Editor's Note: This article originally appeared on the Access Asia Consulting blog on November 28, 2016.
Trade-based money laundering (TBML) in Southeast Asia has been on the rise in recent years, driven by a confluence of factors including robust economic growth, a relatively weak regulatory environment (with the key exception of Singapore,) corruption issues, and the presence of sophisticated transnational criminal networks. These factors, as well as political, socio-economic and cultural dynamics, put the region at heightened risk for TBML in which financial institutions, corporations and governments should play a greater pro-active role in combating.
According to the Organization for Economic Co-operation and Development (OECD), the economies of the Association of Southeast Asian Nations (ASEAN) are expected to grow at a rate of 5.2 percent from 2016 to 2020, which will be led by Vietnam and the Philippines. The major contributors for growth include strong fixed investment, foreign direct investment and an increasing demand of goods from both domestic and foreign customers. But as domestic and international trade increases in the region, which is coupled with enduring signs of bribery and corruption issues, so does the risk for TBML.
The United States Department of Homeland Security has defined TBML as “disguising criminal proceeds through trade to legitimize their illicit origins.” The characteristics of this misconduct include misrepresenting the price, quantity and the quality of either imports or exports. Some of the red flags are over-invoicing and under-invoicing exports and imports, multiple invoicing of goods, manipulating the quantity and even phantom shipments. In addition, payments to a vendor by an unrelated third party and unusual shipping routes are also suspicious indicators.
So, why does TBML matter to financial institutions, corporations and governments? The first reason is its potential adverse consequences to the domestic economy such as governments receiving lower tax revenues when companies under-invoice the value of its shipments. Misrepresenting the value or the quantity of imports and exports may allow criminals and corrupt government officials to transfer capital more easily in order to legitimize the source of funds. Regulatory scrutiny continues to increase across the globe around TBML and financial institutions should take the necessary steps to ensure they do not facilitate nefarious trade deals.
According to research by the Washington-based group Global Financial Integrity (GFI,) three of the top 10 countries for illicit financial flows (IFFs) are in ASEAN: Malaysia, Thailand and Indonesia (ranked as 5, 8 and 9 respectively.) However, when the top 10 countries for IFFs are compared to their gross domestic product (GDP,) the magnitude of the issue is put into perspective. Malaysia can be categorized as the country with the potentially highest risk of TBML because 14.1 percent of its GDP has been identified as potential IFFs.
Another susceptible country is Cambodia. GFI estimated that over $15 billion was lost to illicit financial outflows between 2004 and 2013 – including US$ 4 billion in 2013 – most of it secretly shifted offshore using a technique known as trade misinvoicing. Access Asia also puts Myanmar and Vietnam at heightened risk for TMBL in Southeast Asia, where misinvoicing (including overpricing on imports sold by a member company incorporated in the import country) is a common way of reducing recorded profits to evade taxes. Thus, it is important for financial institutions in such countries to conduct thorough know-your-client due diligence.
Illicit financial flows can have a detrimental effect on a country’s economy by removing revenue from governments which can potentially be used for various development initiatives. In Cambodia, one opposition lawmaker was quoted in local media of saying that the US$ 4 billion reportedly lost to illicit financial outflows in 2013 was more than the entire national budget.
TBML is difficult to detect because of the complexity within the trade finance process itself and the number of entities involved. The unstructured format of the required documentation such as word documents, PDF files and scanned images create additional automation and screening challenges.
So, what more can financial institutions do in the fight against TBML? Access Asia recently engaged with Keith Furst, the founder and financial crimes technology consultant at Data Derivatives, who provided us his views on the issue.
According to Furst, utilizing advanced algorithms should be considered as an effective resource to augment a financial institution’s existing anti-money laundering program specifically to address the unique challenges presented by trade finance.
Many of the unstructured data in the form of PDF files and scanned images can be converted to machine readable text by leveraging optical character recognition (OCR) software. Once these documents are converted into machine readable text then other algorithms can be applied to them such as natural language processing (NLP) where key data elements are extracted for analysis such as geographies, entities, individuals, ports, name of products, quantities and unit prices. There are other opportunities to leverage advanced algorithms such as unit price and unit weight analysis.
The unit price analysis would focus on product pricing falling outside what would be considered normal for that industry and product type in the transaction. This is an incredibly complex task given name similarity among dissimilar products, range of quality, volume discounts, etc. However, certain products and industries would be easier to accumulate pricing profiles and determine discrepancy red flags. Similarly, unit weight analysis would also focus on discrepancy identification, but for volume as opposed to price. Nefarious actors may try to understate or overstate the quantity of goods shipped when compared to the actual payments made. If the payment amount was abnormally low when compared to the product and container it was shipped in then this could be a red flag for an undervalued shipment.
TBML is a very effective tool for transnational organized crime groups to move value across international borders, and the prevalence of such groups operating throughout Southeast Asia – many with links to domestic and international terrorism, is another factor that puts the region at heightened risk for TBML.
Financial institutions tend to be reactive as opposed to proactive when it comes to complying with regulatory requirements, yet taking a strategic approach to compliance can actually be a competitive advantage. Access Asia believes that financial institutions which forecast upcoming trends in the compliance and regulatory space and prepare accordingly will be better equipped to deal with the increased regulatory expectations when compared to their competitors.
Ultimately it will be up to the banks serving Southeast Asia to spearhead the campaign against TBML in their local jurisdictions; a failure to do so could eventually lead to a de-risking process by the large global banks which could affect the availability and cost of trade finance products in the region. Currently, the Monetary Authority of Singapore (MAS) is taking the lead to combat TBML in Southeast Asia, yet Access Asia believes it is only a matter of time before other countries follow suit. If they fail to do so, such countries will fall behind in terms of perception in the eyes of the global financial community and this will negatively effect investment and trade opportunities.