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A Guide on Financial
Crime Prevention in Trade
Finance
GENERAL EDITORS: NEIL CHANTRY, ROSALI PRETORIUS, AND
THIERRY SÉNÉCHAL
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Contents

Executive summary ....................................................................................v

.
Foreword ................................................................................................ vii
.
About the general editors..........................................................................ix
.
About the authors.....................................................................................xi
.
Chapter 1: Financial crime and trade finance .............................................. 1
.
By Neil Chantry, global head of policy and compliance, trade and
supply chain, global transaction banking at HSBC, Rosali Pretorius, partner,
financial services and funds practice at Dentons, and Thierry Sénéchal,
senior policy manager of the banking commission at the ICC
Background...................................................................................1
.
Trade finance and financial crime ......................................................2
.
The economics of regulations ............................................................3
.
The compounding effects of regulations ..............................................4
.
Latest results from the ICC Global Trade Finance Survey .........................5
.
The danger of too much de-risking .....................................................8
.
Trade finance: The need to facilitate financial inclusion ..........................9
.
Chapter 2: Integrating compliance into successful trade finance...................13
.
By Sean Edwards, head of legal, Sumitomo Mitsui Banking Corporation
(SMBC)
Categorising trade finance and developing a risk appetite ................... 13
.
Building the team and allocating the responsibilities............................. 16
.
The architecture of a sound and business-friendly financial crime risk
strategy ...................................................................................... 16
.
Conclusion ..................................................................................20
.
Chapter 3: Fraud in trade finance ............................................................ 23
.
Clarissa Dann, editor, Trade & Forfaiting Review
UNCTAD commodities finance fraud ‘primer’ .....................................23
.
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Contents

The ICC Commercial Crime Services................................................24

.
The letter of credit and the fraud exception rule ..................................25

.
Warehouse fraud .........................................................................28
.
Practical steps ..............................................................................32
.
Chapter 4: Money laundering ................................................................. 35
.
By Robert Parson, partner, and Imogen Holmgren, trainee, Reed Smith LLP
Money laundering offences and obligations relevant to the trade
finance sector ..............................................................................35
.
Money laundering in trade finance ..................................................37
.
Preventive measures to counter money laundering in trade finance ..........44

.
The current situation ......................................................................46
.
Chapter 5: Terrorism financing .................................................................51
.
By Robert Parson, partner, and Imogen Holmgren, trainee, Reed Smith LLP
Terrorism financing offences and obligations relevant to the trade
finance sector ..............................................................................52
.
Money laundering in trade finance ..................................................55
.
Preventive measures to counter terrorism financing in trade finance .........56
.
Chapter 6: Sanctions and trade finance.................................................... 59
By Emma Radmore, managing associate, and Christina Pope, trainee,
Dentons
What are sanctions? .....................................................................59
.
Where do UK sanctions come from? ................................................60
.
Who must comply? ....................................................................... 61
.
International sanctions ...................................................................62
.
What do UK financial sanctions restrict? ...........................................62
.
What do UK trade sanctions restrict?................................................64
.
Key practical issues: Financial sanctions ............................................64
.
Key practical issues: Trade sanctions ................................................65
.
Penalties .....................................................................................65
.
Role of the Financial Conduct Authority .............................................65
.
Sanctions clauses in trade finance related contracts .............................67
.
Checklist for trade finance firms .......................................................67
.
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Executive summary

TRADE FINANCE is a vital component in maintaining a competitive and

productive global economy. Approximately 80 per cent of the world’s
current US$20trn of trade flows is financed by some form of trade credit. An
unfortunate by-product of the success and abundance of such trade activities,
however, is its attraction to perpetrators of financial crime. This is an issue of
global significance, and the work being undertaken to combat abuse of trade
finance activities by criminal and terrorist interests is of paramount importance.
Trade finance has been an area of growing attention in past years, and the
Financial Action Task Force (FATF), the Wolfsberg Group, and the Joint Money
Laundering Steering Group (JMLSG) in particular have drawn attention to the
misuse of international trade finance as one of the ways criminal organisations
and terrorist financiers move money to disguise its origins and integrate it into the
legitimate economy. Business organisations such as the International Chamber
of Commerce (ICC) have consistently voiced strong public support in favour of
improving the resilience of the banking sector and combating financial crime
and money laundering activities. It has also provided practical support from its
anti-crime arm, ICC Commercial Crime Services (CCS).
What is it that makes trade finance a particular target for these criminals?
The problem exists in the fact that the very nature and complexity of trade
finance transactions, and the huge volume of trade flows that exist, can hide
individual transactions and help criminal organisations to transfer value across
borders. As a result of this, every organisation involved in trade finance holds
responsibilities with regards to the prevention of financial crime. This report
covers the various aspects of financial crime in relation to trade finance, and it
outlines the various areas targeted by financial crime and the associated risks.
Drawing on the experience of recognised experts in the trade finance sector,
the report provides practical guidance on the specific financial crime risks in
trade finance, and offers advice on the preventative measures that can be
taken.
Chapter 1 provides the background information on financial crime in
relation to trade finance. It outlines the vulnerabilities of trade finance to
criminals and the need for stringent efforts to combat financial crime. The
chapter provides detailed information on the latest global trade finance data

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Executive summary

and the wider danger to the global economy of too much de-risking in the
global financial marketplace.
Chapter 2 moves on to discuss the proper integration of compliance into
successful trade finance. It provides in-depth advice on categorising trade
finance and developing a risk appetite, and important guidance on the
allocation of responsibilities to deal with financial crime risks. The chapter
includes information on building the architecture of a sound and business-friendly
financial crime risk strategy within an organisation, with detailed advice on: risk
assessments; policies and procedures; due diligence; governance; and training
and awareness.
Fraud in trade finance is the focus of Chapter 3. This section of the report
reviews the specific risks and examples of fraud involving the use of trade and
commodity finance instruments. It identifies how vulnerable banks can be to
fraud when loans are secured on commodities and references the Quingdao
Port scandal, and it suggests some practical approaches to fraud prevention.
Included in the chapter is a detailed explanation of the principles of a letter of
credit and the fraud exception rule.
Chapter 4 tackles the topic of money laundering, with a specific focus on
the offences and obligations relevant to the trade finance sector. The chapter
explores the methods of money laundering used in the trade finance world,
and provides expert advice on the preventive measures which can be taken to
counter money laundering in trade finance.
Terrorism financing is another area of financial crime related to trade
finance, and this is covered in Chapter 5. This chapter outlines the terrorism
financing offences related to trade finance and the obligations relevant to the
trade finance sector. It provides examples of terrorism financing through trade
and the requisite measures to prevent such activities.
Chapter 6 covers sanctions concerns in trade finance, and it explains what
sanctions may be relevant in the trade finance sector in particular jurisdictions. It
assesses the impact and practical application of sanctions and considers what
trade finance firms can do to protect themselves. The chapter also provides a
checklist of activities which are key to any sanctions compliance and protection
programme.
The report is aimed at a broad spectrum of individuals and organisations
involved in different components of the cross-border trade transaction chain.
Specifically, the report will prove helpful to those involved in the financing of
trade – although exporters and importers will also find it a useful guide. The
readership therefore comprises: trade bankers, compliance officers, corporate
treasurers/CFOs of commodities companies, and other exporters and importers,
vendors, consultants, and legal advisers. Regulators will also find it useful as a
barometer of how their requirements are being interpreted and put into practice.

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Foreword

DURING THE course of the three years I have been at the TFR helm, the
symbiotic relationship between trade and the credit that finances it has been
something we have celebrated through our news, case studies, and in-depth
features. It is a very special relationship, but it has come under attack on a
number of fronts.
The global financial crisis caused the steepest contraction of world trade
volume since the Great Depression in the 1920s and damaged economies
which had depended on exports for their growth. Were it not for initiatives
such as former WTO director general Pascal Lamy’s Expert Group for Trade
Finance that helped start projects to remove obstacles to co-risk sharing and co-
financing, trade finance could well have dried up altogether.
But the industry came together, found solutions, and demonstrated how well
financial institutions can pull together in a crisis. One of the legacies of that crisis
has been the increase in financial crime regulation. There is no evidence that
there are suddenly more financial crime perpetrators or more misappropriate
funds – but regulators are certainly jumpier. One can understand them adopting
a belt and braces approach to protecting financial systems, but the unintended
consequence of all of this has been further contraction in trade finance activity.
Sometimes it is easier just not to do the deals at all than put in place all the
measures necessary to avoid censure.
Again the industry has come together with projects such as the SWIFT KYC
Register, and it falls to the financial institutions to share their knowledge and best
practice so that proportionate safeguards fight crime but do not damage trade.
This report sets out the scope of the financial crime regulatory framework in
practical, transactional language, and it aims to promote a wider understanding
of what the requirements mean on the ground. I am grateful to our expert
contributors for all their hard work.

Clarissa Dann
Editor
Trade & Forfaiting Review

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About the general editors

Neil Chantry
Neil is global head of policy and compliance, trade and supply chain, global
transaction banking, HSBC, UK. Neil joined the HSBC Group in London in
1972, initially working with the British Bank of the Middle East in Dubai and
Ras-al-Khaimah in the UAE, Oman, Bahrain, and Djibouti until 1980, when he
went to Hong Kong. Various postings in Hong Kong and Pakistan followed until
in 1994 he transferred to the UK to HSBC Holdings plc, the head office of the
HSBC Group.
Since 1973, Neil has spent the majority of his time managing various import
and export departments, running and developing executive training courses
for trade and foreign exchange, as well as working with business users and
the Group’s IT developers in the specification and design of many of the trade
support systems used by the HSBC Group. Today, Neil is responsible for the
formulation of policy and the maintenance and introduction of best practice
procedures for Trade Services Operations for the HSBC Group, and for the
development of compliance related processes.
Neil has been a representative of the UK delegation to the ICC Banking
Commission since 1994, and was a member of the eUCP Working Group. He
has worked with the SWIFT TSAG Scoping Group and was a member of the
Trade Services Utility Customer Requirements Group and Rules Group, and the
SWIFT/ICC B.P.O. Rules Drafting Group.
Neil is currently head of the ICC Commission on Banking Techniques
and Practice Executive Committee, Chair of the Commission Compliance
Group, and Chair of the ICC UK’s Banking Committee. He is also the chair
of the Wolfsberg Group’s Trade Group working on trade specific guidance to
Wolfsberg members related to the application of various regulatory requirements
for NPWMD, AML, sanctions, and anti-terrorist finance.

Rosali Pretorius
Rosali leads Dentons’ London-based financial services and funds practice.
She focuses on exchange traded and OTC commodity and other derivatives,
alternative investment funds, and the financial regulation of these and
other products. Acting for banks, broker-dealers, fund managers, insurance

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About the general editors

companies, and other financial intermediaries, she advises both sell-side and
buy-side clients.
Rosali read law in South Africa and England. After short stints as a precious
metals analyst in Johannesburg and as law lecturer at King’s College London,
she joined Dentons as a trainee in 1995. Rosali was shortlisted for ‘The
Lawyer’s Assistant Solicitor of the Year Award’ in 2001. In 2006 she was
seconded to the legal department of Goldman Sachs, focussing on commodity
and funds derivatives.
Commended in Lawyer Monthly ‘Women in Law Awards’ which celebrate
and highlight the achievements of women in the legal profession across the
globe, she is a popular speaker on financial services regulation and a regular
contributor to TFR.

Thierry Sénéchal
Thierry Sénéchal is senior policy manager of the banking commission at the
International Chamber of Commerce (ICC). He has 20 years of experience
in financial crime risk, in both investigative and policy functions, in the public
and private sectors, and across a wide range of topics (AML, sanctions,
financial fraud, and insurance claims). As senior policy manager of the banking
commission at the ICC, he leads and coordinates the efforts to develop industry
standards in banking and financial services, including the policy guidelines on
financial crime risks.
He is one of the initiators and a founding member of the ICC AML Task
Force in 2008. Prior to joining ICC, Thierry Sénéchal served as executive
director, financial audit and policy with the Mazars Group, a leading
international accountancy firm of 14,000 professionals in 70 countries (2002–
2005). At Mazars, he led a wide range of client engagements for financial
institutions, central banks, regulators, and government treasuries around the
globe, including AML compliance audits, financial investigations on misuse of
public funds, and evaluation of government budgets.
Before joining Mazars, he served as an international civil servant with the
UN Security Council for which he handled the investigation of a US$350bn
claim programme and overall responsibilities for the review of the banking
and financial claims arising out of the invasion of Kuwait by Iraq. He started
his career as financial fraud and asset recovery investigator with Seri Expert-
McLarens.

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About the authors

Clarissa Dann
Clarissa is editor of Trade & Forfaiting Review (TFR), the specialist trade and
receivables finance information service which is now in its 18th year. TFR
includes a monthly magazine, an online information service, industry events,
reports, and two annual awards competitions. Clarissa’s former roles included
running legal and regulatory publishing teams at Thomson Reuters and Lexis
Nexis before she completed her MBA in 2004 from Cass Business School in
London and re-trained as a financial journalist. Based in the UK, she is regular
participant in and reporter on trade and commodity finance events around the
world, and she is currently studying for the Certificate in International Trade
Finance (CITF). You can follow Clarissa at twitter.com/clarissadann.

Sean Edwards
Sean is an English solicitor, formerly with Clifford Chance, and is now head
of legal at Sumitomo Mitsui Banking Corporation (SMBC) Europe Limited. He
is Deputy Chairman of the International Trade and Forfaiting Association (ITFA)
and Chairman of the ITFA Market Practice Committee. He was a member of
the drafting group of the Uniform Rules for Forfaiting (URF 800), a co-operative
initiative of the ITFA and ICC and published by the ICC. Sean has written
articles on forfaiting for all the major trade finance magazines and he is on the
editorial board of Trade & Forfaiting Review (TFR). Sean has an honours degree
in law from Bristol University.

Imogen Holmgren
Imogen graduated at the University of Poitiers, France in Public Law and is a
trainee solicitor in the Trade Finance team of the Energy & Natural Resources
Group of Reed Smith. She joined the London office of Reed Smith in 2013 after
having worked originally in Reed Smith’s Paris office.

Robert Parson
Robert is a partner in the Energy & Natural Resources Group of Reed Smith,
based in the London office. He graduated in Law at Sheffield University and,
after spending the early part of his career with Reed Smith’s London Legacy

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Commodity practice at Richards Butler, he built a strong reputation as a partner

in one of London’s best-known trade law firms before rejoining Reed Smith in
2008.
He focuses on the financing of international trade and commodities, acting
for many of the world’s major commodity banks, traders, exporters, and other
participants in the global trade market, and he advises regularly on structured
trade finance deals, international payments, letters of credit and guarantees,
and supply chain finance solutions. Robert is named in the current editions of
Legal 500 and Chambers as a leading individual. He is the editor of the legal
journal Finance & Credit Law.

Christina Pope
Christina is a trainee in Dentons’ financial services and funds group. On
graduation, Christina worked for Kroll in the legal technology business, and then
joined Dentons as the senior paralegal and manager of litigation support in the
dispute resolution department. Christina has completed a Masters in Law, which
included an elective in Financial Regulation and Compliance.

Emma Radmore
Emma is a managing associate in Dentons’ London-based financial services and
funds practice. She advises on all aspects of regulation under financial services
legislation, and her client base includes UK, European, and international firms,
both within and outside the regulated sector. Her main areas of focus are
advising on structure of business to obtain the best financial regulatory treatment,
the scope of the authorisation requirement under the Financial Services and
Markets Act 2000, and helping clients to obtain authorisation, drafting
client take-on documentation, and advising on compliance with regulatory
requirements. She advises clients in all parts of the financial sector, including
banks, insurers, asset managers, and intermediaries, with a focus on the retail
markets.
A large part of Emma’s practice involves advising clients on policies and
procedures to counter financial crime. She advises regulated and unregulated
firms on anti-money laundering requirements, the financial sanctions regime, and
the prevention of bribery and corruption. She has advised clients in all industry
sectors on the impact of the Bribery Act 2010 on their businesses, and she has
given training, drafted high-level principles, recommended compliance strategies
and reviewed and amended global anti-corruption policies for Bribery Act
compliance. Emma also advises on drafting and amending contracts to deal
with bribery risks. She has written many articles on regulatory and financial
crime issues, and has spoken at several seminars, including at the British
Bankers’ Association, the Futures and Options Association, and the Institute

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A Guide to Financial Crime Prevention in Trade Finance

of Money Laundering Prevention Officers. She is on the editorial board of

Compliance Monitor, Financial Regulation International, and World Securities
Law Report. She won the ‘Best Regulatory Lawyer’ award at the Compliance
Register Awards in 2013. She also won the ‘Best Compliance Trainer’ award
at the Compliance Register Awards in 2006, 2011, and 2012 and the ‘Best
Compliance Training Programme Designer’ in 2013. Emma is the editor of the
firm’s weekly financial regulatory e-newsletter, FReD, which won the award for
‘Best Editorial Team’ at the 2011 and 2012 Compliance Register Awards.

