Trade Misinvoicing: A Common TBML Typology

Trade is the backbone of the global economy and all of us benefit from the trading of products and services across the continents. Global Trade Atlas (GTA) expected an increase in the real value of global trade in both 2020 and 2021 to respectively 188,70.58 and 197,94.77 USD billion. While global trade is expanding year by year, we have observed an increasing trend in the illicit activity by criminals trying to move the economic values of criminal proceeds through global trade. The immense volume of goods traded across the globe make it very attractive for criminals to hide behind complexities of global trade in order to move their illicit funds.

There are number of techniques that criminals use to hide behind legitimate trade—e.g., over- or under- pricing, phantom shipments, misrepresenting the quantity/quality of underlying goods and altering the invoices to deceive banks, trading companies and authorities. In March 2020, Global Financial Integrity (GFI) issued a very comprehensive report on Trade-Related Illicit Financial Flows in 135 developing countries. Although many types of illicit activities fall under the umbrella of “illicit financial flows” (IFFs)—tax evasion, smuggling, piracy, counterfeiting, etc—this report only focuses on trade misinvoiving.

GFI utilized sophisticated data mining and filtering methodologies to identify the approximate values of misinvoiced trades. The advocacy group compared data submitted by governments to the United Nations Comtrade Database every year to perform a country trade-gap analysis.

Another very important fact identified by GFI is that trade misinvoicing is not a problem for developing countries alone. Rather, the size of misinvoiced trades between developing countries is approximately identical when compared with misinvoiced trades between developing and developed countries. Hence, trade misinvoicing is a significant problem in developing countries as well as developed countries.

According to GFI report, “IFFs are illegal movements of money or capital from one country to another. GFI classifies illicit flows as funds which are illegally earned, transferred, and/or utilized across an international border. The primary sources of illicit flows include grand corruption, commercial tax evasion, and transnational crime.

Some examples of IFFs might include:

• A drug cartel using trade-based money laundering techniques to use the illegal proceeds of narcotics sales to purchase used cars, which will be exported to the drug source country and sold;
• An importer using trade misinvoicing to evade customs duties, value-added tax (VAT), or income taxes;
• A corrupt public official using an anonymous shell company to transfer stolen state assets into a bank account in the United States;
• A wealthy individual or multinational corporation hiding taxable income or wealth from national tax authorities in offshore centres or tax havens – often referred to as “secrecy jurisdictions”;
• A human trafficker smuggling cash across the border; or
• An individual wiring money to finance terrorist activities in another part of the world”

A report published by RUSI highlighted that “the World Trade Organization (WTO) estimated the value of global merchandise trade at nearly US$18 trillion in 2017. However, less than two percent of all shipping containers are searched each year to verify the veracity of customs invoices, providing an easily accessible channel for illicit activity. This also indicates that as the volume of global trade has increased in recent decades, the opportunities for trade misinvoicing have increased as well.”

It is quite challenging for financial institutions to detect over/under invoicing due to large transactional volumes, lack of trained staff, complexity of transactions as well as the fact that only 20% of total trade transactions are carried out through bank financing while 80% are conducted through open-account trade.

The US Government Accountability Office (GAO) separately published a detailed report on TBML in December, highlighting a number of TBML typologies, including trade misinvoicing through open-account transactions. As it is evident from the diagram below, a bank normally only processes the payment when processing an open-account trade transaction, but it does not have access to bill of lading or any other document (unless specifically requested) to understand the quantity of the underlying goods.

The limitation with an open-account trade transaction is the absence of documentation for the bank to review because the transactions usually are processed straight through without any checks from the bank. At the same time, a mitigating opportunity for the bank is present in the form of valid KYC on their client since, for an open-account trade transaction, both buyer and seller must be on-boarded clients of their respective banks. It is very important for a bank to have a very effective transaction-monitoring controls in place with realistic and accurate client profiles, including transactional volumes, values, frequency, jurisdictional exposure, key products, clients and delivery channels, etc. When a bank has all these information saved in a client profile, a well intergrated transaction monitoring system should be able to detect any deviation from pre-defined risk parameters.

It is very crucial for financial institutions to be able to understand the risks associated with open-account trade transactions just as when a bank offers the financing for a physical trade transaction. The limitation of trade-finance transactions is usually lack of information held within the bank because only the applicant of an LC (buyer) needs to be the client of the issuing bank. However, the beneficiary of payment (seller) does not have to be the client of either the applicant or beneficiary bank. This exposes the exporter bank to the risk of making a payment to a seller who may not be a fully on-boarded client of the bank. The limitations include not having a detailed transactional profile or information on beneficial owners and trading history. At the same time, a mitigating opportunity for both the applicant bank as well as the beneficiary bank is present in the form of trade documents—e.g., bills of lading, certificates of origin of product, inspection certificates and copies of the invoice. Banks must have very well-trained operations and compliance staff to be able to identify any red flags within the trade documents to mitigate the risk of over/under invoicing.

Bank as well as corporate firms involved in global trade must understand the vulnerabilities of this sector from a financial crime perspective and ensure that their staff fully understands how to identify the illicit transactions and how to assess and effectively mitigate the financial crime risks through enhancing their control frameworks. International Compliance Association (ICA) and KYC360 recently published a real-life case studies based article titled “Tricks of the trade” that highlights how criminals try to over/under invoice in order to move the value from one country to another while hiding behind legitimate trade activities.

Trade misinvoicing is a very successful technique utilised by organised criminals. However, if the financial institutions involved in global trade deals have adequately trained staff, effective transaction monitoring systems, accurate transactional profiles of their clients and access to efficient technological solutions, then the risk can be sufficiently mitigated, if not fully eliminated.

Aamar Ahmad is a subject matter expert on TBML and financial crime prevention. His clients include banks and energy trading corporations. Aamar is a public speaker on AML and financial crime matters and frequently delivers training seminars and workshops. Aamar has delivered number of projects for global banking clients, including trade finance thematic reviews, trade finance policy gap analysis, and the drafting and delivery of bespoke training for banking staff.

This article is expressing personal opinions and is meant for information purposes only. The article does not intend to replace professional or legal advice. It is recommended that readers seek independent professional or legal advice, or speak to authorised persons/organisations.