Finding the Achilles' heel of

trade-based money laundering

Executive Summary

With trade-based money laundering (TBML) on the rise, banks need to sit up and take notice. That might sound simple enough, but tackling TBML is an inordinately difficult task. In this Banking Insights report, Jon Draper explains why that process has to begin with developing a clear understanding of why TBML matters. He also explores what’s stopping banks from making meaningful progress in their mission to confront it.

Data scientists are hot property. That’s not exclusive to the insurance world. But thanks to their ability to uncover all kinds of insight and combat fraud, they’re a particularly valuable asset to insurers.

In order for them to be as valuable as they can be, however, data scientists need to have the right tools and working relationships with the fraud team to turn that insight into something productive.

Trade Based Money Laundering:

the same, but different

If you thought the financial system was complex, with its vast range of accounts, instruments, transaction types and business structures, that’s nothing compared to the diversity of the global trade system. Its near-infinite array of trading opportunities across industries creates a huge variety and breadth of possible laundering typologies.

In many ways, TBML is similar to other types of money laundering. It essentially comprises the same three steps – placement, layering and integration. It’s so alike, in fact, that regulation doesn’t distinguish between TBML and broader money laundering. This has lulled many into thinking that there’s nothing significantly new about TBML – that it can be treated with existing money laundering controls.

But while trade-based money laundering is similar, it varies significantly from other money laundering in key areas. The placement, layering and integration of TBML happens in an entirely different system – trading products or services, rather than via financial services.

The challenge is magnified when you consider that over 80 per cent of global trade takes place without banks involved in financing.

Despite this, the financial services industry plays a unique role in dealing with money laundering. Sat at the heart of many transactions (both financial and trade-based), it’s the sector that’s most-heavily regulated for money laundering. And it has built up formidable capability and expertise to deal with traditional money laundering.

One more onerous obligation

Like your banking peers, you may be under increasing regulatory pressure to take a more active role in dealing with TBML. You’ll probably (understandably) feel that more AML responsibilities are the last thing you need.

But a better understanding and visibility of the trading activities of organised crime and terrorist groups has the potential to help banks, Law Enforcement Agencies and society. It empowers them to more effectively deal with TBML as well as traditional money laundering, fraud, sanctions, PEP-specific compliance and financial crime.

Attempting to address financial crime without improving visibility over trade activity leaves significant pieces of the puzzle missing – creating further effectiveness and efficiency challenges.

The tragedy of TBML

Trade-based money laundering is so hard to spot because it’s hidden in plain sight amongst legitimate economic activity. It often involves genuine trade and all the associated paperwork, with only the subtlest of clues hidden deep in the trade structure or trading histories to indicate suspicion. While an over-invoice or goods description discrepancy might seem innocent enough, TBML perpetuates harm to business, governments, society and individuals.

TBML enables organised criminals to make use of the funds generated by their crimes with a much lower risk of getting caught compared to traditional financial or cash laundering. Those proceeds are then reinvested into crime, funding and sustaining criminal and terrorist activity.

This disconnect between apparently profitable, victimless, allegedly-legitimate trade and extreme global harm means TBML is incredibly tough to tackle.

Three Parts to the Regulatory Riddle

You may reasonably wonder, if it’s such a menace, why are we still struggling to understand and detect criminal and terrorist abuse of the global trade system? We found three main reasons why this challenge has proved so difficult.

#1 – Regulatory focus
The focus of the AML regulatory environment is the reporting of transactions that are suspected to have an association with money laundering to law enforcement. Authorities can then investigate, disrupt and prosecute the criminals involved.

Money laundering is sometimes seen as a relatively low priority by resource stretched law enforcement, revenue, customs and border security staff since it doesn’t (on its own) cause harm. Government and law enforcement agencies need intelligence about criminals that will help bring them to justice, but that can be hard to find in amongst thousands of reports of suspect financial transactions.

Back to your day-to-day toil and – like your peers – you probably spend a hefty amount of time creating exacting reports of possible money laundering activity, including details of how it’s executed. Money laundering and criminal activity may be related, but with banks and government agencies working independently, any relationships between trades and crime would require substantial specialist resources to investigate fully.

The ultimate result of all this is a system where you and your peers spend billions of dollars each year producing SARs and yet the overwhelming majority don’t contribute to law enforcement activity.

#2 – Incentives to share
Banks currently prioritise, investigate and report on suspicious activity based purely on the transactions and information they see. But organised crime groups and terrorists are wise to this, and spread their activity across multiple banks and jurisdictions to avoid detection.

It is widely acknowledged that greater information sharing between banks could help to solve this, but there are challenges when it comes to privacy and data protection.