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Chapter 1: Financial crime and trade
finance
By Neil Chantry, global head of policy and compliance, trade and
supply chain, global transaction banking at HSBC, Rosali Pretorius,
partner, financial services and funds practice at Dentons, and Thierry
Sénéchal, senior policy manager of the banking commission at the
ICC

Background
GLOBAL TRADE relies upon accessible finance for trade transactions. Trade
finance assists customers with their import and export requirements by providing
import/export financing as well as country and counterparty risk mitigation.
Trade finance, as a transaction banking product, is a core banking business
serving the real economy. The availability of trade finance and, consequently,
its ability to help companies facilitate cross-border transactions through different
banks across different jurisdictions is essential to support global supply chains.
According to the Bank for International Settlements (BIS), trade finance
directly supports about one-third of global trade with letters of credit (LCs)
supporting about one-sixth of total trade.1 The importance of trade finance in
emerging markets is even greater.2 Trade finance assists exporters and importers
pursuing opportunities in the most challenging markets. Without the effective
mitigation of risk developed by trade finance over centuries, trade would, in
many cases, just not flow.
Short-term trade finance is especially important to SMEs, in particular in
emerging economies. Most trade transactions require financing to be provided
either by the buyer or by the seller. Several key characteristics distinguish the
market for trade finance from other forms of finance. Trade finance is inherently
low risk compared to many other forms of finance.3 More than everything else,
the trade finance industry is characterised by short-term maturities, with security
in the underlying goods being moved in a transaction. The average tenor of a
trade finance transaction is less than 180 days.4
Bank involvement in cross-border trading is defined by the type of
transaction and the degree of security required by the transaction parties. In
trade, banks typically take on several roles including:

(i) Acting as intermediaries in the exchange of documents;

(ii) Issuing performance guarantees for either party or guaranteeing payment on
behalf of the buyer; or
(iii) Extending lines of credit to facilitate a transaction.

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Chapter 1: Financial crime and trade finance

As party to a trade finance transaction, the bank reduces risk and increases
liquidity for the counterparties by taking on a proportion of the risk itself. For
example, LCs reduce payment risk by providing a framework under which
a bank makes (or guarantees) the payment to an exporter on behalf of an
importer once delivery of goods is confirmed through the presentation of the
appropriate documents.

Trade finance and financial crime

Trade finance has been an area of growing attention in past years. The
Financial Action Task Force (FATF), the Wolfsberg Group and the Joint Money
Laundering Steering Group (JMLSG) have all drawn attention to the misuse of
international trade finance by criminal organizations and terrorist financiers to
move money to disguise its origins and integrate it into the legitimate economy.
The complexity of transactions and the huge volume of trade flows can hide
individual transactions and help criminal organizations to transfer value across
borders. As financial institutions have gradually introduced increasingly effective
controls to combat more traditional methods of money laundering and terrorist
finance, and world trade has grown, it has perversely become more attractive
to criminals to use trade finance products.
Those characteristics of trade that make it attractive to money launderers
– global, and therefore subject to different standards of regulation and
enforcement; often opaque, in that it can be difficult to trace the origin of the
goods; and long supply chains, manufacturer, trader, consigner, consignee,
notifying party, financier, shipper, insurer and freight forwarder – often also
make it vulnerable to fraud.
Many countries now see sanctions – also referred to as restrictive measures
– against third countries, individuals, or entities, are an essential foreign policy
tool to pursue certain foreign and security policy objectives.5 Given their
key role in facilitating global trade and the international economy, financial
institutions are increasingly expected to act effectively as enforcers of those
sanctions policies. Regulators worldwide, but especially in the US and the UK,
are placing ever higher expectations on financial institutions to manage their
sanctions risk. Compliance with domestic and international sanctions regimes is
now a key regulatory challenge for financial institutions, and trade presents its
own specific challenges. The destination of the goods may be sanctioned, or
one of the parties in a long supply chain may be sanctioned, or there may be
an issue with the underlying transaction itself.
The global financial crisis of 2008–09, and resulting economic slowdown,
signaled the need to review the global financial regulatory framework to
reinforce the banking sector’s ability to absorb economic shocks and to build a
stronger, safer international financial structure. It is now widely recognised that

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financial crime itself can be a threat to the stability of a country’s financial sector
and institutions.6 Business organisations such as the International Chamber of
Commerce (ICC) have consistently voiced strong public support for the stated
goals of improving the resilience of the banking sector and combating financial
crimes and money laundering.

The complexity of the global trade system makes it vulnerable to

financial crime
How many containers are moving per year in Singapore?
98,000 containers moving per day in Singapore.

How many FTZs are there in the world, and in how many countries
(offering special tax and economic incentives within a country)?
Over 3,000 FTZs globally active:

„ 200 in the US alone, over 90 in EU countries;

„
„ In about 135 countries; and
„
„ Employing about 43 million people
„
How many transactions are logged each hour for one of the largest retail
stores in the US?
1 million transactions per hour. In each minute, 168 million emails sent.

80 per cent of data is unstructured (emails, trading instructions, etc.) versus

20 per cent of structured relationship (e.g. SWIFT).

The economics of regulations

The need for a resilient financial system
Financial crime is an issue of global significance and the work being undertaken
to combat abuse of the financial system by criminal and terrorist interests
is of paramount importance. The banking industry supports vigorous and
co-ordinated action in this regard on the part of national and international
authorities in collaboration with the private sector. Financial institutions have
significantly increased their efforts to prevent the financing of crime and terrorism
by adding substantial compliance resources to their organisations, changing
the culture of compliance within their institutions, and improving processes and
controls.
Action to prevent and combat money laundering and terrorist financing thus
responds not only to a moral imperative, but also to an economic need. Indeed,
money laundering, the financing of terrorism, financial fraud, and other financial

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Chapter 1: Financial crime and trade finance

crimes can have significant negative economic effects. Financial criminal

activities severely undermine the integrity and stability of financial systems and
may have significant negative spill over effects on the capacity of financial
institutions to carry out normal business activity and provide financing, in
particular to the corporate sector in the less developed and emerging markets,
where they is a perceive a higher degree of financial crime risk.
As a result, the industry fully supported the need for appropriate regulations
to reduce financial crime risks. For instance, recently, most business associations
commented on the UK FCA thematic review7 on the potential for unintended
damage to the provision of trade finance by increased due diligence
requirements when dealing with less developed or developing countries, where
the infrastructure to fight financial crime is either deficient or nascent, according
to FATF.

The compounding effects of regulations

At the same time, recognising the growing importance of interconnected
economies, the industry finds it essential to maintain Global Value supply
Chains (GVCs8) as a driver of growth and productivity, and to overcome
constraints preventing emerging countries from benefitting from the flow
of goods and services in value supply chains. In a world of increasingly
fragmented value supply chains spanning across developed and emerging
markets, the availability of trade finance, and the ability of banks to facilitate
international trade through linkages between different banks across jurisdictions,
is fundamental to ensure that international trade remains a major driver of
recovery, growth, and prosperity across the globe.
Heightened compliance and risk assurance measures make it difficult for
banks to maintain their existing trade relationships, and challenge their ability
to support GVCs. The problem is felt more acutely by the less developed and
emerging markets which are perceived to represent a higher financial crime
risk. These jurisdictions are in danger of being left without access to GVCs.
In particular, counterparty banks—banks that are not account-holding client
­
­
banks but rather entitled to limited services for the purpose of facilitating an
underlying client transaction—are faced with rising Counterparty Due Diligence
­
­
(CDD) requirements and costs. Higher CDD requirements, a lack of globally
consistent standards and costs constrain the ability of banks to maintain multiple
counterparty relationships, particularly in developing countries. They challenge
their ability to support GVCs and global growth while putting into question the
viability of relationships. This has resulted in ‘de-risking’ – reducing in banking
relationships, business lines, and activities.

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Latest results from the ICC Global Trade Finance Survey9

The supply of trade finance continues to be constrained by many of the
same issues reported in previous surveys (See Figure 1 on the next page).
The three top issues that were identified as ‘significant’ impediments were all
characteristics of issuing banks. These included ‘AML/KYC requirements’ (69
per cent), ‘issuing bank’s low credit ratings’ (59 per cent), and ‘previous dispute
or unsatisfactory performance of issuing banks’ (55 per cent).
The continued mention of these issues suggests that markets alone are not
meeting demand. Moreover, according to the last edition of the ICC Global
Survey on Trade finance, AML/know your customer (KYC) requirements stood
out as the major inhibitor of trade finance. They are reported to have led to a
decline in transactions by 68 per cent of the 298 banks participating in the ICC
survey. Globally, Africa was the region that was most negatively impacted by
these requirements (See Figure 2 on page 7). Among firm types, SMEs were the
most negatively impacted. Onerous AML/KYC requirements led many banks
to decline individual transactions. In 31 per cent of respondent banks they also
resulted in the complete termination of banking relationships. Compliance with
these requirements is important – banks do not want to be used for criminal
purposes.
However, the compliance process is resource intensive. De-risking appears
to be impacting access to trade finance, especially among SMEs and
companies in developing countries. The cost of compliance for one counterparty
has been cited as high as US$75,000. This cost is compounded by a lack
of harmonisation between jurisdictions, a problem cited by 70 per cent of
respondents. This suggests that there are some measures regulators could take
to reduce the unintended consequences of compliance which contribute to trade
finance gaps, lowering growth and job creation. More than a third (38.52 per
cent) of respondents reported closing correspondent account relationships in
2013 due to the increasing cost and complexity of compliance (including more
stringent AML and KYC).
As regulatory views may differ from examiner to examiner, regulator to
regulator, and country to country, the handling of regulatory risk requires
a broad compliance strategy in order to ensure its avoidance. This is why
organisations such as the ICC called upon G20 Governments to take on
specific recommendations, including:

„ The encouragement of national supervisors to establish a framework for

„
mutual recognition of base level CDD standards, through the FATF and BIS
standards setting processes. Such a framework must assess the degree to
which two countries’ Risk Based Approach (RBA) country CDD standards are
broadly consistent and achieve an equivalent level of risk assurance;

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AML/KYC requirements 9.01% 6.31% 15.32% 27.93% 41.44%

Basel regulatory
requirements 14.02% 15.89% 28.97% 27.10% 14.02%

Low country
4.59%

credit ratings 8.26% 34.86% 30.28% 22.02%

3.77%

Issuing bank’s low 9.43% 27.36% 31.13% 28.30%

credit ratings

Previous dispute or
unsatisfactory performance 12.50% 13.46% 19.23% 26.92% 27.88%
of issuing banks

Constraints on your
bank’s capital 21.57% 16.67% 27.45% 18.63% 15.69%

4.81%
Lack of dollar liquidity 32.69% 20.19% 21.15% 21.15%

High transaction costs

5.83%

or low fee income 22.33% 35.92% 26.21% 9.71%

Low company/obligator
2.78%

credit rating 17.59% 27.78% 32.41% 19.44%

Insufficient collateral
from company 9.43% 14.15% 25.47% 28.30% 22.64%

Other 18.75% 18.75% 25.00% 12.50% 25.00%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

1 2 3 4 5
Very insignificant Very significant

(The shaded sections in the Figure above appear in the same order as this key.)

Figure 1: Impediments to trade finance

6
 Western Europe 30.53% 16.84% 27.37% 14.74% 10.53%
Central and Eastern Europe 12.90% 23.66% 32.26% 29.03% 2.15%
North America 35.23% 13.64% 20.45% 17.05% 13.64%
Central America 12.35% 22.22% 28.40% 25.93% 11.11%
South America 9.52% 17.86% 36.90% 30.95% 4.76%
Caribbean 11.39% 21.52% 29.11% 30.38% 7.59%
Russia 8.79% 14.29% 37.36% 27.47% 12.09%
Other 10.14% 11.59% 34.78% 27.54% 15.94%
Advanced Asia (Hong Kong,
Japan, Korea, Singapore) 20.88% 27.47% 31.87% 15.38% 4.40%
Developing Asia (excl. India and China) 9.20% 14.94% 36.78% 28.74% 10.34%
Author copy

India and China 10.34% 21.84% 31.03% 29.89% 6.90%

Middle East and North Africa 8.14% 13.95% 24.42% 30.23% 23.26%
Sub-Saharan Africa 12.35% 13.58% 17.28% 32.10% 24.69%
Others 8.57% 15.71% 32.86% 32.86% 10.00%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

1 2 3 4 5
Very insignificant Very significant

Figure 2: Regions affected by the most stringent compliance requirements

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Chapter 1: Financial crime and trade finance

„ The addition of specific guidance notes in the FATF 40 Recommendations

„
to define the minimum financial crimes policies and procedures acceptable
to the regulators so that financial institutions can set a standard approach.
This would enable them to obtain acceptability from the regulators for
establishing a trade-transaction-only relationship with another financial
institution using the risk based approach; and
„ Conducting a global study into the impact of new compliance standards on
„
global trade flows, with special focus on SMEs and the emerging markets.
Such assessment is necessary to find a balanced approach between
combatting financial crime and the global development agenda.

The danger of too much de-risking

There has also been an increase in de-risking in the global financial
marketplace, whereby large international correspondent banks10 are exiting
significant segments of business and further reassessing their risk appetite relative
to costs associated with ensuring high standards of adherence to anti-money
laundering (AML), counter-terrorism financing (CTF) and Know Your Customer
(KYC) rules.11 The no tolerance and high-penalty approach to sanctions
breaches adopted by many governments has compounded the risks. With fines,
such as that imposed recently on BNP Paribas running into the tens of billions
of dollars it is unsurprising that banks and other financial institutions are reacting
quickly to any hint that there is even the slightest possibility that a transaction
might be in breach.12 This behaviour can result in unintended consequences,
among which is the risk of financial exclusion, particularly as it concerns the
provision of international trade financing services in emerging markets.
The imbalance between costs of compliance and the risks of non-
compliance relative to return has led to decisions by correspondent banks to
de-bank respondent institutions, cease offering certain products, and cut lines of
service to certain market segments. In many cases, exit is not related to actual
compliance violations but rather to perceived risks and the subsequent costs of
due diligence which far exceed the relationship return.13 There are times when
compliance checks on smaller customers or correspondents in emerging markets
may not be cost-effective relative to scale. This can result in some deals in
developing economies, particularly with SMEs, being deferred or not transacted
at all. Many banks have simply pulling out of risky jurisdictions, such as Ethiopia,
Indonesia, Myanmar, and even Pakistan (where only one large Western bank
still maintains a significant retail banking presence14) altogether. With the sums
of money and levels of potential reputational damage at stake, this panicked
response from many financial institutions is understandable. However, it is not
clear that de-risking is worth it. As The Economist explains:

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‘Were all of this actually preventing terrorism it might be judged a fair trade-
off. Yet—and this is the second problem with this approach—it seems likely
­
­
­
­
to be ineffective or even counter-productive. Terrorism is not particularly
expensive, and the money needed to finance it can travel by informal routes.
In 2012 guards on the border between Nigeria and Niger arrested a man
linked to Boko Haram, a Nigerian terror group, with €35,000 ($47,000)
in his underpants: laughable, except that the group has killed around 1,500
people this year alone. Restrictions on banks will encourage terrorists to
avoid the banking system. That may hinder rather than help the fight against
terrorism. A former spy complains that it has become harder to piece
together intelligence on terrorist networks now that the money flows within
them are entirely illicit.’

In addition, the prevalence of a zero-tolerance compliance environment

has begun to overtake the risk-based approach espoused by the regulatory
community, with the possibility of financial penalties, reputational damage,
and individual legal culpability outweighing the business rationale for some
transactions.15 Overall, there is a growing need for a balance in combating
financial crime and ensuring that the important development agenda of financial
inclusion and real economy financing is not diminished. Approximately 50
per cent of adults do not have a bank account and are financially excluded
in society. Whilst predominantly a developing world problem, there are also
significant numbers of excluded or unbanked adults in developed regions
including Europe and North America. For the unbanked, it is a challenge to
gain access to banks and the services they offer. Therefore, in a world of
increasingly fragmented value supply chains spanning developed and emerging
markets, the availability of trade finance and the ability of banks to facilitate
international trade between banks across jurisdictions is fundamental.

Trade finance: The need to facilitate financial inclusion

The provision of trade finance plays a central role in ensuring that all members
of the community are economically and financially included. Restrictions on
financial inclusion, in advanced and developing markets, have the potential to
become a major unintended effect of increased supervisory and enforcement
activity by regulators. This manifests itself in problems for banks in day-to-day
operations with customers, such as restrictions on lending to businesses.
Well-intentioned rules, designed for sophisticated markets, can have
powerful unintended effects, particularly when combined with other rigorous
standards around new capital and liquidity rules. Harmonisation of regulations
– such as those under development dealing with beneficial ownership,
transparency, and a consistent approach to enforcement and sanctions –

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will mitigate the cost and associated unintended consequences. This would
incentivise financial service providers to embed the right behaviours to promote
financial inclusion.

