? A: The process of disguising the proceeds of crime and moving value through the use of trade transactions in attempt to legitimize their illicit origins 4

5 Trade Finance Overview Typically short-term financing to facilitate import and exports of goods Can be documentary and non-documentary Letters of credit, stand-by letters of credit, guarantees Parties typically involved: buyer/seller, importer/exporter, issuing bank, confirming bank, advising bank, and the shipper. 5

6 Risk Factors The expansion of the international trade system has led to a wider range of risks and vulnerabilities for the financial community. Trade finance typically involves multiple parties in multiple jurisdictions making the process of due diligence more difficult. Trade finance can be more document based making it more susceptible to documentary fraud. These factors make it a potential sanctuary for money laundering, terrorist financing and the circumvention of sanctions or other restrictions put in place by governments worldwide. 6

7 Regulatory Expectations To institute risk-based policies, procedures, and processes to manage the risks associated with trade finance activities and to implement effective due diligence, monitoring, and reporting systems 7

8 Regulatory Expectations Three keys to an effective program: Know Your Customer (KYC) Customer Due Diligence (CDD) Enhanced Due Diligence (EDD) The Regulator really wants you to know who you are dealing with! 8

9 Mitigating Risk in Trade Finance An effective tool: Risk-based customer due diligence What does this mean: Know your customer s business. Does the underlying transaction make sense? Any unusual pricing? What banks are involved in the transaction? Has your customer used them in the past? Has your institution dealt with them in the past? How many financial institutions are involved? 9

10 Gathering Useful Information Shipping vessel issues: What is the ship s home port? What is the ship s port of registry? Does it fly a flag of convenience? This is the practice of registering a merchant ship in a country different from that of the ship s owners. The flag of convenience system allows ship owners to be legally anonymous. Panamanian, Liberian, and Marshallese flags of convenience account for almost 40% of the entire world fleet of merchant ships. 10

11 Background Information on the Transaction Are high risk jurisdictions involved? Are the goods in transit in non-cooperative jurisdictions? Does the transaction involve high risk activities; such as weapons, precious metals, crude oil, chemicals mixtures or dual use technology? Are all necessary documents present? Any excessive alterations? Any payments or assignments to third parties? Who they are? Where are they located? 11

12 OFAC Risk in Trade Finance OFAC checks for all parties involved? All parties involved, including non-customers such as banks, shippers, and transit ports, should be checked against OFAC lists. Be wary of sanctioned entities in any part of the transaction, particularly US branches of foreign banks. (Subject to OFAC rules) 12

13 Using Technology to Help Mitigate Risk CDD is key as automated transaction monitoring/data analysis systems have proven difficult with Trade Finance Some computerized models can help. Data analysis systems can: Provide historical averages for your customer s transactions to help detect deviations (including weight, quantity, and even prices of goods to be shipped) Provide industry/trade averages for similar types of customers engaging in similar transactions But systems can fail if the customer has been laundering funds since the first transaction, redundancies must be built into the system. 13

14 Mitigating Money Laundering Risk in Trade Finance Red Flags: Parties are unwilling to provide requested information Entities and other parties existence cannot be validated Shipment locations or description of goods not consistent with letter of credit No description of goods No description of technology (especially weapons-related, computer technology, and other sensitive industries with export limits) Merchandise weight/amount makes no sense for the purported transaction 14

15 Mitigating Money Laundering Risk in Trade Finance Red Flags-continued: Transaction structure appears unnecessarily complex In letters of credit, changing beneficiary name, address, or other identifying information before payment is made Bill of lading for cargo that is in containers but no container numbers are provided Goods are severely or obviously under- or overpriced Payment terms are unusual, payment to unrelated third parties 15

16 Shell Corporations Use of Shell Companies / Corporations Shell companies have no physical presence, have no significant assets or other ongoing business activities Common locations of Shell Corporations: United States Bahamas Cook Islands Cayman Islands Antigua Panama Nigeria Vanuatu 16

17 Shell Corporation Issues in the US The power to incorporate entities rests with the individual states, not the federal government. Many states laws permit corporations, general partnerships, trusts, and other business entities to own and manage LLCs. This enables the concealment of layers of ownership. States with the most registered LLCs: Arkansas, Colorado, Delaware, Kentucky, Nebraska, Nevada, New York, Oklahoma, Oregon, Rode Island, South Dakota, Utah, Washington and Washington DC 17

18 Shell Corporations Red Flags-continued: Applicant or Beneficiary LLCs with domestic (US) addresses whose Issuing or Confirming bank accounts are located in a foreign country. Transacting businesses share the same address, provide only a registered agent s address, or raise other addressrelated inconsistencies. An unusually large number and variety of beneficiaries receive wire transfers from one company Frequent involvement of beneficiaries located in high-risk, offshore financial centers. 18

19 Shell Corporations Red Flags-continued: Huge transactional flows for private companies with no publicly available ownership/product information. Significant money movements often between Trading or Investment companies. Multiple high-value payments or transfers between shell companies with no apparent legitimate business purpose. 19

20 Additional information Federal Financial Institutions Examination Council BSA/AML Examination Manual pages_manual/manual_online.htm 20