Banks providing trade finance products, including standby and back-to-back letters of credit (LCs), are exposed to unique financial crime risks in the Middle East and North Africa (Mena), fresh guidance warns.
Trade in all markets can be an “attractive way to launder the proceeds of crime or evade sanctions”, but the Mena region “exhibits its own specific typologies that reflect the unique risks that transit this geography”, says a detailed report from the Global Coalition to Fight Financial Crime (GCFFC), a public-private anti-money laundering partnership.
Authors include Nishanth Nottath, head of AML at Mashreq Bank, Channing Mavrellis, illicit trade director at Global Financial Integrity, and Fahad Haque, HSBC’s regional head of sanctions for Mena and Turkey.
“Countries that are large facilitators of trade with a thriving business market and mature financial infrastructure are more vulnerable to the threat of trade-based financial crime,” the report says.
“The Middle East epitomises the concept of a trade hub, connecting the East, West and Africa with its prime geographic location, advanced economies, and long and rich history of trade.”
The Mena region is particularly exposed to transshipment risks, where cargo is moved from one vessel to another before being moved onwards, due to its proximity to sanctioned countries such as Iran and Syria, as well as the maritime trade opportunities presented by Iran’s geographical location.
The UAE has long been flagged as high-risk by financial crime standards bodies for those reasons, as well as its extensive use of financial and commercial free zones.
In March this year, it was added to a greylist of high-risk countries maintained by the Financial Action Task Force, though officials cited “significant improvements” in its crime-fighting systems and controls.
The GCFFC report flags several risks associated with trade finance instruments across the wider region, however, and urges banks to use its guidance as a “compendium of knowledge” to tackle the movement of illicit funds.
Trade finance exploited
Back-to-back LCs are flagged as an area of risk. The report says these structures – where one bank, Bank A, issues an LC to a second bank, Bank B, as collateral for the issuance of a separate LC – are often used where the underlying trade agreement prevents the applicant’s bank from issuing an LC directly to the beneficiary. That might be due to the credit quality of the issuing bank, it says.
“A sanctions evader can use a back-to-back LC to remove the name of a sanctioned bank from the documentation more effectively than would be possible with a transferred LC,” the report says.
“With a back-to-back LC, the beneficiary receives a letter of credit from an unsanctioned bank without mention of the original issuing bank. The beneficiary may not even know that a sanctioned institution is involved in the transaction.”
Red flags include instructions to amend the terms of an agreement, the destination of goods and the names of vessels, parties or financial institutions.
Standby LCs can also be exploited as part of a money laundering scheme, the report says. The applicant and beneficiary could collude to violate the terms of the standby LC, prompting payment to the beneficiary underpinned by seemingly legitimate documentation.
“If trade-finance processing staff notice that SBLCs [standby LCs] are constantly being triggered between an applicant and a beneficiary, one of two outcomes is likely,” the report says.
“Either the applicant is enduring a terrible streak of bad luck and poor business judgement, or both parties are conspiring to employ SBLCs to transmit vast amounts of value across borders without raising the suspicions of supervisory authorities.”
Blank endorsed bills of lading (BLs), where no recipient of the endorsed document is specified, can also be used to facilitate crime by obfuscating the true identity of parties involved, it says.
“A money launderer may choose to use a blank endorsed BL as it acts similarly to a bearer cheque… meaning that financial institutions will not be able to apply standard customer due diligence procedures,” the report says.
Switch BLs, where a second set of BLs is issued to substitute the first set once no longer in circulation, are also exploited to launder funds or evade sanctions, again by disguising the identities of the parties involved or the origin of the goods being sold.
Fighting financial crime
The report says behaviour that could indicate trade finance instruments are being exploited requires further investigation by the banks involved, but institutions should be making better use of digital technology and network-building tools.
For financial crime schemes that require collusion between the seller and buyer, the report says banks can analyse information from multiple data sources to identify linkages between entities.
This process helps “build patterns of ownership, hidden relationships, networks, and map transaction flows between entities”, it says. Digitising trade documents such as LCs and BLs are “fundamental” in improving the quality and quantity of that underlying data.
Banks should also use technology to assess vessel-related data, which it says provides “a wealth of information including true ownership and usage”.
“If applied intelligently, this data can be used to assess contracts and additional risk factors, such as ownership by any sanctioned parties and whether the vessel is capable of carrying the goods it is meant to be carrying,” the report says.
Universal use of optical character recognition, where digital information is extracted automatically from paper documents, should be combined with real-time vessel tracking, red flag monitoring and price checking.
“Combining internal and external data provides a richer overview of the customer and its counterparties,” it says, adding that digital invoicing systems “should reduce certain types of financial crime, for example double invoicing” if universally used.
The GCFFC was founded in 2018 by Europol, the World Economic Forum and Refinitiv, and launched formally in June 2020. Other members include the European Banking Federation, the Royal United Services Institute and the Institute of International Finance.
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