References
1. ‘Global Survey 2014: Rethinking Trade & Finance 2014’, International Chamber of
Commerce, Paris.
2. The Committee on the Global Financial System, ‘Trade Finance: Development and
Issues’, January 2014. See: www.bis.org/publ/cgfs50.pdf.
3. International Chamber of Commerce, April 2013, Global Risks: Trade Finance
Report, www.iccwbo.org/News/Articles/2013/New-ICC-report-says-low-risk-trade-
finance-not-to-be-feared.
4. See the ‘ICC Global Risks Trade Finance Report 2013’, ICC Publishing, Paris.
5. See, for example, stated European Union Common Foreign and Security Policy
Objectives at http://eeas.europa.eu/cfsp/sanctions/index_en.htm.
6. See, for example, the view of the IMF at www.imf.org/external/np/exr/facts/aml.
htm.
7. In 2013 the UK’s FCA carried out a thematic review of financial crimes, focusing on
the need to increase the levels of CDD and related due diligence that banks need to
have in place to conduct the finance of international trade in a safe environment. This
highlighted, amongst other issues, that on a risk-based approach, the due diligence
requirements for maintaining correspondent bank relationships for trade has been
significantly increased.
8. GVCs are a major driving force of globalisation. They are an inevitable outgrowth of
the application of transformative information and transport technologies, combined
with new business models and largely open borders. The GVC phenomenon
promotes integration on multiple levels; local, regional, and international.
9. ‘ICC Rethinking Trade & Finance 2014’, 2014.
10. Correspondent banking is the provision of a current or other liability account,
and related services, to another financial institution, including affiliates, used for
the execution of third party payments and trade finance, as well as its own cash
clearing, liquidity management, and short-term borrowing or investment needs in a
particular currency. A correspondent bank is effectively acting as its correspondent’s
agent or conduit, executing and/or processing payments or other transactions for
the correspondent’s customers. These customers may be individuals, legal entities, or
even other financial institutions.
11. From a practical standpoint, one emerging market institution interviewed by BAFT
previously served as a correspondent for other emerging market institutions without
a branch presence in the US from which to clear dollar transactions. However, as
of 2014, the bank has closed 60 per cent of their correspondent accounts and
now only conducts business with direct customers. The bank experienced a loss

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of US$150m in revenue over five years as a result of exiting relationships. From

a quantitative standpoint, a survey of BAFT members found that 56 per cent of
respondents have decreased the number of correspondent relationships in the past
three years. Over 41 per cent of respondents felt that increased compliance costs led
to a reduction in transaction banking flows which ultimately impact trade and general
commerce
12. See The Economist, ‘Hitting at Terrorists, hurting business: Forcing banks to police the
financial system is causing nasty side effects’, 14 June 2014, see www.economist.
com/news/leaders/21604172-forcing-banks-police-financial-system-causing-nasty-
side-effects-hitting-terrorists.
13. For example, quantitative analysis of bank due diligence costs have found that
onboarding per client can range from US$25,000–50,000, with an average yearly
KYC due diligence of over 600 hours per client. This can in turn make business with
smaller clients, particularly in emerging markets, less feasible.
14. See The Economist, ‘Poor Correspondents: Big banks are cutting off customers and
retreating from markets for fear of offending regulators’, 14 June 2014.
15. Examination standards, for example, have in some cases deviated from the risk-based
approach, with banks taking on roles beyond the normal course of a correspondent
relationship and more akin to the activities of public authorities. This includes
checking the ownership of both the applicant and beneficiary; validating if the
ultimate buyer received the goods even though the bank acts as a confirming bank
and does not have a relationship with the buyer; validating the vessel or container
information; and validating the price of the goods being shipped.

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Chapter 2: Integrating compliance

into successful trade finance
By Sean Edwards, head of legal, Sumitomo Mitsui Banking
Corporation (SMBC)

WITHOUT PROPER integration of the policies, systems, and procedures needed

to deal with the financial crime and compliance risk required by their regulators,
banks and other providers of trade finance run the all too real risk of either
losing business or being censured by their regulators, facing fines, and worse,
having their licence to operate revoked. Finding the middle ground where both
risk can be avoided and profitable business can be conducted is therefore
crucial. This chapter focuses on how to live and work with financial crime
prevention regulation. Particular attention has been given to how marketing
professionals should become involved in the compliance process, balancing
limitations on their time and their optimal employment with developing a
successful strategy for dealing with financial crime risks.

Categorising trade finance and developing a risk appetite

Trade finance, like any other branch of banking, is of course exposed to the
risk of fraud and money laundering. Banks also face the risk of being used
for terrorist financing or flouting sanctions. The challenge for trade financiers is
to determine what additional financial crime risk exists in their business simply
by virtue of engaging in trade finance and, once this has been determined, to
provide the necessary extra resources.
Two questions need to be asked and answered before this determination
can take place. First, it is necessary to categorise the different activities that
trade finance departments engage in. Then the firm should assess its risk
appetite for each of the activities.

Complexity of trade finance types and prioritisation

Not all trade finance is created equal, at least in the eyes of the regulators, and
it is critical to ensure that resources are not allocated to the wrong area. For
example, jumbo pre-export finance (PXF) transactions will not require the same
amount or type of checking or verification as the purchase of rights under a
confirmed deferred payment letter of credit by a non-nominated bank.
The following suggested list sets out activities in ascending order of
complexity, so far as financial crime risks checks are concerned:

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„ Syndicated loans for trade purposes such as pre-export or pre-payment

„
loans;
„ Bilateral working capital lending to corporates and financial institutions
„
engaged in trade finance;
„ Bilateral trade-related loans to the same entities;
„
„ Bilateral loans for the financing of specified goods or services to those
„
entities;
„ Guarantees, performance/bid bonds;
„
„ Supply chain finance;
„
„ Issuance of letters of credit;
„
„ Collections;
„
„ Re-financings of letters of credit/purchase or discounting of letters of credit,
„
or other payment obligations such as negotiable instruments, by nominated
banks or by the original holders of those instruments; and
„ Purchase or discounting of letters of credit or payment obligations where the
„
purchaser is not a nominated bank or the original holder.

This categorisation may not be comprehensive or relevant to all trade finance

institutions. What is important to note is that this categorisation is not the same
as the more familiar categorisation of counterparties and customers into high,
medium, and low risk. What this approach attempts to tease out is, for any
given risk category, first the number and transparency of the counterparties
and, second, the number of documents that are likely to be available and so
submitted for checking. This will be relevant to gauging what additional policies
or procedures will need to be put in place to deal with the perceived additional
risks arising from trade finance business.
The Financial Conduct Authority (FCA) in its thematic review of the financial
crime risks in trade finance (the ‘Thematic Review’1) has concentrated very
heavily on the information and the warnings (the so called ‘red flags’) which
only verification of documentation can provide. This, of course, is not to say that
where no documentation is provided no risk exists – indeed the opposite may
be the case – but, at a transactional level, monitoring and awareness of risk will
most easily be judged through the transactional documentation being provided.

Determining risk appetite

Determining risk appetite is the second issue that must be tackled. At the most
basic level, which customers does the bank want to deal with and what types
of business will it accept from those customers? While much of the focus by
regulators and industry groups has been on paper-based transactions such as
letters of credit (which generate quantities of verifiable information not available
with, say, open-account trading), a more fundamental and broader conception

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of financial crime risk must be adopted. Factors such as reputational risk and
the cost of ensuring compliance where insufficient transactional information is
available should be taken into account. Such a decision will also need to take
into account wider organisational and corporate governance responsibilities.
Such decisions must be taken at the very highest levels of management, a point
made in the Thematic Review.
Risk appetite is not, however, limited to the initial decision as to which clients
to take on. It must also be applied operationally. In the words of the Thematic
Review, a risk-sensitive approach must be taken and the control framework
should be ‘tailored to the role of the bank in a particular transaction’. The Joint
Money Laundering Steering Group (JMLSG) devotes an entire chapter (Chapter
4) in Part 1 of its Guidance to Financial Institutions to this theme.2
This point is well-illustrated by reference to the examination of documentation
in letters of credit (LCs). In LCs, a mainstay of trade finance business for many
smaller banks, the standard for examination of documentation is determined
by the Uniform Customs and Practice for Documentary Credits (UCP). Does the
document comply on its face with the requirements of the credit as articulated
in Article14 of UCP 600? The FCA considers that this philosophy has misled
many banks into believing that, with the possible exception of sanctions, wider
financial crime issues do not need to be considered if there is a complying
document. Any such mind-set is outdated and clearly wrong. In the UK at least,
the need to comply with financial crime legislation will override the rules of the
UCP and excuse the examining bank from obeying Article 14. This does not
mean, however, that the UCP no longer has any place in the examination of
documents. It is submitted that it is only when the appropriate financial crime
checks have revealed the possibility of financial crime taking place that the UCP
must be ignored.
The difficulty often arises in practice when the voluminous and often highly
detailed information that can now be obtained very easily as to, for example,
ship movements, loading dates and so on, appears to cast doubt on a
document which is in all other respects compliant. Recognising that commercial
reality might result in a mismatch cannot, in and of itself, lead to the conclusion
that a financial crime has occurred. A further exercise has to take place and
analysis has to be carried out. An inaccurate loading date, for example, may
be acceptable if it can be determined that those goods do exist and were
loaded. If the information, however, shows that the goods do not in fact exist or
were loaded onto a different ship, the conclusion is likely to be that a financial
crime has occurred and that the transaction must be rejected notwithstanding
the apparent compliance of the documents. The traditional fraud exception
under English law for refusing payment under a letter of credit requires a very
high level of proof that a fraud has occurred.3 By contrast, the corresponding

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level of proof under financial crime legislation is much, much lower and requires
merely reasonable suspicion. (Chapter 3 covers fraud in further detail.)

Building the team and allocating the responsibilities

Infinite resources and an unlimited supply of experienced staff will never be
possible. This is even truer of front-office staff who are, after all, recruited to
produce profits. Does this mean that they should not concern themselves at all
with financial crime risks?
The answer is unequivocally no. In the new regulatory environment the costs
associated with getting it wrong must be factored into doing business. The use
of front-office staff is therefore justified by the risk. The challenge is to use them
intelligently, ensure they are properly supported, and optimise their involvement.
As a general rule, the use of front-office staff is optimised when they are
involved in the conception and creation of arrangements to deal with financial
crime risk and at the beginning of counterparty relationships. The relationship
between front-office staff, non-customer facing intra-departmental resources, and
separate organisational or even external resources can thereafter be mapped
always with a view to encouraging efficiency both in terms of overall costs and
use of time.
One way of looking at this mapping is to consider the areas explored in the
Thematic Review.

The architecture of a sound and business-friendly financial

crime risk strategy
Risk assessment
The involvement of marketing officers and the senior management of trade
finance departments is critical at this stage because the results of this assessment
will influence the complexity, cost, and scope of the systems that will ultimately
need to be implemented. Importantly, the assessment will affect what trade
finance products and services can be offered and to what category of
customer.
This assessment must cover not only the areas of activity presently
undertaken by the firm, but also potential future business. It must be as
comprehensive as possible and must be endorsed by the highest level of
management. Those at the very top of the firm and not just the trade finance
department must be involved. (Lack of senior management awareness and
involvement was an important criticism of the Thematic Review).
Building on the initial categorisation referred to above, which will act as
an initial triage and give a rough indication of the intensity of both the initial
effort and the ongoing maintenance of the systems, the assessment should take

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account of the risk factors associated with each piece of business and customer.
These factors will include:

„ The jurisdiction of current or targeted counterparties or the countries where

„
marketing will take place;
„ The products to be marketed;
„
„ The legal organisation of the counterparties and their beneficial owners;
„
„ The business sector; and
„
„ How products will be sold (e.g. through agents, online, in face-to face
„
meetings etc.).

The results of this assessment can then be used to produce an overall rating or
status for the type of business being undertaken, or to be undertaken, to be
weighed against the firm’s chosen risk appetite. This rating process can be –
and to some extent must be – mechanistic (for example, by allocating weights
or scores to different factors), but should always be finally evaluated against
the controls which will include the value that can be attributed to marketing staff
being involved in the initial assessment and, of course, as transactions begin to
flow.
External data sources should be used as much as possible to produce an
objectively defensible assessment. Such sources are more numerous for certain
factors than others. For example, in the assessment of the risk posed by the
jurisdiction, Transparency International (www.transparency.org) and the Financial
Action Task Force (FATF4) produce information and rate countries against
different indicators (such as human rights, population control, poverty etc.).
Understanding the universe of different entities involved in any line of
business is critical and a current flashpoint. Customer due diligence now goes
beyond knowing your immediate customer and may also require knowing
your customer’s customer (so-called ‘KYCC’). And not just customers, but
potentially correspondent banks and other intermediaries regularly used by
the immediate client. In relation to letters of credit, for example, guidance has
been issued by the Wolfsberg Group5 and the JMLSG as to which parties
are to be subject to due diligence, which is being reviewed in the light of the
need for KYCC. Clearly the degree of due diligence required on any particular
letter of credit will depend on the bank’s involvement with that credit, but in
view of the changed landscape it is no longer possible to stop at immediate
credit risks. Amongst other things, the need to screen for breaches of sanctions
(where partitioning of transactions by reference to immediate contractual
counterparties does not give protection), may lead to a risk of allegations of
abetting circumvention or avoidance if underlying parties are not taken into
consideration. If the business being targeted is likely to involve multiple parties,

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trans-shipments (etc.), all the extra costs of verifying this should be factored in
up-front.

Policies and procedures

Following the risk assessment, a policy must be formulated and procedures then
created to implement the policy.
Marketing, and senior trade finance staff (product and sales) must be
involved in the writing of the policy. Procedures must be reviewed by them
and their contribution will still be substantial but it is necessary at this point that
dedicated compliance personnel should begin to weigh in more heavily.
The final policy will also either set out the risk appetite referred to above or
reflect the logic stemming from that policy. It will, at a high level, explain the
procedures to be implemented and allocate responsibilities and make clear the
type of financial crime risks that are relevant to the business to be undertaken.
Procedures must be detailed and must be consistent with the policy in
terms of scope so that, for example, banks as a matter of policy will not deal
with certain kinds of products and will not need to be concerned with the risk
arising from those products. Marketing and product teams must help to frame
the procedures with compliance staff as they must be, for the former, realistic
and achievable and, for the latter, capable of satisfying in practice regulatory
requirements which ultimately have the force of law.

Due diligence
Here we are primarily concerned with customer due diligence (CDD) in the
form of know your customer and anti-money laundering checks and verification.
This work is often divided into up-front due diligence and on-going monitoring/
transaction due diligence.
It is very beneficial for marketing staff to be involved in up-front CDD which
will involve investigation of the customer’s business, often known as ‘know your
business’ or KYB. The more comprehensive the description, the better focused
the resources utilised to deal with the financial crime risks can be, and fewer
then are the questions which are likely to arise when business does occur. For
example, where a client has a commodity business which traditionally involves
little documentation (for example, purchasing an unprocessed commodity from
small local farmers), an explanation of historical practice, track record, and
details of the client’s final off-takers will serve to support an assessment that the
customer is not running a risky business (in financial crime terms) despite a lack
of voluminous documentation.
Marketing staff should also be primarily responsible for obtaining the
information about the client for assessment and, indeed, for questioning that
information when it is incomplete or unconvincing. This is not only because it

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is easier for them to obtain such information, but also because such interaction
with the client can be sensitive and is therefore best handled by those with a
personal knowledge of the client. Public information should be obtained either
by supporting staff within the marketing unit or dedicated compliance staff,
although this ideal is not always attained in practice.
One of the greatest organisational challenges for banks in dealing with
financial crime is finding the right balance and mix of staff in dealing with
transactional due diligence. The focus is often too narrowly focussed around
AML issues and examination of documentation.
On-going monitoring and transactional due diligence is best handled by
dedicated staff with the exception of periodic reviews of the client’s business.
Here regulatory pressures can pull in opposite directions. On the one hand,
compliance staff must be independent from the front office. On the other hand,
as the Thematic Review recognises, they need to be sufficiently experienced.
Squaring this circle usually requires establishment of an experienced cadre of
processing staff with well-documented procedures and clear lines of referral
and escalation. This is the approach recommended by the FCA in the Thematic
Review which proposes, as a good operational model, a structure with two
initial levels of review followed by referral to a compliance/investigations team.
Building up a good processing team is likely to be the single biggest area
of expenditure when building up an effective structure. Such staff are often
centred around letters of credit experts. It is critical, however, that such expertise
is only a starting point in building up these teams. They must – to use the words
of some commentators – be ‘enlightened’ and fully alive to both the nature of
financial crime risks and the demands of financial crime legislation. The dangers
of taking a limited face-value approach to compliance is highlighted in the
Thematic Review and has been discussed above.
Such teams will look for red flags, will be aware of how far to take KYCC,
and will be technically competent. Use of external suppliers is likely to be very
beneficial. Particularly well-known is the International Maritime Bureau but there
are a number of initiatives to establish KYC/AML databases (e.g. by SWIFT).
These suppliers are likely to be expensive, however, and consequently use of
these external resources must be well-judged. Automated systems to look for
sanctions and other issues such as dual-use goods must be fully employed and
cannot be carried out manually in a cost-efficient way.
Provided that the right staff are recruited for this role, they should also be
able to apply the risk appetite or sensitivity to transactional situations mentioned
above in the introduction to this chapter. If such staff are costly, the rewards of
establishing the right team are correspondingly immeasurable. The cost of lost
opportunities to do future business must be factored in here as much as the
immediate financial cost of employment.

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Governance and management information

In relation to governance, many of the concerns around organisation referred
to in the Thematic Review are dealt with above. In particular, the inter-action
between compliance, processing, and front-office staff has been discussed. The
Thematic Review also clearly believes that audit functions have an important role
to play. The growth of the paper trail, which was found deficient by the FCA
in many institutions reviewed, is, in audit terms, both cause and effect. If proper
structures are put in place there is nothing to fear and much to embrace in audit
reviews especially in the early days of operation.
The involvement of senior management is also emphasised. Senior
management can assist by setting the tone, but they must also be part of the
chain of escalation. Corporately and operationally, this will only work if lower
levels have fully investigated all the issues and have attempted to solve them.
Routine referral to senior management is, in most cases, not desirable as it will
delay resolution and dull the determination of more junior staff.
Production and delivery of management information must, however, be
routine and regular. This can be either direct to the senior management or to
appropriate committees. Although production of this information is best left to
processing and compliance staff, any questioning by senior management should
also involve and be directed to front-office staff as it may touch on issues of
wider concern.