Vendors have proposed multiple technology solutions based on a range of Privacy-Enhancing Technologies (PET) such as homomorphic encryption and multiparty computation. This was the focus of a recent FCA TechSprint. We’ve found that the key issues preventing banks from adopting such solutions are less about technology and more about incentives.

Successful solutions need to be able to:

Develop a clear business case for industry participants (most likely banks) to fund the implementation and operation.
Develop, agree and implement standards for how information can be shared between banks in such a way that sufficient additional context is provided to fuel the business case while providing the required assurances around data security, privacy and commercial sensitivities. Once such standards are agreed, multiple PET options exist to smoothly implement the agreed constraints.
Gain the backing of industry regulators. Ideally the solution will align with suitable legislation such as section 314(b) of the US Patriot Act, which explicitly permits US banks to share information for the purposes of identifying and reporting activity associated with money laundering or terrorism.

#3 – Siloed government targets
Government agencies have targets to manage and reduce particular types of harm. But by seeking to hit their targets while minimising public spending they’ll sometimes misdiagnose criminal activity. Myopically focussed on their own targets, they’ll avoid digging deeper to look for the primary intent of the criminal activity itself.

For example, customs authorities might observe an incident involving the undervaluing of goods. They could regard it as an attempt to evade duties – which aligns with their primary responsibility. But while evasion of duties may be one effect of the under-valuation, criminals might also be trying to launder money through under-invoicing. That laundering could involve wider criminal activity such as trade in narcotics, arms, human trafficking, or corruption, as well as accompanying potential clues – such as the nature, scale, timing, location and entities involved.

Yet investigating these links requires substantial effort – including collaboration and data sharing across agencies and jurisdictions. In many cases, the effort would prove fruitless in terms of delivering significant new intelligence relevant to the customs remit. As a result, driven by its targets and with inevitably constrained budgets, the customs agency is effectively incentivised not to pursue such investigations.

How to solve a problem like TBML

There’s currently a significant blind spot for all three major stakeholder groups: banks, regulators and government agencies. That’s understandable, when the incentives are so complex and there are only very limited pockets of deep understanding around how TBML works and what an effective way to derive intelligence should look like. This makes it extremely hard to set targets that have a real impact on TBML.

New approaches are starting to drag this shady practice from the murky shadows into the light. In the BAE Systems Futures team, we’re currently exploring ways to help banking firms like yours along with law enforcement and government agencies to tackle the challenges that have held back progress on TBML.

Among the pioneering new solutions we’re evaluating is a platform that could create a clear incentive for banks to share analyses of TBML patterns to improve the efficiency and quality of SARs while retaining the necessary control over data. This could help with the challenge of creating incentives. If law enforcement and other government agencies were to join the platform with appropriate controls, it could assist in aligning regulatory focus as well.

We’re also exploring an approach to automate the investigation of potential leads across teams and even multiple organisations. That includes automated proportionate data sharing requests, before the resulting information packs are handed to human investigators, thus addressing siloed government targets.

These approaches are aimed at tackling some of the specific collaboration challenges that we learned about after conducting deep research into TBML. If these solutions are to work, it will be as much about engineering incentives as it will be about engineering technical solutions.

How we can help

Take part in the conversation

We’re evaluating the feasibility of an automated intelligence sharing platform that could be used by banks, law enforcement and other organisations to better understand and tackle TBML. To do this, we are soliciting insights and opinions from across the spectrum of industry, government and law enforcement. If you’d like to get involved, contact us at learn@baesystems.com.

Use Social Network Analytics to find indicators

The obfuscated nature of many TBML activities means banks are starved of intelligence – one reason why it’s a popular tactic for criminals. However, by using Social Network Analysis, it possible to visualise networks, understand transactions and establish links between individuals and organisations. Ask us about our SNA Visualiser.

Take an early step with customer education

It’s common for innocent banking customers to be caught up in TBML scams. The cost as an innocent bystander can be crippling, both financially and in terms of trust and reputation. Educating and preparing customers for to identify signs of Trade Based Money Laundering will help banks defend against benefits both customers and banks. Our consulting team can help at learn@baesystems.com

For more information go to:

baesystems.com/bankinginsights

Profile

Jonathan Draper

Product Strategist, Futures

at BAE Systems

Jonathan is Product Strategist in the Futures team at BAE Systems Applied Intelligence. The Futures programme is an internal startup incubator which invests in building and bringing to market new solutions for these emerging challenges.

Jon and his team research significant emerging challenges that face those who protect nations and citizens from crime, acts of terror and state conflict.

Jonathan has over 15 years’ experience helping government and large commercial organisations to manage security and risk in their digital and financial operations.