Training and awareness

Training flows from and to front-office staff. It will flow to them in the form of
awareness of and sensitisation to financial crime risks. This may be delivered by
compliance staff or external providers. It will, however, also flow from marketing
officers to compliance and processing staff as a part of an iterative process
to produce targeted training that is relevant for the bank and its particular
business. A complaint often made is that back and middle office functions do
not understand the very specific nature of much of trade finance. Realistically,
producing good quality training must involve marketing staff at least during initial
development.
Marketing staff are particularly invaluable when producing training material
based on case studies. The FCA has said this is a useful form of training.

Conclusion
An intelligent and constructive approach is required to the management of
financial crime risks in trade finance. The complex nature of trade finance has
meant that it has appeared, to many regulators and compliance personnel, to
be an area open to abuse. This is not always a well-founded conclusion and it
is within the gift of the trade finance community to remedy this misapprehension.

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This chapter has shown that with proper integration of marketing staff a
solution is available. In other words, when those responsible for communicating
the bank’s trade finance products and services to potential customers have a
thorough grounding in financial crime risk prevention, the bank will manage
customer expectations appropriately. This will require more investment in
regulatory and compliance issues than has hitherto been the case by these
areas, but it must be accepted that, without such involvement, the wheels of
trade finance will grind ever more slowly.

References
1. See ‘TR13/3 - Banks’ control of financial crime risks in trade finance’, July 2013, at:
www.fca.org.uk/news/tr13–03-banks-control-of-financial-crime-risks-in-trade-finance.
See also: www.tfreview.com/news/legal-regulatory/fca-financial-crime-risks-final-
guidance-softens-kyc-position.
2. ‘Chapter 4: Risk-based approach’, in Prevention of money laundering/combating
terrorist financing, Joint Money Laundering Steering Group, 2011. See: www.jmlsg.
org.uk/download/7324.
3. See United Trading Corp SA v Allied Arab Bank Ltd [1985] 2 Lloyd’s Rep. 554;
Times, July 23, 1984.
4. An intergovernmental body set for ‘the development and promotion of national and
international policies to combat money laundering and terrorist financing’. The FATF
comprises 34 member jurisdictions and two regional organisations representing most
major financial centres in all parts of the globe. See www.fatf-gafi.org for further
information.
5. An association of 11 global banks whose aims are to develop industry standards
and related products for KYC, AML, and counter-terrorist financing policies. See
www.wolfsberg-principles.com for further information.

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Clarissa Dann, editor, Trade & Forfaiting Review

THE SPECTRE of fraud lurks in most areas of domestic and international

commerce, and trade finance is no exception. As demonstrated by China’s
Qingdao Port scandal1 where multiple loans were secured against the same
collateral, and the pre-financing scam highlighted by ICC where false shipping
documents were presented to trigger payment under a letter of credit (LC),2 no
cross-border trade transaction is immune from this particularly insidious form of
financial crime.
Fraud not only damages businesses and banks, but also entire economies.
For example, in May 2014, a study from Global Financial Integrity revealed
that the over and under-invoicing of trade transactions facilitated at least
US$60.8bn in illicit financial flows into or out of five specific African countries
between 2002 and 2011.3
This chapter reviews the specific risks and examples of fraud involving the
use of trade and commodity finance instruments, and it suggests some practical
approaches to fraud prevention.

UNCTAD commodities finance fraud ‘primer’

Although written more than ten years ago, every commodity finance
professional would do well to review Lamon Rutten’s ‘primer’ on new techniques
used by financial fraudsters in the commodities markets.4 Now manager
of policies, markets, and ICT at the Technical Centre for Agricultural and
Rural Cooperation (CTA), at the time of writing in March 2003 Rutten was
an economist at the UNCTAD secretariat. His introduction sets out a telling
perspective on what makes an organisation vulnerable to fraud in the first place.

‘If an organisation is badly managed, the potential for fraud and abuse
increases. Proper government regulations can prompt organisations to
put basic controls in place, and can force them, to some extent, to be
transparent about their dealings, but not even a perfect regulatory framework
can replace proper company-level control systems for the use of financial
instruments. A lack of checks and balances, unclear reporting lines and an
unclear division of responsibilities all contribute to an environment in which
staff may feel that they can commit fraud and get away with it.’

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Rutten continues:

‘The remedies for this are well known, although they are not necessarily
applied even in large organisations. The division of responsibilities needs to
be spelt out and measures [need to be] taken to ensure that responsibilities
are met. Reports on transactions from outside parties (e.g. brokers, collateral
managers) should not go to the person that initiated the transaction. Multiple
checks and balances need to be built into the system – for example, to
separate the responsibility for entering into financial transactions from cash
flow management responsibilities, and the two individuals or departments
controlled by yet another person/department – and all should report to a
specific member of senior management.’

Rutten emphasises that a manager should keep an eye out for unusual
behaviour: ‘Managers should be aware of possible signs of trouble – for
example, traders who regularly come in over the weekend, and who may use
the time to tamper with computer systems or records, or who do not take any
holidays for fear that their temporary replacement could discover fraud.’

The ICC Commercial Crime Services

Based in London, the ICC Commercial Crime Services (CCS) is the anti-crime
arm of the International Chamber of Commerce. The International Maritime
Bureau (IMB) is one of its specialised divisions, with the main task of protecting
the integrity of international trade by seeking out fraud and malpractice. The
information gathered from sources and during investigations is provided to
members in the form of timely advice via a number of different communication
routes without identifying the sources. The IMB lists the threats and explains how
members can reduce their vulnerability to them. In particular, the IMB provides
an authentication service for trade finance documentation. It also investigates
and reports on a number of other topics, notably documentary credit fraud,
charter party fraud, cargo theft, ship deviation, and ship finance fraud.
The IMB verifies 2000 trade transactions and bills of lading every week.
While this is a small proportion of the global volumes it gives the IMB enough
insight to spot patterns and identify what documents might be forged or
disguised to bypass sanctions screening. The IMB also conducts post-fraud
investigations and provides expert evidence. For further reference, Mukandan
summarises the IMB’s activities in a helpful video which can be viewed online at
www.youtube.com/watch?v=5wy58e8jf1U.
The CCS director, Pottengal Mukundan, is a popular speaker at trade
finance and compliance conferences and specialises in the investigation,
detection, and prevention of onshore and offshore commercial and maritime

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crime. He makes the point that the Uniform Customs and Practice for
Documentary Credits (now UCP 600) discourages banks from assuming
responsibility outside the compliance of the documents presented. ‘Banks take
the view [that] they are merely financing the trade transaction. They do not
assume responsibility for the existence or quality of the commodities traded. The
system is based on documents. Documents can be forged’, he once told the
editor of TFR.

The letter of credit and the fraud exception rule

This section summarises a talk given by trade finance lawyer Geoff Wynne at
the International Trade and Forfaiting Association conference in 2011 (at the
time of the conference, Wynne was a partner at Dentons, but is now at Sullivan
& Worcester UK). This section sets out a reminder of the principles of a letter
of credit (LC) and where it is possible for a bank to refuse to pay out when
presented with an LC if there is sufficient evidence of fraud. As will be seen, the
fraud argument is sometimes deployed as an excuse not to pay up and it falls to
the courts to decide whether fraud was present or not.

Transaction independence – When is a letter of credit that is

‘synthetic’ still a letter of credit?
When the Abu Dhabi Islamic Bank argued that the ‘synthetic’ structuring of the
LC it had confirmed to Fortis Bank meant it could legitimately refuse payment,
this tested the resilience of the LC with some important implications for structured
finance arrangements.
The case of Fortis Bank (Nederland) NV v Abu Dhabi Islamic Bank
(heard by the Supreme Court in New York in August 2010), highlighted the
independence of the LC from the underlying trade transaction, and how the use
of fraud as an argument not to pay does not really wash when all parties were
aware of the structure of the transaction. The box out below summarises the
facts of the case.
This was a synthetic transaction in that it was not fully related to an
underlying trade transaction, but was used to generate finance for the
beneficiary. However, the judge gave very short shrift to ADIB’s arguments that
its synthetic nature meant it was fraudulent.

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Fortis Bank (Nederland) NV v Abu Dhabi Islamic Bank

„ A deferred payment LC was issued by Awal Bank (Bahrain) and
„
confirmed by the Abu Dhabi Islamic Bank (ADIB) in June 2008 on behalf
of Bunge (a large European commodities trader for US$40m to facilitate
the sale of Brazilian soybeans and maize).
„ This was a ‘synthetic’ transaction as it was not really related to an
„
underlying trade transaction.
„ ADIB confirmed its reimbursement obligation to Fortis.
„
„ ADIB then did not wish to pay. Awal, the issuing bank, had gotten into
„
difficulties and ADIB knew it would not receive payment from them. ADIB
alleged fraud.
„ Fortis sued and won. The judge held that all parties were aware of the
„
transaction structure and the documents were in order.
The full case report, including the judgment, can be viewed at http://law.
justia.com/cases/new-york/other-courts/2010/2010–52415.html.

Letters of credit – A reminder

What makes LCs so useful is that they are an irrevocable payment undertaking
given by (usually) a bank, and payment is made against documents presented
in accordance with UCP 600, the current Uniform Customs and Practice for
documentary credit rules. When this happens, both the confirming and issuing
bank are liable for the payments. It is important to remember that an LC is a
transaction in documents. Documentary letters of credit are usually payment
instruments, but they can be used as financing instruments – and many parties
use these for financing in the context of deferred payment undertakings and the
refinancing of LCs. This is not unusual.
UCP 600 is very specific about the roles, duties, obligations, and rights of
the issuing bank, the advising bank if there is one, the confirming bank, and the
nominated bank (which may be the negotiating bank). The dramatis personae
in Fortis are really the issuing, confirming, and nominated bank. UCP 600
requires documents to be presented and examined within agreed standards
and timescales. Letters of credit can be available by sight payment, deferred
payment, acceptance, and negotiation. This case was about deferred payment
LCs and, to a certain extent, the other parties are outside of UCP 600. The
applicant and beneficiary are mentioned in the UCP 600, but their rights and
obligations are outside these and are often documented separately.
Once the beneficiary has its money and the bank has made its paid, what
follows is an interbank transaction. The nominated bank/confirming bank makes
payment and the confirming bank looks to the issuing bank. In the normal course
of events, if the bank has given value on an LC it will always be paid by the

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confirming bank or issuing bank under that LC. The one big exception is fraud,
which was why ADIB chose that argument to try to avoid payment on that basis.

Fraud unravels all

We have established that the LC is independent from the underlying transaction
and that, if the right documents are presented, the confirming bank and
anyone else who has accepted liability has to pay. In other words, what
makes LCs sacrosanct is certainty of payment.
However, the fraud exception operates, for example, where the seller/
beneficiary, for the purpose of drawing on the LC fraudulently presents to the
confirming bank documents that contain – expressly or by implication – material
representations of fact that they know are untrue or are otherwise fraudulent on
their face. Where this is the case and the bank is aware of the fraud, then it is
entitled to refuse payment if it finds out before the payment – and to recover the
money as paid under the mistake if it finds out afterwards.
That was and is the basic rule and, despite many attempts to look at
widening the fraud exception rules, there have been few successes. One
example was Solo Industries v Canara Bank (2001), where a fraudulent
misrepresentation to induce an LC was a defence of non-payment.5
In answer to the question of whether or not a buyer can refuse to reimburse
the bank for paying the seller when fraudulent documents were present, the
following needs to be noted:

„ The fraud exception only takes effect where a beneficiary’s fraud is evident
„
and the bank is aware of this before payment;
„ A buyer will only be entitled to refuse to reimburse the bank where a
„
beneficiary has presented fraudulent documents and the bank has failed to
take reasonable care in inspecting the documents to verify compliance with
the terms of the LC;
„ UCP 600 has provided for a different standard of inspection from UCP
„
500. Article 14(a) (replacing UCP 500 13(a)) no longer stipulates that the
examination be made with reasonable care – ‘a ... bank must examine a
presentation to determine, on the basis of the documents alone, whether
or not the documents appear on their face to constitute a Complying
Presentation’; and
„ The net effect of all the above is that provided a bank can: (a) satisfy itself
„
that the documents are a Complying Presentation according to UCP 600;
and (b) has neither irrefutable evidence of a beneficiary’s fraud nor clear
evidence of such fraud which the beneficiary has failed to refute, then that
bank should pay the beneficiary under the letter of credit and be entitled to
be reimbursed by the buyer for doing so.

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Implications of Fortis
There are a number of ‘synthetic schemes’ in existence – with many of them
having been called ‘Bunge schemes’, as Bunge had promoted them. These
were devices used between two related companies within the same group that
can produce financing opportunities for banks in emerging markets. They rely
on LC and UCP 600 treatment of LCs and the concept of compliant document
presentation and deferred payment undertakings.
The Fortis case was unconventional in that copies were requested instead
of original bills of lading. There is actually nothing wrong in this and goods do
not actually have to move to be a trade transaction – warehouse financing is a
good example of this principle.
One bank offering a refinancing facility for an LC to another is, in theory,
a continuation of a trade transaction – it is valid but perhaps more akin to a
working capital facility. The important thing is to ensure that a real transaction
is in place. English courts analyse the documents and look at what has been
structured on the transaction, and make decisions on that basis rather than
seeking to rewrite the deal. In Fortis, that was what the New York court did as
well.
The ‘when trade got paid’ successes for trade payment following the
Kazakhstan banking crisis was more about the priority given to short-term
indebtedness where there was not enough money to pay all the creditors – the
validity of the original transactions was never in question.6

Learning points from Fortis

Fortis was an important case because it highlighted the arguments about what
the underlying transaction is really about, and its relationship with the original
trade. It also demonstrated that these more unusual transaction structures can
be risky if not properly documented in line with UCP 600, although they are
workable in certain circumstances. It is vital that it can be demonstrated that
all parties know what the transaction is and have complete and transparent
information – so that there can be no defence of fraud.
Last but not least, structured transactions of this nature are dynamic and
need to support the will to do deals and structure them so that everyone can
make a profit – which means having certainty and getting paid.

Warehouse fraud
On 11 September 2011, Qingdao Port in China’s Shandong region confirmed
that the metals financing fraud had involved around 400,000 tonnes of
base metals. This was made up of around 300,000 tonnes of alumina,
80,000 tonnes of aluminium ingots, and 20,000 tonnes of copper. The same

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consignments of metals had been pledged multiple times by borrowers to raise

trade finance loans.
The investigation prompted lawsuits from trading firms, warehouses, and
banks around the world, including HSBC and Standard Chartered. The scandal
was a wake-up call to the industry. For the banks, the suspected fraud is a
warning shot.
Vivienne Lloyd, base metals analyst at Macquarie Securities, told the Wall
Street Journal in September 2014 that banks have tightened up on issuing letters
of credit, which has made it harder for importers to get hold of metal. She said:
‘It has definitely changed the conversation around risk in metals financing’.7
This is just one example of how vulnerable banks can be when loans are
secured on commodities. Accidents do happen. One banker told TFR how a
particular consignment of tobacco he was financing literally self-combusted in
the warehouse because of errors in storage and temperature – and insurance
protection is one means of mitigating that risk. But if fraud is involved and the
goods never existed in the first place, the insurer is unlikely to pay the claim.

Warehouse woes – Supply chains can become vulnerable to fraud

Global economic activity looks set to pick up. However, with increased trading
activity comes more risk, such as the potential for international fraud relating
to goods in storage. Warehousing provides a vital function in the international
trade of commodities, but it also provides the potential for serious losses when
things go wrong. Several high-profile cases in recent years illustrate the legal
difficulties, risks, and complexities involved in fraud cases.

Singapore Tin Industries

Perhaps one of the best-known cases of supply chain fraud relates to the
collapse of Singapore Tin Industries (STI). The case involved a claim by ABN
AMRO, a category II member of the London Metal Exchange, against CWT
Commodities, under a collateral management agreement (CMA).8 Under the
agreement, CWT was obliged to issue warehouse receipts and certificates of
quality for tin that STI was using as security for trade finance as provided by
ABN AMRO. To store the metal, CWT leased a warehouse at STI’s premises.
CWT issued certificates of quality and warehouse receipts in relation to
tin ingots, concentrates, slag, and also seven batches of tin dross. The bank
advanced over US$22m to STI, of which at least US$10m was not repaid.
It transpired that STI had been acting fraudulently by, as the judge put it,
‘round-tripping’ the tin dross inventory. The seven batches of tin dross were
reportedly purchased from and sold on to third parties in transactions financed
by the bank. In reality, no actual sales of the tin dross were made by STI and
it was left in the warehouse and mixed with additional tin dross produced by

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STI to provide security for additional rounds of financing by the bank. As the
Singapore judge commented: ‘The reality was that the bank was advancing
money on the security of tin dross produced entirely by STI and left to
accumulate in the warehouse.’

Stone & Rolls

Another notable example of warehouse fraud was the losses incurred by
Komerční Banka, a Czech bank, through finance provided to Stone & Rolls,
a Geneva-based trading company. In that case, estimated losses of around
US$250m were incurred under 30 LCs issued in relation to large quantities of
Russian and Ukrainian agricultural products sold by Stone & Rolls.
Komerční’s problem was that there were no genuine sales of produce stored
in Russian warehouses; the invoices and warrant lists presented were sham, and
Stone & Rolls was found to have participated in a dishonest scheme designed
to defraud the Czech bank.
A United Nations working paper on warehousing issues has also
highlighted similar problems in other cases.9 In one example, several Hungarian
banks incurred losses where they had provided finance against warehouse
receipts which, it was eventually discovered, had been issued by private rather
than public warehouses. In another case, US banks provided finance for imports
of commodities into Russia, but faced losses when it was discovered that the
warehouse receipts provided for the goods were fake.

Risk factors
Although supply chain fraud cases are usually complex and generally turn on
their own distinct sets of facts, there are some common risk factors that can be
identified as key areas of concern:

„ Accurate monitoring of warehouse goods and the method of storage: An

„
obvious but all too common issue is determining whether the goods ever
made it into the warehouse in the first place. Fraud on the part of the
warehouseman or other party issuing warehouse receipts can mean that the
goods simply never arrived – a problem that can have a significant impact
on insurance claims. Other problems can involve theft, forgery, or false
endorsement of the receipt.
„ If the goods made it to the warehouse, are they still there? Poor warehouse
„
security and management can result in theft, misappropriation, or
misallocation.
„ Both storage methods and the clear segregation of goods within the
„
warehouse can be significant: Given that the insolvency of the warehouse
can be a complicating factor, a major aspect in ensuing litigation is often

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the resolution of competing proprietary claims to goods that are recovered.

Inability to identify consignments is a significant complicating factor in such
disputes.
„ Potential conflicts of interest can also lead to problems where a party both
„
owns a warehouse and uses it to store its own goods.

Because these issues are so varied, when things go wrong they inevitably lead
to legal proceedings that tend to be complex. Before taking a look at some of
the practical steps that can be taken to minimise risk, it is worth considering the
common legal difficulties.
When goods go missing, parties inevitably tend to look to their insurance
cover for recourse. Unfortunately, insurance claims in relation to supply chain
losses can raise some tricky legal issues and false comfort. For example,
even though an insurance policy governed by English law may provide cover
for theft, where the loss occurs in another country it is quite possible that the
meaning of theft may not be limited to the English technical definition.
While in England it may be sufficient to support a claim for theft by
establishing a prima facie case of intention to steal together with a dishonest
appropriation, in other jurisdictions (for example Russia) it may be necessary to
show that there has actually been a prosecution or conviction for theft in relation
to the incident in order for it to constitute theft under the policy.
A more fundamental problem can occur when it transpires that goods
were never actually delivered to the warehouse, for example where fraudulent
warehouse receipts have been issued. In such cases it can mean that risk in
relation to those goods is not covered under the insurance policy, as the goods
never existed, with the result that no recovery can be made.
Although it is sometimes assumed by holders of entitlement that their
insurance policy (or warehouse policies) will cover them in the event of fraud, if
it turns out the goods never existed, the chances are they will not be protected.10
In cases of insolvency, there is often extensive litigation to determine
property rights in the face of competing claims by creditors. Unlike the strength
and clarity of the entitlement to metal embodied by a London Metal Exchange
(LME) warrant, entitlement to goods/materials held by other warehouses can be
far more complex.
Invariably in cases involving fraud there is insufficient property recovered
to meet the competing claims. Again, the jurisdiction in which the property is
located becomes a key factor given that the relevant law governing property
rights is generally the place where the asset is held (the lex situs). Title disputes
relating to unsegregated products can be particularly difficult, whatever the
jurisdiction. The result is that although parties may have taken great care in
choosing the law that governs their contractual relationships, they may find

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this to be irrelevant when determining whether they are able to defend their
proprietary rights against competing creditors.

Practical steps
From these practical problems and litigation traps there are a number of lessons
that can be learned to minimise the risk of warehouse fraud:

1. Warehouse arrangements: Inevitably, initial attention should focus on the

warehouse arrangements themselves. Care should be taken to establish the
legal and beneficial ownership of the warehouse, as well as the suitability
of the facilities. Investigation of previous losses from the facility due to theft or
fraud can be informative, as well as the insurance arrangements and claims
history. Where a CMA is used, care is required to ensure that the control
and supervision provisions relating to the goods are suitably robust and that
the task is entrusted to an independent, approved collateral manager.
2. Understand which country’s law applies: Given the importance of the lex
situs both for insurance and insolvency claims, it is advisable at an early
stage to gain a clear understanding of the applicable law of the country
in which the warehouse is located. Security or proprietary interests in the
goods should be protected under local law wherever possible, and this
should be reflected, where necessary, in the storage arrangements or CMA.
3. Insurance: Finally, great care should be taken concerning insurance
arrangements. The terms of cover require careful scrutiny, with particular
regard to whether all the anticipated risks are covered, including the effect
of local law upon interpretation of the policy. As we have seen, fraud can
pose particular challenges in this context and specific fidelity cover for
misappropriation or fraud should be obtained where appropriate.

Tread carefully
Although warehouse fraud, in relation to metals at least, is relatively rare, when
problems do arise they are invariably complex and expensive. The difficulties
in minimising exposure to such risks are, to a great extent, practical in terms of
identifying and protecting against risky procedures. However, significant legal
issues can also arise to trap the unwary and lead to exposure and losses that
may be considerably greater than anticipated. Care taken to address issues of
applicable law, title, and insurance at an early stage can do much to provide
protection against potential fraud.

References
1. See Bernard Goyder’s summary of the scandal, ‘Phantom metal - the Qingdao port
scandal’, TFR, September 2014, at: www.tfreview.com/node/10904.
2. See the pre-financing scam involving false shipping documentation highlighted

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by the ICC International Maritime Bureau in August 2012 at: www.tfreview.com/

node/8108.
3. Baker, R., Clough, C., Kar, D., LeBlanc, B., and Simmons, J., ‘Hiding in Plain Sight:
Trade Misinvoicing and the Impact of Revenue Loss in Ghana, Kenya, Mozambique,
Tanzania, and Uganda: 2002–2011’, Global Finance Integrity, May 2014. See:
www.gfintegrity.org/report/report-trade-misinvoicing-in-ghana-kenya-mozambique-
tanzania-and-uganda/.
4. Rutten, L., ‘A primer on new techniques used by the sophisticated financial fraudster,
with special reference to commodity market instruments’ (report prepared by the
UNCTAD secretariat), March 2003. See: http://unctad.org/en/Docs/ditccom39_
en.pdf.
5. Solo Industries UK Ltd v Canara Bank [2001] EWCA Civ 1059. The full judgment
can be viewed at www.simic.net.cn/upload/2008–07/20080702161112103.pdf.
6. For a feature on how trade did ‘get paid’ during the Kazakhstan banking crisis, see
‘IFA world: When trade does get paid...’, TFR, February 2011, at: www.tfreview.
com/node/6405.
7. Curran, E. and Inman. D., ‘Missing Qingdao Copper Spawns Web of Lawsuits’, The
Wall Street Journal, September 2014. See: http://online.wsj.com/articles/missing-
qingdao-copper-spawns-web-of-lawsuits-1411409796.
8. See Day-Robinson, D. and Kenny, M., ‘In safe hands, the practicalities of collateral
management explained’, TFR, March 2012, at: www.tfreview.com/node/7542.
9. See: www.ruralfinance.org/fileadmin/templates/rflc/documents/Review_of_
Warehouse_pdf.pdf.
10. See Sullivan, M., ‘Will insurance pay? Not always under English law’, TFR, January
2013, at: www.tfreview.com/node/8519.

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Chapter 4: Money laundering

By Robert Parson, partner, and Imogen Holmgren, trainee, Reed
Smith LLP

MONEY LAUNDERING is defined by the Financial Action Task Force (FATF)

as ‘the processing of… criminal proceeds to disguise their illegal origin’ in
order to ‘legitimise’ the gains of criminal property.1 Based on the estimates of
the International Monetary Fund (IMF) and the United Nations Office on Drugs
and Crime, it is estimated that 2–5 per cent of the global GDP is laundered
every year by criminal organisations.2 A high proportion of that figure involves
cross-border transactions. The suppression of money laundering activities which
make use of trade payment channels is a goal which all involved – traders,
banks, regulators, and law enforcement agencies – are keen to achieve.
The involvement of organised crime in trade payments has led to additional
regulatory and other scrutiny in an already heavily regulated sector. There
is some evidence that the introduction of the measures necessary to combat
money laundering has, and will continue to, apply a brake to trade growth and
increase costs.

Money laundering offences and obligations relevant to the

trade finance sector
The anti-money laundering regime applicable to financial institutions in the UK
is extensive and covered by more than one source – those being legislation,
regulation, rules, and guidelines. The key elements of the applicable framework
for countering money laundering that are currently in place in the UK are the
following:

„ The Proceeds of Crime Act 2002 (as amended) (POCA);

„
„ The Money Laundering Regulations 2007;
„
„ HM Treasury Sanctions Notices and News Releases; and
„
„ The FCA Handbook.
„
Money laundering related offences relevant to the trade finance sector
Several offences related to money laundering exist, and the groups of offences
that concern players in the trade finance sector (i.e. financial institutions and
financial organisations – and their customers) are the following3:

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„ Performing any act with knowledge or suspicion that it will assist in

„
concealing, or entering into arrangements for the acquisition, use, and/or
possession of criminal property;
„ Failing to report as soon as practicable any knowledge, suspicion or,
„
where there are reasonable grounds for knowing or suspecting, that another
person is engaged in money laundering; and
„ Tipping off a person suspected of money laundering: (i) that disclosure has
„
been made to a nominated officer (e.g. a Money Laundering Reporting
Officer generally referred to as the MLRO) or law enforcement authorities; or
(ii) that an investigation into allegations of money laundering is contemplated
or is currently taking place, where this is prejudicing or likely to prejudice an
investigation or proposed investigation.

POCA provides that a court is to take into account whether the alleged offender
followed any relevant guidance issued by a supervisory authority or other
regulatory body and approved by HM Treasury. The guidance that has been
approved is that of the Joint Money Laundering Steering Group (JMLSG).
The Money Laundering Regulations 2007 also place a general obligation
on players in the trade finance sector (and generally on all those that are
deemed at risk of being involved with money laundering) to establish and
maintain adequate and appropriate risk-based policies and procedures to
prevent money laundering, notwithstanding whether or not money laundering
takes place. The Regulations provide that the policies and procedures must
cover customer due diligence, reporting, record-keeping, internal control, risk
assessment and management, compliance management, and communication.
Under the Financial Services and Markets Act 2000 (FSMA), the Financial
Conduct Authority (FCA) may initiate proceedings for offences under prescribed
regulations relating to money laundering where the failure to comply with them
constitutes an offence.
With respect to FCA-regulated firms, the Senior Management Arrangements,
Systems and Controls requires that such firms have ‘effective systems and
controls for countering the risk that a firm might be used to further financial
crime, and specific provisions regarding money laundering risks’.4 Furthermore,
the FCA Handbook of rules and guidance provides for standards and practices
that are applicable to all FCA-regulated firms and to all ‘approved persons’.
In particular, the FCA Handbook requires the implementation of appropriate
systems and controls over the management of money laundering risk.

Other international initiatives

Other international initiatives that may impact on trade finance players are
the offences under the US Patriot Act and further international guidance
such as that provided by The Wolfsberg Group,5 and the FATF guidance on

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anti-money laundering on an international scale. The Wolfsberg Group has

issued numerous guidelines on money laundering issues arising in the course
of correspondent bank to bank business in which general and sector specific
principles are provided.6 FATF issues the International Standards on Combating
Money Laundering and the Financing of Terrorism and Proliferation which has
as its goal the provision of minimum international standards for action to ensure
that the efforts to prevent money laundering are applied consistently at an
international level.

The proposed 4th Anti-Money Laundering Directive

In March 2014, the European Parliament approved the draft of the 4th Anti-
Money Laundering Directive in which a key feature is the obligation on each
member state to implement and maintain publicly available ultimate beneficial
ownership registers for both corporate entities and trusts. Given the widespread
involvement of offshore trading entities in ‘tax efficient’ jurisdictions and the
frequent creation and use of special purpose offshore corporate vehicles in
complex trade and commodity structured financings, the imposition of such a
regime could have a substantial impact upon the time and cost of compliance.
This may require market participants to rethink traditional approaches to
financing.
There is some uncertainty as to the timetable for the formal issuance of this
directive. The draft directive first needs to be approved by the European Council
prior to implementation by each member state.

Money laundering in trade finance

Description of the sector and the methods of money laundering in the
trade finance world
In accordance with the Wolfsberg Group Trade Finance Principles,7 trade
finance can ‘in its broadest interpretation, be described as being the finance by
financial institutions of the movement of goods and services between two points,
both within a country’s boundaries as well as cross border’. So the vast majority
of financially settled international transactions fall within that broad definition.

An attractive market for money launderers

Trade is attractive to money launderers for the following reasons:

„ Size: Global trade is over US$35 trillion per year.

„
„ Numbers: Tens of thousands of transactions take place every day, in
„
amounts varying in value from a few hundred dollars to over USD100
million for a crude oil transaction.

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„ Geography: Global trade really is global with goods and service

„
transactions involving literally every country in the world.
„ Mode: Transactions take place by road, rail, air and water and all
„
combinations of these transport methods.
„ Abundance: Many banks offer trade finance solutions to their clients
„
and are keen to expand their business, making trade finance abundantly
available.
„ Opaque: Due to globalisation of production, assembly, as well as
„
distribution, it is becoming virtually impossible to assess the actual origin
and end-use of products (for example, German cars made in China
exported to Australia, or French handbags produced in Thailand sold in
the USA.).
„ Long supply chain: manufacturer, trader, consigner, consignee, notifying
„
party, financier, shipper, insurer and freight forwarder.
„ Regulations: Not every jurisdiction regulates trade transactions, within
„
certain jurisdictions there are Free Trade Zones.
„ Coordination: Customs and regulatory bodies are not joined-up
„
internationally.
„ Lack of control: an estimated 80 per cent of payments for trade
„
transactions takes place on an open account basis, making it virtually
impossible to check if the transaction is real.

Based on a report entitled ‘Illicit Financial Flows from Developing Countries:

2002–2011’ by the organisation Global Financial Integrity,8 it is estimated
that 80 per cent of illicit funds from developing countries are laundered
through trade. Another report, published by PwC in September 2014 and
entitled ‘Goods gone bad: Addressing money-laundering risk in the trade
finance system’ (‘Goods gone bad’), estimates that the amount of illicit funds
from developing countries laundered through trade increased from 2002 to
2011 from US$200bn to US$600bn.9 This increase demonstrates that money
launderers have become more interested in laundering money through trade
over the last couple of decades. This is not only due to the nature of the market,
but also the lack of enforceable harmonised global monitoring structures
and procedures, and to the increase of efforts to target alternate means of
laundering dirty money in other markets.

A global market
Today’s market operates on an international scale with enormous volumes
of trades carried out each year (in 2013, the total aggregate value of
world merchandise export and commercial services exports amounts to over

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US$23tn – of which over US$18tn is merchandise – based on the World

Trade Organisation’s statistics10). The scale of this market makes it extremely
difficult for enforcement entities and for financial institutions to determine which
‘needle in the haystack’ is illicit, especially when the money launderers choose
their methods with care. As an example, if money launderers are only slightly
‘over-invoicing’ products from say US$15 to US$16 per tonne/metic ton (MT)
(please see below for an explanation of over invoicing), this may be difficult for
financiers, regulators or law enforcement agencies to distinguish from innocent
fluctuations in market prices unless these are set against a precise accountable
industry benchmark. This becomes even more difficult in volatile markets such as
commodity trading.

Market trends: The increase in ‘open account’ transactions

Based on the figures of the 2014 ICC Global Trade and Finance Survey,11 the
volume of SWIFT trades (i.e. collections, guarantees, letters of credit) reduced by
0.65 per cent as a proportion of the total amount of trade flows meaning that
trading on ‘open account’ terms increased – a sign of increased confidence in
the market. Trading on ‘open account’ terms means the buyer and seller agree
on the terms of the provision of the goods and the payment (or the netting of the
payment) is made directly through the banking system without the provision of
any credit from financial institutions. It is generally acknowledged in the market
that between 70–80 per cent of global trade flows are now made on ‘open
account’ terms. This means that it is more difficult for financial institutions to fully
discern the nature of the commercial transactions and they may only be in a
position to monitor transactions based on the standard anti-money laundering
and sanctions screening on clean payments (and netting of payments).

Complex transactions
For dealings that are not on ‘open account’ terms – i.e. when credit is provided
by financial institutions – trade finance transactions can often be complex with
many different parties (normally more than one financial institution is involved)
located in different countries, acting in different capacities, with diverse interests.
Trade finance is fragmented in nature.
In this respect, trade finance operations can take many forms. They can
involve any of the following:

„ Transmission of funds with presentation of certain documents (e.g. shipping

„
documents) or provided on a conditional basis (e.g. where a specific event
has to occur);
„ Granting of undertakings where payment will take place in the event of
„
default (e.g. bonds, guarantees, indemnities, and standby letters of credit);
and

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„ Financing complex structures where the financing is the main focus and the
„
provision of trade finance instruments is only considered as secondary (e.g.
securitisations, involving special purpose vehicles).

A market with a traditional approach

The trade finance industry is considered as a traditional market compared to
other financial sectors that operate and rely mainly on IT platforms, though
there has been a steady increase in volume of trade across supply chain
finance platforms in recent years. The trade finance industry relies on the trust
developed over the generations in its paper instruments and documentation
process (e.g. letters of credit (LCs) and shipping documents such as bills of
lading). With a wide variety of trade finance instruments, as mentioned above,
this traditional approach to trading involves a great many paper instruments.
For anti-money laundering purposes these must therefore be managed in large
part manually to determine any risk. Automated processing of LCs and other
payments is now the norm across a large proportion of international trade
transactions but, particularly in developing countries, many areas of international
trade remain paper bound. The processing of LCs is therefore a considerable
operational burden for financial institutions in terms of cost and time, and from
an operational risk perspective it is also subject to human error – evidenced by
the continuing high number of discrepancies which are not caught at the first
inspection by a bank of documents presented for payment. Human error can be
limited by the use of the red flags system by staff. (See below for more detail on
the red flags system.)

Lack of harmonisation
The international trade market is a global market where goods are exported
and imported to different countries around the world. This characteristic means
that the actors in this market and in trade finance transactions must abide by the
anti-money laundering laws, regulations, and rules applicable in the different
jurisdictions that they encounter. As trade finance transactions are also document
heavy, in most instances national law will apply to these instruments (e.g.
national law will, in most cases, be applicable to the enforcement of a bill of
exchange). This specificity renders the monitoring of financial institutions and the
investigations conducted by governmental bodies into their transactions more
difficult.
Discrepancies and deviation from standard practice are routinely waived
expressly to prevent the trade finance system becoming clogged with minor
disputes as to form and content of documents. Even where payments are made
through bank issued payment instruments, there is a limit to the degree of
worthwhile scrutiny which financial institutions can bring to bear on individual

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payments in ‘real time’ – where the performance by a contract party and its
banker of payment obligations is time critical. Even where time is available,
the nature of the payment obligation means that the paying bank cannot see
precisely how the sum paid is commercially justified. By way of example,
international supply contracts awarded by competitive tender will frequently
require the provision of a local law governed performance bond issued by a
local bank and counter-secured by an international bank via a guarantee or
standby letter of credit. The performance bond will often be payable locally
against a bare statement of default and demand. The international bank counter-
securing that bond will pay out against the local bank’s bare statement that it
has been obliged to pay. Short of proving the local bank to be fraudulent, the
international bank has no option but to honour its obligations. Claims can in
some cases be wildly disproportionate to any conceivable damage or loss.
These excess claims are more likely to be motivated by commercial opportunism
than criminality but it does demonstrate the limitations on a bank’s ability to
monitor the end purpose of every payment.
In the ICC’s Global Trade and Finance Survey issued in 2014, 60 per
cent of the respondents to the survey considered the lack of harmonisation of
compliance standards created a significant challenge for the industry. Needless
to say, several organisations such as The Wolfsberg Group and the FATF
have as an objective the provision of international guidelines and practices
for financial institutions in respect of anti-money laundering procedures and
standards. However, these are only guidelines and are not an enforceable
standard of practice.
In addition to the complexity and multiple laws and regulations applicable
to trade finance transactions, it is noted by PwC in their report issued
in September 201412 that there is also a lack of data-sharing between
governmental authorities (customs, tax, and legal authorities). The report also
mentions that the traditional, document-heavy approach in trade finance
also hinders the ability to create reliable IT and data tools to counter money
laundering and PwC expressly state that this approach ‘promotes reliance on
manual systems of investigation and analysis, which not only limits an institution’s
own statistical analysis but limits the potential to create timely, accurate reference
data that could be shared with other parties to facilitate identification of trade
based money laundering risks.’

Efforts focused on combatting money laundering in other sectors

Trade finance is not only attractive to money launderers due to its nature, but
also because regulators and therefore financial institutions have been focusing
efforts and staff to counter money laundering in sectors other than trade finance.

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Methods used for trade-based money laundering

Money launderers use different techniques that evolve and adapt to the
regulatory framework and the law enforcement environment in place, as well
as to the type and the source of criminal property that is being laundered. For
trade-based money launderers, either: (i) the importer/buyer and exporter/seller
of the goods act in concert and are aware that the funds originate from illicit
means; or (ii) only the exporter/seller or the importer/buyer is laundering money
and the other is not aware that the funds are illicit – in which case the launderer
is acting fraudulently towards the other party.
The current techniques used by trade based money launderers that have
been identified are outlined in the following sections.

Under invoicing
A money launderer is under invoicing when the goods are exported at a value
which is below the fair market value of the goods. Here, the importer/buyer
will have an excess value when the importer/buyer re-sells the goods on the
open market. This allows the exporter/seller of the goods to transfer funds to the
country in which the importer/buyer of the goods is located.

Over invoicing
Over invoicing is the opposite of under invoicing where the goods are exported
at a value which is above the market value of the goods so that the exporter/
seller will have an excess value upon payment from the importer/buyer. This
allows the exporter/seller of the goods to receive funds from the country in
which the importer/buyer is located. An example reported by the JMLSG
is the case of a West African businessman receiving transfers from several
business entities based in Europe of approximately US$7m and linked to the
fishing industry, during a three-year period. The transfers out of the account of
approximately US$4m over the same period were made to various businesses
in the maritime industry. The analysis carried out showed that the income of the
West African entities was ‘grossly disproportionate to reported sales’ and that
one of the business partners was suspected of money laundering in Italy.13

Multiple invoicing
This is the case where more than one invoice is issued for the same goods
whereby the exporter/seller can justify the receipt of multiple payments from
the importer/buyer for the same shipment. These payments become even more
difficult to track and monitor when they are made by more than one party
(for example, the importer/buyer and a possible guarantor or through their
banks by documentary credit) and for multiple legitimate reasons (for example,

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amendment of payment terms, payment of default interest for delay in delivery,

or difference in interest rate).

Over shipment
In this case, the seller/exporter delivers more goods than the quantity or quality
(or both) of the goods detailed in the invoice. Here the value of the goods
is misrepresented in the shipping documents. This allows the exporter/seller
to transfer excess value to the importer/buyer which the importer/buyer can
convert to clean funds.

Under shipment (also known as ‘short shipping’)

This is the opposite to over shipment where the seller/exporter delivers less in
goods than the quantity or quality (or both) of the goods detailed in the invoice,
allowing the exporter/seller to receive excess funds from the importer/buyer.

Phantom shipments
This is the extreme case of under shipment where no goods are shipped and all
shipping documentation is falsified. An example is where one of the methods
used was to provide false invoices of precious metals which never reached
the country of the importer, as in the case reported by the JMLSG of silver and
gold smuggling for the purpose of VAT evasion and money laundering. In this
case, the total amount of funds involved was USD$101m. Fifteen suspects were
arrested, four of whom were charged with money laundering offences.13

False or misleading description of traded goods

This technique involves falsifying information on the transaction documents or in
relation to the type or the source of the goods traded so as to mislead the other
parties and avoid any suspicion (i.e. dual purpose goods – see the information
on proliferation financing which will be covered in Chapter 5).
In using the methods above, money launderers also use other techniques
that facilitate the money laundering process in trade finance transactions some
of which are as follows:

„ The use of front companies and shell companies: This technique consists
„
of masking illicit funds behind businesses that conduct legitimate business
activities generating legitimate business profits. This technique of hiding
behind a corporate identity is used by money launderers in all sectors and
such businesses are usually set up in tax havens with strong regulations on
bank secrecy.
„ The use of funnel accounts: In this case, the money launderer deposits the
„
funds in one geographical area (often in amounts below the cash reporting
threshold) which are then withdrawn in a different geographical area.

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„ The use of barter transactions: These transactions involve the exchange of

„
goods, one for another. Please see the example of the diamond market in
Chapter 5.
„ Lightly regulated countries and free trade zones: These countries and zones
„
are attractive to money launderers as they are easy places to set up legal
entities, to avoid or bypass custom controls, and to undertake operations in
which goods are transformed or used to produce other goods (i.e. dual use
goods).

Preventive measures to counter money laundering in trade

finance
In order to be proactive, stay ahead of the overflow of regulatory reform and to
mitigate the risks associated with money laundering in trade finance, financial
institutions and trade organisations need to, amongst other things, design and
implement risk-based monitoring and customer due diligence procedures within
their policies and training. Not all financial institutions are currently performing
to the standard required by the regulators in the UK, as illustrated in the FCA’s
review of a panel of international banks’ procedures in determining risks in
the trade finance sector and the examples of poor due diligence practice
exhibited.15
In line with the obligations set out in the Money Laundering Regulations
2007, the JMLSG guidance sets out not only the general obligations of financial
institutions and further advice in respect of their risk-based procedures and
policies, but also sector specific guidelines on such policies and procedures.
The main obligations and advice set out in the JMLSG guidance specific to the
trade finance sector are covered in the following sections.16

The ability to assess the risk

The starting point for a risk-based approach is that the customer is not a money
launderer and that criteria to be established in the firm’s policy should indicate
whether a customer presents a higher risk. Higher risk must be escalated to
senior management.

Customer due diligence

Due diligence is to be undertaken on the customer who is the instructing
party for the purpose of the transaction. It is often the case that, for trade
finance transactions, the customer is already a customer of the bank where
due diligence has already been carried out and where the bank is to assess
whether further due diligence is required. It is recommended that due diligence
on the other parties should be carried out – the extent of such due diligence
should be contained in the firm’s written policy but should be more or less

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extensive depending on which capacity the financial institution is acting in, to

the amount of information the financial institution has access to, and if enhanced
customer due diligence is required (in correlation to the risk involved).

Different capacities of the financial institution in a trade finance transaction

The instructing party, on which customer due diligence is to be carried out by
firms, will depend on the role of the firm in the transaction and the instruments
that the bank is providing17:

„ Import (outward) LC – The instructing party for the issuing bank is the
„
applicant;
„ Export (inward) letters of credit – The instructing party for the advising/
„
confirming bank is the issuing bank. Firms should follow the specific
guidance provided by the JMLSG on correspondent banking;
„ Outward collections – The instructing party is the customer/applicant;
„
„ Inward collections – The instructing party is the customer/applicant; and
„
„ Bonds/guarantees – The instructing party is either the customer,
„
correspondent bank, or another third party.

Forfaiting transactions
Forfaiting is a method of trade finance that allows the exporter to transfer
account receivables at a discount to financial institutions in consideration for
cash on a ‘without recourse’ basis. In this case, the instructing party will normally
be the exporter on whom due diligence should be carried out. The firm should
also carry out due diligence on the other parties to the transactions, such as the
importer and the transaction documents to ensure the validity of the transaction.

Enhanced due diligence

When the transaction presents a higher risk based on the firm’s risk assessment
of the transaction (i.e. types of customers, countries in which the trade is
involved, type of goods etc.), customer due diligence should be undertaken
as per the above but with additional checks that will enable the bank to fully
understand the commercial aspects of the transaction and to be fully assured
of the legitimacy of the transaction. Examples of the additional checks are as
follows18:

„ Enquiries into the ownership of the other parties of the transaction;

„
„ Obtaining information from the instructing party on the frequency of trade
„
and the quality of the business relationship between the parties;
„ Checking the ICC International Maritime Bureau for warning notices; and
„
„ Referring the transaction to external agencies such as the ICC Commercial
„
Crime Services.

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Screening
This is dealt with in Chapter 5.

Monitoring
Financial institutions are under an obligation to report suspicious transactions.
In their general monitoring, financial institutions usually use the following
information to flag suspicious transactions19:

„ Payment values;
„
„ Volume of payments;
„
„ Countries of payment;
„
„ Originator and beneficiary;
„
„ Patterns based on the country or entity involved; and
„
„ Volume of shipments.
„
The depth and frequency of the monitoring depends on the risk analysis of
the business/transaction/parties involved. In any event, structured controls and
procedures for monitoring purposes should be included in firms’ policies.

Training of staff
Firms must hire staff with a high level of understanding of the trade finance
sector, including export licence regimes and authorisations of trading. The staff
need to receive regular training outlining both how trade finance transactions
can be used by money launderers, and how to understand and manage the
risk. It is stated in the JMLSG guidance that training programmes should refer
to the FATF’s red flags that are generally directed to governmental agencies
but can be useful also in the private sector. The FATF red flags can be found in
Annex 15-V of Chapter 15 of Part II of the JMLSG Guidance, a few examples of
which are as follows:

„ Significant discrepancies between the description of the commodity on the

„
bill of lading and the invoice;
„ Significant discrepancies between the description of the goods on the bill of
„
lading (or invoice) and the actual goods shipped; and
„ Inconsistency between the size of the shipment and the scale of the
„
exporter’s or importer’s regular business activities.

The current situation

In the trade finance sector, KPMG noted a significant divergence in practice
between US banks and those based in Western Europe and other regions in
terms of both the use of existing customer information across bank departments
and the independent verification of trade documentation to identify potential

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money laundering transactions. A lack of tailor-made anti-money laundering

training for the trade finance sector has also been highlighted. All these factors
have raised the profile of trade finance with regulators, and banks can expect
increased attention from the authorities.
An example of non-compliance was the case of Standard Bank where the
FCA’s first notable fine was issued in January 2014 (£7.6m) because the bank’s
policies for preventing money laundering were not in practice being applied
with consistency – particularly with regard to PEPs (politically exposed persons)
and those corporates associated with them.20 In the US, meanwhile, Standard
Chartered Bank was on the receiving end in August of a US$300m fine from
the New York State Department of Financial Services for failure to adhere
to remedial measures it had undertaken to put in place in relation to its anti-
money laundering procedures following an earlier investigation and fine by the
same authorities in 2012.21 The message appears to be that the regulators are
beginning to target non-compliant players in the trade finance sector.
To emphasise their focus on the trade finance sector, in June 2014 the FCA
published an amended version of its 2013 Financial Crime Guide together with
the results of its survey of a number of banks active in the trade finance sector
handily titled ‘Examples of good and poor practice in Banks’ control of financial
crime risks in trade finance’.22 The new guidance took effect on 12 June 2014.
The section on anti-money laundering policies and training reveals that some
banks at least are still not picking up on the theme of trade finance specific
policies and training which have been flagged up by the regulators previously.
Some of the findings of ‘poor’ practice make worrying reading.
The obligations on banks to risk assess, carry out both simple and enhanced
due diligence, and continually monitor the customers who they bank is a costly
burden. In the 2014 ICC Banking Commission Global Survey, firms indicated
that the main restriction to developing their trade pipeline was the burden of
compliance. In order to develop the market but at the same time counteract
against money laundering and terrorist financing, a balance needs to be found
by the industry players in the industry in the implementation of appropriate
procedures that do not reduce the appeal of the trade finance market.
As mentioned in the paragraph on ‘Lack of harmonisation’ above, and as
noted by international regulatory bodies and authorities, another solution to
the problem of money laundering in the trade finance sector would be more
significant intervention at state level that would provide a reasonable global
price benchmark for products. PwC states that price benchmarks for products
between countries will provide invaluable data to counter money laundering.
A harmonised ‘method for detecting and identifying trade-based money
laundering is the analysis of import and export data between countries at macro
level.’23

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References
1. FATF, ‘What is money laundering?’, see: www.fatf-gafi.org/pages/faq/
moneylaundering/.
2. See: www.imf.org/external/np/speeches/1998/021098.htm.
3. As set out in the JMLSG Guidance at: www.jmlsg.org.uk/.
4. See the JMLSG Guidance.
5. An organisation of international and market leading banks engaged in correspondent
banking business such as, amongst others, Banco Santander, Citigroup, Credit
Suisse, Deutsche Bank, Goldman Sachs, and Barclays. See www.wolfsberg-
principles.com.
6. The relevant guidelines of The Wolfsberg Group are the ‘Wolfsberg Trade Finance
Principles’ (see www.wolfsberg-principles.com/pdf/standards/Wolfsberg_Trade_
Principles_Paper_II_(2011).pdf) and the ‘Wolfsberg Anti-Money Laundering Principles
for Correspondent Banking’ (see www.wolfsberg-principles.com/pdf/home/
Wolfsberg-Correspondent-Banking-Principles-2014.pdf).
7. The Wolfsberg Group, ‘The Wolfsberg Trade Finance Principles (2011)’. See: www.
wolfsberg-principles.com/pdf/standards/Wolfsberg_Trade_Principles_Paper_
II_%282011%29.pdf.
8. See: www.gfintegrity.org/reports/.
9. See ‘Goods gone bad’, at: www.pwc.be/en/publications/2014/money-laudering.
jhtml.
10. See: www.wto.org/english/news_e/pres14_e/pr721_e.htm.
11. See: www.iccwbo.org/Products-and-Services/Trade-facilitation/ICC-Global-Survey-
on-Trade-Finance/.
12. See ‘Goods gone bad’, at: www.pwc.be/en/publications/2014/money-laudering.
jhtml.
13. See: www.jmlsg.org.uk/other-helpful-material/article/front-companies.
14. See: www.jmlsg.org.uk/other-helpful-material/article/silver-and-gold-smuggling.
15. FCA, ‘Banks’ control of financial crime risks in trade finance’, July 2013. See: www.
fca.org.uk/static/documents/thematic-reviews/tr-13–03.pdf.
16. For further detail on the obligations and guidelines, please refer directly to the JMLSG
Guidance.
17. Please refer to the JMLSG Guidance for more information on the extent of customer
due diligence to be undertaken.
18. List provided in the JMLSG Guidance.
19. List provided in the JMLSG Guidance.
20. See: www.fca.org.uk/news/standard-bank-plc-fined-for-failures-in-its-antimoney-
laundering-controls.
21. See: http://online.wsj.com/articles/n-y-financial-watchdog-fines-standard-chartered-
300-million-1408466076.

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22. This can be found at http://fshandbook.info/FS/html/FCA/FC/link/PDF.

23. See ‘Goods gone bad’, at: www.pwc.be/en/publications/2014/money-laudering.
html.

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Chapter 5: Terrorism financing

By Robert Parson, partner, and Imogen Holmgren, trainee, Reed
Smith LLP

TERRORISM IS defined in Section 1 of the Terrorism Act 2000 (TACT) as,

amongst other things, ‘the use or threat of action… designed to influence the
government or an international governmental organisation, or to intimidate the
public… [which is made] for the purpose of advancing a political, religious or
ideological cause… [and which involves] serious violence against a person…
or serious damage to property, endangers a person’s life… or creates a serious
risk to the health or safety of the public… or is designed seriously to interfere
with, or seriously to disrupt, an electronic system.’
The TACT sanctions and punishes acts of terrorism, and it also criminalises
the financing of terrorism. Under Schedule 7 of the Counter-Terrorism Act
2008 (CTA), terrorist financing is defined as the ‘use of funds, or the making
available of funds, for the purpose of terrorism, or the acquisition, possession,
concealment, conversion or transfer of funds that are (directly or indirectly) to be
used or made available for those purposes’.
There are many similarities between the act of laundering criminal property
and the movement of funds on the one hand, and the act of financing terrorist
activities on the other. However, the main differences between the two lie in
the fact that the funding of terrorism is, in general, more difficult for financial
institutions to detect and prevent because:

„ Terrorism financing is a broad term encompassing any financing of terrorist

„
activity which could involve small amounts to finance a single terrorist act or
the flow of a significant amount of funds financing the infrastructure of major
terrorist organisations such as Al Qaeda. The difference in terms of funds
flow makes it difficult to detect and prevent compared to money laundering
which tends to consist of significant individual amounts of funds laundered;
and
„ Unlike money laundering, terrorism can be and often is financed by
„
apparently legitimate sources such as charitable donations, and it is difficult
for the actors in the financial sector to determine at which point those funds
cease to be legitimate and are therefore determined to be funds intended
for financing terrorism. In the past, organisations such as Sanabel Relief
Agency, which was registered with the UK Charity Commission, were

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subsequently found to be fundraising fronts for Al Qaeda and other terrorist

organisations.

Terrorism financing offences and obligations relevant to the

trade finance sector
Similar in a sense to the anti-money laundering regime, the measures countering
terrorism financing applicable to financial institutions in the UK are extensive
and can be found across a range of sources (legislation, regulation, rules,
and guidelines). The anti-money laundering regime and the counter terrorism
regime go hand in hand and therefore several key elements of the applicable
framework for countering money laundering that are currently in place in the UK
are the same for countering terrorism financing. The key elements for countering
terrorism financing are the following:

„ TACT;
„
„ CTA;
„
„ The Terrorist Asset Freezing etc. Act 2010 (TAFA);
„
„ The Money Laundering Regulations 2007;
„
„ HM Treasury Sanctions Notices and News Releases; and
„
„ The FCA Handbook.
„
Money laundering related offences relevant to the trade finance sector
Several offences related to terrorism financing exist, and the main offences that
are applicable to the trade finance sector are contained in TACT. The legislation
states that any person who:

„ Invites another person to give and provide money or other property, or is

„
engaged in the sole action of receiving money or other property with the
intention for it to be used, or has reasonable cause to suspect that it may be
used, for the purpose of terrorism. It is also considered an offence to provide
any asset with the knowledge (or reasonable suspicion) that it will or may
be used for the purpose of terrorism (section 15);
„ Uses money or other property for the purpose of terrorism or possessing
„
such money or other property with the intention for it to be used (or
reasonably suspects that it may be used) for the purpose of terrorism (section
16);
„ Enters into or is concerned in an arrangement resulting from which money
„
or other property is made or is to be made available to another with the
knowledge (or reasonable suspicion) that it will or may be used for the
purposes of terrorism (section 17);

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„ Enters into or is concerned in an arrangement which facilitates the retention

„
or control by or on behalf of another of terrorist property by concealment,
removal from the jurisdiction, transfer to nominees, or in any other way. This
offence will not be charged if it is evident that the alleged offender had no
knowledge (or reasonable cause to suspect) that the arrangement related to
terrorist property (section 18); and
„ Fails to comply with the duties of disclosure of any offence under the above
„
that the person believes or suspects that another has committed (section 19).

TACT provides that a court is to take into account any relevant guidance issued
by a supervisory authority or other regulatory body and approved by HM
Treasury when considering whether an alleged offender failed to report under
TACT. Guidance has been approved by the Joint Money Laundering Steering
Group (JMLSG).
Other than the offences under TACT:

„ The CTA grants HM Treasury power to issue directions by which the

„
Treasury may impose additional requirements to be complied with (e.g.
additional due diligence, monitoring, or reporting measures) in entering into
or pursuing transactions or business relationships with a person carrying out
business in the country, with the government of the country, or with a person
resident or incorporated in the country concerned by the direction. The
Treasury may only issue directions if all conditions of Section 1 of Schedule
7 of the CTA are met (e.g. that the Financial Action Task Force (FATF) has
advised that measures should be taken in relation to the country because of
the risk of terrorist financing or money laundering); and
„ The TAFA grants HM Treasury power to freeze assets in the event of an
„
offence committed pursuant to Section 11 of TAFA. Section 11 provides
that one must not deal with funds or economic resources owned, held, or
controlled by ‘designated persons’ or make funds, economic resources,
or financial services available to or for the benefit of such persons. Under
TAFA, a ‘designated person’ is referred to as a person designated by the
Treasury or a person that is included in the list provided for by Article 2(3)
of Council Regulation 2580/2001. The Treasury may make final or interim
designations under the conditions set out in Section 2 of the TAFA (e.g.
if they reasonably believe the person is or has been involved in terrorist
activities).

Other initiatives
EC Regulation 881/2002 imposes specific restrictive measures directed
against persons associated with the Al-Qaeda network, including flight bans

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and the freezing of funds and other financial resources regarding the Taliban
in Afghanistan. Several organisations also provide general and sector specific
guidelines and recommendations on ways to prevent terrorism financing. For
example:

„ FATF issues the ‘International Standards on Combating Money Laundering’

„
and the ‘Financing of Terrorism and Proliferation’ which has as its goal to
provide minimum international standards for action to ensure that the efforts
to prevent money laundering are applied consistently at an international
scale.
„ The Counter-Terrorism Implementation Task Force (CTITF) of the United
„
Nations has provided a number of reports such as the ‘CTITF Working
Group Report’ in which it provides general principles for combatting
terrorism financing for the public and private sector.1 Although it stresses
the importance of combatting terrorism financing, it also states that
‘authorities should exercise caution not to introduce laws or regulations
burdening private and public sector stakeholders in the name of countering
the financing of terrorism without sufficient evidence or typologies that
the burden is proportionate to the risk’. In this report, CTITF also shares
its findings one of which is that financial institutions usually comply with
the general reporting anti-money laundering/counter terrorism financing
requirements, but no in-depth research has been carried out as to the
methods specifically used by persons intending to finance terrorism and that
there are few specific indicators available other than sanction indicators for
financial institutions to assess the risk of terrorism financing.
„ The World Bank and the International Monetary Fund issued a ‘Reference
„
Guide to Anti-Money Laundering and Combating the Financing of Terrorism’
in which it provides guidelines for countries to implement a regime that
complies with international standards.2

The Money Laundering Regulations 2007 and the FCA Handbook

The Money Laundering Regulations 2007 and the Financial Services and
Markets Act 2000 (‘FSMA’) also apply to terrorism finance. In this respect,
players in the trade finance sector are obliged to establish and maintain
adequate and appropriate risk-based policies and procedures to prevent
terrorism financing which must cover customer due diligence, reporting,
record-keeping, internal control, risk assessment and management, compliance
management, and communication.
Furthermore, under FSMA, the Financial Conduct Authority (FCA) may
initiate proceedings for offences under prescribed regulations relating to
terrorism financing where the failure to comply with the requirements of the

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Money Laundering Regulations 2007 constitutes an offence, in which case the

standards and practices set out in the FCA Handbook of rules and guidance
are also applicable. FCA-regulated firms and ‘approved persons’ are therefore
required to implement appropriate systems and controls over the management of
terrorism financing risks.

Money laundering in trade finance

For the same reasons described in Chapter 4 in relation to money laundering,
the trade finance market is also attractive to financiers of terrorism. Although
money laundering and terrorism finance are different in terms of their aims, the
methods used by money lauderers are the same for persons wishing to finance
terrorism via trade transactions.

Proliferation financing
There is currently no agreed legal definition of ‘proliferation financing’, but
the working group at the FATF proposed the following definition: ‘the act of
providing funds or financial services which are used, in whole or in part, for
the manufacture, acquisition, possession, development, export, trans-shipment,
brokering, transport, transfer, stockpiling or use of nuclear, chemical or
biological weapons and their means of delivery and related materials (including
both technologies and dual use goods used for non-legitimate purposes), in
contravention of national laws or, where applicable, international obligations’.
This definition refers to the notion of ‘dual-use goods’ which are goods that can
have both a commercial and a military purpose. Numerous international and
European sanctions are currently in place for dual-use goods.

Examples of terrorism financing through trade

Tobacco smuggling
In 2002, a suit was filed by the European Community against an American
tobacco company alleging money laundering activities surrounding cigarette
smuggling. It was suspected that the proceeds from the smuggling of cigarettes
from Turkey, through the Northern border of Iraq, and into two PKK controlled
areas of Iraq (allegedly violating trade embargoes in Iraq) were used to fund
terrorist activities of the PKK and other terrorist organisations operating in
Northern Iraq.3
In 2004, ten people were arrested for smuggling more than US$2m in
contraband cigarettes from Virginia to New York. One subject was arrested in
Detroit and found with hundreds of thousands of dollars in wire transfer receipts
showing payments to people associated with Hezbollah.4

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Sugar trade
Allegations have been widely published to the effect that sugar exported from
Somalia to Kenya illegally is funding the terrorist group Al-Shabaab.5

The production and refining of oil

ISIS is believed to control some 60 per cent of Syria’ oil fields and have
established export routes – including across the Turkish border – to raise finance
for their terrorist activities.6

The diamond trade

The FAFT and the Egmont Group of Financial Intelligence Units have recently
produced a report on ‘Money Laundering and Terrorist Financing through
Trade in Diamonds’.7 In this report, it points out that the diamond market has
vulnerabilities that can be used and exploited by money launderers and persons
wishing to finance terrorism. Examples of such vulnerabilities are:

„ The global nature of the trade;

„
„ The fact that diamonds can also be used as currency;
„
„ That it is difficult to produce a price benchmark;
„
„ That it is a specialised market where law enforcement authorities and
„
financial institutions do not necessarily have the requisite knowledge or level
of awareness; and
„ The characteristics of the product (small in size and in weight so easily
„
transportable and of high worth where one stone can reach more than
US$20m).

This report concludes that ‘diamonds could therefore be used to finance

terrorism in a scenario where a donor or financier purchases diamonds
legitimately, using lawfully derived funds, and then transfers the diamonds to a
terrorist or terrorist organisation who exchange the diamonds for equipment or
cash intending to finance terrorist activities.’

Preventive measures to counter terrorism financing in trade

finance
The prevention measures employed in trade finance transactions to counter
money laundering are the same as those employed to counter terrorism
financing.
With regards to preventive measures against proliferation financing, it is
extremely difficult for firms to monitor and determine which dual-use goods are
used for proliferation due to the highly specialised knowledge and experience
needed to determine if such goods are to be used for proliferation purposes,

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and due to the very few transactions and customers in this type of illicit
transaction. Nevertheless, FATF published reports in 2008 and 20108 which
assess the risk of financial institutions being involved in such transactions.
With regards to sanction checking within financial institutions, the FCA, in its
amended version of its 2013 Financial Crime Guide, pinpointed failures seen in
trade finance banks in relation to sanctions checking, and it noted the following
key areas of concern:

„ Staff dealing with trade-related sanctions queries who are not appropriately
„
qualified and experienced to perform the role effectively;
„ A failure to screen trade documentation;
„
„ A failure to screen against all relevant international sanctions lists;
„
„ A failure to keep up-to-date with the latest information regarding name
„
changes for sanctioned entities, especially as the information may not be
reflected immediately on relevant sanctions lists;
„ A failure to record the rationale for decisions to discount false positives;
„
„ A failure to undertake risk-sensitive screening of information held on
„
agents, insurance companies, shippers, freight forwarders, delivery agents,
inspection agents, signatories, and parties mentioned in certificates of
origin, as well as the main counterparties to a transaction; and
„ A failure to record the rationale for decisions that are taken not to screen
„
particular entities and retaining that information for audit purposes.

The FCA’s emphasis on the fact that banks should not confuse money laundering
risks with sanctions risks comes, of course, at a time when banks are stretched in
dealing with the increasing volume of sanctions related to the Crimea/Ukraine
crisis. Of course resources within the law enforcement agencies, regulators,
and the banks themselves are not limitless. With well in excess of 200,000
Suspicious Activity Reports (SARs) being sifted through by the authorities
every year, it is clear that parties to trade transactions take money laundering
reporting obligations seriously. It remains to be seen whether that level of risk
assessment and performance of anti-money laundering obligations will satisfy
a regulator keen to establish zero tolerance towards money laundering and
terrorist financing.

References
1. See: www.un.org/en/terrorism/ctitf/wg_financing.shtml.
2. See: http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTFINANCIALSECTOR/
EXTAML/0,,contentMDK:20746893~menuPK:2495265~pagePK:210058~piPK:
210062~theSitePK:396512,00.html.

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3. Source: EC v RJ Reynolds (30 October 2002), EC v RJ Reynolds, Phillip Morris (1

February 2002).
4. See: www.washingtonpost.com/wp-dyn/articles/23384-2004Jun7_2.html..
5. See: http://sabahionline.com/en_GB/articles/hoa/articles/features/2013/04/24/
feature-01.
6. See: www.ibtimes.co.uk/iraq-crisis-isis-sells-stolen-crude-oil-raising-over-1-million-per-
day-1462389
7. See: www.fatf-gafi.org/documents/news/ml-tf-through-trade-in-diamonds.html.
8. See: www.fatf-gafi.org/topics/financingofproliferation/documents/
typologiesreportonproliferationfinancing.html. See also: www.fatf-gafi.org/media/
fatf/documents/reports/Status-report-proliferation-financing.pdf.

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Chapter 6: Sanctions and trade

finance
By Emma Radmore, managing associate, and Christina Pope,
trainee, Dentons

SANCTIONS CONCERNS are common in trade finance. Trade finance may

involve designated persons or goods, and it often uses irrevocable instruments
such as demand guarantees and letters of credit. Firms in the trade finance
sector need to manage their sanctions risk both at the outset of a contract or
relationship and on an ongoing basis. Sometimes they may face a stark choice
of breaching sanctions or breaching the contract. They should therefore analyse
their legal position when agreeing documents to manage this risk.
This chapter explains what sanctions may be relevant in the trade finance
sector. It is written from a UK legal perspective with particular reference to
the regulatory requirements that apply to trade financiers operating in the UK
and authorised under the UK Financial Services and Markets Act 2000. UK
sanctions laws, however, apply more widely, covering not only any UK firm
but also anyone doing business in the UK. This chapter does also refer to the
importance of other sanctions, particularly those imposed by the US. It assesses
the impact of these sanctions and considers what trade finance firms can do to
protect themselves.

What are sanctions?

Sanctions are legal measures designed to impose restrictions on dealings with
countries, governments, entities, or individuals in an attempt to influence a
change in policy or actions, or as an enforcement tool to align compliance with
international legal or diplomatic standards. The international community uses
sanctions, in particular, when there is a perceived risk to global peace and
security, including terrorism and illicit financing.1
Sanctions broadly sit in two categories: financial sanctions, which seize and
restrict availability of funds, and trade sanctions, which impose embargoes on
certain goods or services.

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Financial sanctions
Depending on the policy stance or actions they aim to address, financial
sanctions can include:

„ An outright ban on any inward or outward funds transfer (or transfers

„
allowed subject to notification and/or licences);
„ An asset freeze;
„
„ Limits on trading;
„
„ Investment bans; and
„
„ Most recently, restrictions on capital market activities.
„
Financial sanctions could target any person or organisation in a given country,
or they could be limited, for example, to governments or to named entities
and individuals designated by the particular sanctions regime. Sanctions
are invariably targeted at named entities and individuals. From a European
perspective, Iranian sanctions are the exception to this general rule.

Trade sanctions
The most often applied trade and other sanctions measures are:

„ Embargoes on exporting or supplying arms and associated technical

„
support, training, and financing;
„ A ban on exporting equipment that might be used for internal repression;
„
„ Financial sanctions on individuals in government, government bodies, and
„
associated companies, or terrorist groups and individuals associated with
those groups;
„ Travel bans on named individuals; and
„
„ Bans on imports of raw materials or goods from the sanctions target.
„
Where do UK sanctions come from?
Sanctions that apply under UK law usually stem from decisions of the EU (which
in turn derive from recommendations of the United Nations (UN) Security
Council) and from autonomous UK government decisions. The sanctions
are contained in secondary legislation (with a few exceptions discussed
below). UN Recommendations are not directly applicable to businesses in
any jurisdiction until implemented by their governments into national law. It is,
nevertheless, useful for firms active in sensitive industries or jurisdictions to be
aware of UN Recommendations, to give themselves time to prepare for national
implementation – which can sometimes follow very quickly.
The EU makes its financial sanctions by Regulations, which are directly
applicable to individuals and businesses within Member States. The UK

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Government (in the form of HM Treasury (Treasury)), however, makes secondary

legislation that sets out both the scope of the sanctions and the consequences
of breach. Separately, the UK makes its own sanctions under the Terrorist Asset
Freezing, etc. Act 2010 and there is, to some extent, also an overlap with
directions the Treasury makes under the Counter-Terrorism Act 2008.
As of November 2014, the UK had in place financial sanctions affecting
nearly 30 jurisdictions and regimes.2 The Treasury constantly updates lists of all
entities and individuals who are designated under the various sanctions. These
are Designated Persons, and the Treasury keeps lists by regime, and on one
combined list known as the Consolidated List.3 This Consolidated List includes
all names sanctioned under EU Regulations and persons designated under the
Terrorist Asset Freezing, etc. Act. The Treasury keeps a separate list of entities
subject to restrictions on capital raising under the Ukraine sanctions,4 and yet
another setting out Directions under the Counter-Terrorism Act and Financial Task
Force advisories. Although the Counter-Terrorism Act and Financial Task Force
advisories relate mainly to money laundering risks, they will also be relevant to
firms’ sanctions compliance.
The lists of Designated Persons for each relevant regime vary widely in both
numbers of names on the list and frequency of updates. Certain lists bear few
names and have not been updated for some time. Others (chiefly those relating
to Al-Qaida, Terrorism and Terrorist Financing, Ukraine, Syria, and Libya) bear
more names and/or are updated regularly.
UK Trade Sanctions also stem from UN and EU laws, and are usually
implemented into UK law by amendment to the Export Control Order 2008.
The Department for Business, Innovation and Skills (BIS) administers trade
sanctions, including export controls and arms embargoes, through the Export
Control Organisation (ECO). It separately lists jurisdictions and regimes towards
which various trade sanctions apply. The lists, like the Consolidated List,
constantly change.

Who must comply?

All individuals and legal entities incorporated under the laws of any part of
the UK or who are in the UK must comply with UK and EU sanctions. British
nationals or legal entities who are established under English law, but run their
business outside of the UK, must also comply with UK and EU sanctions.
In principle, therefore, the UK sanctions regime applies to anyone
incorporated in the UK (including overseas branches) or any British national,
wherever they are. It does not apply to subsidiaries of UK companies which are
incorporated and run outside the UK.

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International sanctions
Businesses and individuals in the UK may also be subject to the sanctions
regimes of other jurisdictions, such as those of the US Office of Foreign Assets
Control (OFAC).5 For instance, UK branches of US businesses must comply with
both UK and US sanctions regimes, as will US nationals working in the UK.
Similarly, US branches of UK entities will be subject to both sets of sanctions.
Increasingly, large financial institutions find they have no practical choice but
to implement a group-wide financial crime compliance policy that requires all
entities within the group to comply with sanctions relevant to any one or more
entities within the group.
Also, parties may be asked to comply with third party country laws or a
particular transaction may fall under a third country sanction due to its nature.
For example, the parties transact in a currency of a state which has a sanction
in place for the counterparty or beneficiary. US sanctions are particularly
relevant, not least because many transactions are denominated in US dollars
and therefore at some point will involve a US bank which is subject to the US
sanctions regimes even if other participants are not. The scope of US sanctions
is also so wide that it can at times catch businesses with no US link, especially if
their actions cause a US entity to breach US sanctions.
It is outside the scope of this chapter to discuss sanctions imposed by
jurisdictions outside the UK, but firms must be aware of those relevant to them
and factor into their compliance programmes the requirements and risks these
sanctions present. The many, large fines the US enforcement authorities have
imposed on international banks for breach of US sanctions and anti-money
laundering laws (most recently BNP Paribas) underline the importance of taking
a holistic jurisdictional approach to risk management and compliance.

What do UK financial sanctions restrict?

The existence of a sanctions regime does not of itself prevent all dealings with
any person in, or related to, the particular jurisdiction or regime. Instead, each
regime will bar all, or specific, dealings with any individual or entity that is a
Designated Person or is owned by a Designated Person, or that will be for the
benefit of a Designated Person.
Each financial sanctions regime has its own scope. However, several
features are common to most regimes. The sanctions:

„ Apply to dealings with ‘Designated Persons’;

„
„ Apply to ‘funds’ which are, broadly, any financial asset or benefit. Not
„
just cash or payment instruments, but also letters of credit, export financing
instrument, bonds or other financial commitment and securities;

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„ Apply to ‘economic resources’ which are any assets which can be used to
„
get funds, goods, or services;
„ Cover both direct and indirect dealings; and
„
„ Cover actions taken deliberately to avoid sanctions.
„
There are several offences and obligations created by UK Statutory Instruments
for each regime. However, in general, under each instrument it is a criminal
offence for any UK national or UK incorporated body, or any other person in
the UK (a UK Person) to:

(a) Deal with funds or economic resources belonging to, or owned, held or
controlled by, a Designated Person;
(b) Make funds available, directly or indirectly, to a Designated Person;
(c) Make funds available to any person for the benefit of a Designated
Person. Funds are considered to be ‘made available’ for the benefit of
the designated person only if that person gets, or may get, a significant
financial benefit;
(d) Make economic resources available, directly or indirectly, to a Designated
Person;
(e) Make economic resources available to any person for the benefit of
a Designated Person. Economic resources are considered to be made
available for the benefit of a designated person only if that person gets, or
may get, a significant financial benefit;
(f) Intentionally engage in activities knowing the object or effect of them is
(whether directly or indirectly);
(i) to avoid the prohibitions in (a) to (e) above; or
(ii) to enable or facilitate the contravention of these prohibitions.

For offences (a) to (e), the offence is committed where the UK person knows, or
has reasonable cause to suspect, its actions will constitute the offence.
Any UK person who finds themselves in possession of funds or economic
resources held or controlled by a Designated Person must freeze them in an
appropriate bank account. Banks must notify Treasury of frozen funds they
receive. Any UK person wishing to deal with a Designated Person, or to
continue to deal with a person who has become a Designated Person, may
apply to Treasury for a licence to do so. Whether this licence will be granted
depends on a number of factors.
Banks also have a duty to report relevant information to Treasury and
respond to Treasury enquiries. Failing to do so, or misleading Treasury, is also a
criminal offence.

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As well as these general restrictions on dealings with Designated Persons

and persons related to them, there are further restrictions for some regimes,
notably the one for Iran. Although restrictions against Iran have been relaxed to
some extent, the UK government does not encourage trade with, or investment
in, Iran and has withdrawn commercial support for trade. It advises companies
that any trading with Iran is done at their own risk. Where banks choose to
trade with Iranian entities, they must be aware of the added restrictions that
sanctions impose on the Iranian banking sector specifically, and on any transfers
of money to or from Iranian persons.
In relation to Ukraine, the EU introduced separate sanctions that restrict
named state-owned Russian banks and their subsidiaries, and specified oil and
defence entities from accessing EU primary and secondary capital markets
or the loan markets. While these entities are not Designated Persons for the
purposes of the asset freeze, UK trade financiers must consider their position
under this separate regime also if doing business with any of these entities. US
law introduced similar, but not identical, restrictions.

What do UK trade sanctions restrict?

Arms embargoes are imposed by the UN or EU on ‘arms and related material’
(such as military ammunition, weapons, and goods). The UK typically interprets
this as covering all goods and technologies on the UK Military List. Goods
that are not specifically listed might also need a licence under the Military
End-Use Control. Controls on the supply of military items between another third
country and the sanctions target (trafficking and brokering) also apply. Certain
specific sanctions are imposed on dual-use goods such as petrochemicals or
telecommunications items.
It is a criminal offence to export, import, or trade in goods that are subject
to a sanctions and embargo regime or which are dual-use goods without a
specific licence from the ECO. The restrictions will extend to many financial
services entities that may provide funding or insurance in relation to the goods.
What licence is required depends on the goods, the jurisdictions in question,
and the role of the entity. The ECO provides guidance to exporters and other
firms on when a licence may be needed and what type of licence.6

Key practical issues: Financial sanctions

It can be difficult to assess whether UK financial sanctions bite where an entity
subject to UK sanctions, A, is contracting or dealing with a person B who is
not themselves a Designated Person, but who has a link by ownership with
Designated Person C. It is not safe to assume that if the contracting party is not
designated, then there is no problem. However, the link will not necessarily

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mean the transaction cannot proceed. It is necessary to assess whether the

nature of the link and of the contract mean there is a sanctions problem.
There are in fact several questions:

„ Would the benefits B would derive under the contract constitute ‘funds’ or
„
‘economic resources’?
„ If the answer to the above is ‘yes’, would the funds or economic resources
„
be made available to C?
„ What degree of ownership and control is necessary between B and C for
„
sanctions to bite on contracts with B?
„ If the necessary ownership and control is present, would C get a significant
„
financial benefit from using the funds or economic resources which A would
be ‘making available’?

Sometimes the answers to these questions will be obvious, but at other times the
firm will need to carry out significant due diligence to form its view.

Key practical issues: Trade sanctions

The main problem trade financiers face in complying with trade sanctions is in
the due diligence that is sometimes necessary to determine the possible and
intended purpose of goods that are the subject of the finance. In the absence
of clear guidance on the levels of expertise financiers are expected to have,
applying a risk-based approach becomes essential, yet sanctions legislation
does not expressly recognise such an approach.

Penalties
Each piece of sanctions legislation sets out the penalties for breach. In
principle, there are no defences. There is no regulatory guidance or procedural
requirements. On conviction a person will be liable to imprisonment (for periods
up to seven years depending on the offence) and/or a fine. A breach of a
sanction also carries personal liability for officers of the company, as well as
the company itself. So far, the UK authorities have not shown great appetite
for bringing sanctions prosecutions, and it is the US enforcement authorities
who have imposed high fines on many international banks for sanctions (and
sometimes also money laundering) offences.7

Role of the Financial Conduct Authority

In the UK, the more pressing fear for financially-regulated entities is the long arm
of the Financial Conduct Authority (FCA). Banks offering trade finance services
will fall within FCA’s regulatory remit (even though they will be prudentially
regulated by the Prudential Regulation Authority). Other firms may also,

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depending on the precise activities they carry out. Almost every firm involved in
the UK’s trade finance sector will fall within the Money Laundering Regulations
2007 (MLR) and will need to be registered with FCA for MLR supervision if they
are not authorised under the Financial Services and Markets Act 2000 (FSMA).
The FCA’s objectives under FSMA include integrity, of which taking
necessary action to prevent financial crime (including breach of sanctions
restrictions) is one. The FCA has taken enforcement action against companies
who have failed to put in place satisfactory systems and controls to prevent them
being used by sanctions targets. It usually takes action for breach of Principle 3
of its Principles for Business, which states: ‘A firm must take reasonable care to
organise and control its affairs responsibly and effectively, with adequate risk
management systems’. The rules in the senior management rules block of the
Handbook also impose high level requirements on firms in relation to financial
crime prevention. The FCA can also bring action for breach of the Money
Laundering Regulations 2007 and, so far, has done this once, when it fined RBS
for failure to have in place proper sanctions systems and controls – even though
there was no evidence the bank had done business with any sanctions target.
Enforcement action by the FCA is a concern because the FCA’s powers are
sweeping, ranging from a fine (which will match the severity of the conduct,
taking into account the financial position of the firm in question) to removal of a
firm’s authorisation. The FCA does not have to prove the firm has committed a
criminal offence – just that its systems and controls were not adequate. Its other
powers include taking the same range of actions against individuals within the
firm who are approved persons and whose jobs meant they were complicit
in, or should have spotted or acted to prevent, the conduct in question, and
appointing third party experts to review and suggest improvements to a firm’s
procedures, at the firm’s cost. So action by FCA creates both business, financial,
and reputational concerns.
Firms should take careful note of both the sanctions guidance that forms part
of the Joint Money Laundering Steering Group (JMLSG) Guidance notes8 and
also, in particular, the FCA’s Financial Crime Guide (FC).9 The FC is not binding
guidance, but the FCA intends firms to use it in a proportionate way, and build
its recommendations into their risk-based approach to compliance. It gives
examples of good and poor practice which may be of help to firms, and backs
up its guidance with thematic reports.10
While no chapter of the FC should be read in a vacuum, Chapter 7 of the
guide is devoted to sanctions and asset freezes. It provides guidance to firms on:

„ Governance;
„
„ Risk assessment;
„
„ Screening against customer lists;
„
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„ Matches and escalation; and

„
„ Weapons proliferation.
„
The FCA and its predecessor have also carried out both general and trade-
finance specific reviews into how banks comply with their sanctions obligations,
including a 2013 review on trade finance business.11 Firms should not ignore
FCA guidance and should be prepared to justify instances where their policies
and procedures depart from it.

Sanctions clauses in trade finance related contracts

Sanctions operate as a matter of law, irrespective of the terms of a contract.
So, if sanctions prohibit taking certain actions, then the contract cannot be
honoured. In the trade finance context this may lead, for example, to a payment
not being made under a guarantee or letter of credit.
Financiers have sometimes included what have become known as ‘sanctions
clauses’ in their transaction documents. Mostly this is because they are: (a)
concerned about their position; and (b) it is a means of telling counterparties
that they are subject to sanctions laws. However, it is also sometimes used
as a method to attempt to get counterparties to comply with sanctions laws
that would not otherwise apply to them. Sometimes these clauses can cause
problems, not least because it can (especially for Cuban sanctions) be an
offence for an EU entity to agree to comply with US sanctions where the EU
entity is not legally obliged to do so.
The International Chamber of Commerce (ICC) has issued guidance on
this point.12 The guidance states that informative clauses – merely stating the
bank’s obligation to adhere to applicable laws on sanctions – are acceptable.
However, it says parties must avoid including clauses which go beyond the
scope of the applicable laws and regulation. The danger of doing so is that
financiers may create a discretionary obligation in a contract which should be
irrevocable.

Checklist for trade finance firms

Clearly each business has its own business model. But key to any sanctions
compliance and protection programme must be:

„ Appreciation from the board of the importance of sanctions compliance and

„
allocation of appropriate resources, both human and financial;
„ Assessment of the areas of business that present the most risk from sanctions
„
restrictions – products, geographies, and customers/counterparties;
„ Assessment of applicable sanctions laws;
„
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Chapter 6: Sanctions and trade finance

„ Appropriate screening of applicable sanctions lists, with proper calibration

„
of automated programmes, and an appropriate amount of human
involvement and an articulated policy for assessing and reporting possible
matches;
„ Training programmes, policies and procedures to report matches, licensing
„
requests, and assess whether obligations arise under any other financial
crime prevention laws; and
„ Comprehensive but proportionate clauses in contracts.
„
There is no one-size-fits-all sanctions policy for financial institutions, but any
programme should include at least these elements. It is also critical to have
an overall financial crime compliance policy, to ensure the right matters are
reported to the right authorities. For example, identifying a sanctions target that
a firm must report to Treasury may (but will not necessarily) also cause the firm
to form a suspicion of money laundering, which it may need to report to the
National Crime Agency (NCA).

References
1. An example of this is the round of EU and US sanctions imposed on Russia in
response to the Ukraine crisis. See ‘Latest US/EU sanctions puts Russian energy
exploration and lending in deep freeze’, TFR, September 2014, at: www.tfreview.
com/node/10911.
2. See: www.gov.uk/government/collections/financial-sanctions-regime-specific-
consolidated-lists-and-releases.
3. See: www.gov.uk/government/publications/financial-sanctions-consolidated-list-of-
targets.
4. HM Treasury issued general guidance for exporters following the 12 September
sanctions here: www.gov.uk/government/news/doing-business-in-russia-and-ukraine-
sanctions-latest.
5. The resource centre, which includes tools to search OFAC Specially Designated
Nationals, Blocked Persons, and Sanctions lists, can be found at: www.treasury.gov/
resource-center/sanctions/Pages/default.aspx.
6. An example of the ECO’s guidance on Russian sanctions can be found at: http://
blogs.bis.gov.uk/exportcontrol/uncategorized/notice-to-exporters-201422-new-eu-
sanctions-against-russia/.
7. One example being the US$8.97bn fine imposed on BNP Paribas in respect of
Sudanese oil finance in July 2014.
8. See: www.jmlsg.org.uk/.
9. See: http://fshandbook.info/FS/html/FCA/FC.
10. See: www.fca.org.uk/about/what/protecting/financial-crime. This is the FCA’s
‘Fighting financial crime’ which contains links through to the thematic reviews

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(including the one the FCA did on trade finance) and the ‘Guide for firms’ on
financial crime.
11. For the FCA’s current position on KYC see ‘FCA financial crime risks final guidance
softens KYC position’, TFR, July 2014, at: www.tfreview.com/node/10660.
12. Published in August 2014 at www.iccwbo.org/Advocacy-Codes-and-Rules/
Document-centre/2014/Guidance-Paper-on-the-use-of-Sanctions-Clauses-2014/.

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