AML Transaction Monitoring Overview: Transaction Monitoring coverage over various banking products
Proper and efficient risk assessment process is key to preventing money laundering and terrorist financing. Legitimate products offered by financial institutions can be used by criminals to conceal illegal origins of funds or to finance terrorism, therefore it is crucial that a risk assessment is able to identify risks related to and specific to various products, their vulnerabilities and risks related to the type of market that they are directed to. In this paper we focus on two examples of high risk products: trade finance and real estate related products.
The FATF Recommendations outline the necessity for financial institutions to “identify and assess their money laundering and terrorist financing risks (for customers, countries or geographic areas, and products, services, transactions and delivery channels)”[1]. Risk assessments will be unique for each financial institution based on consideration of all of these categories.
FATF recommends shifting from a ‘check-box’ approach, currently often applied by financial institutions, to a risk based approach, which allows institutions to adopt a more flexible set of measures, which are commensurate to the nature of risk. High risk factors should be assessed during periodic KYC controls, but also during ongoing transaction monitoring procedures.
All banking products can be used by fraudsters to launder money, however some of them are more vulnerable than others. These products are usually marked as higher risk by the financial institutions for monitoring purposes, thereby subjecting customers utilizing these products to more frequent and thorough investigations. Such products are often associated with higher level of anonymity and involve high volume transactions or foreign currencies.
In this paper we focus on two examples of high risk products: trade finance and real estate related banking products.
There is no universal list of relevant factors since the characteristics of products and services vary between jurisdictions and financial institutions. When assessing the risk posed by a particular product, banks have to consider all surrounding factors such as relevant legislation and regulation as well as the unique risk factors in each jurisdiction.
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Trade finance based money laundering is an attractive method to launder money, finance terrorism or proliferation due to possibility of large cross-border transfers without raising suspicion. Moreover, paper-based processes of the global trade finance leave it open to abuses such as forging invoices or bills of lading used as proof of transactions that never took place. Trade transactions allow therefore to hide in plain sight, under the cover of legitimate trade, business through forged documentation thereby posing significant detection challenges (see also corporate banking differentiators).
The United Kingdom and Singapore can be considered one of major financial centres that could be severely affected by AML risks posed by trade finance activities due to the high volumes of trade transactions going through these areas. The Financial Conduct Authority (FCA) and Monetary Authority of Singapore (MAS), the UK and Singapore watchdogs respectively, issued guidelines for financial institutions to provide transparency and clear regulations for international trade. In these papers, they outline the best practices and recommendations on how to assess and monitor trade finance business as well as identify deficiencies in banks’ controls over trade finance.
Already in a 2013 paper on “Banks’ control of financial crime risks in trade finance”[2], the FCA indicated that banks “had generally developed effective controls to ensure they were not dealing with sanctioned individuals and entities. However, policies, procedures and controls to counter money laundering risk were generally weak and most banks had inadequate systems and controls over dual-use goods”.
”Dual-use goods include software, technology, documents, diagrams and other goods that can be used for civil and military purposes. They range from raw materials (eg, aluminium alloys) to components (eg, bearings) and complete systems, such as lasers.”[2]. Dual-use goods are considered high risk due to their potential use as a weapon - they “may have military applications, or may contribute to the proliferation of weapons of mass destruction”[3]. In order to identify dual use goods in transactions well trained staff with specialist knowledge is required.
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‘Trade Finance Principles’ issued by The Wolfsberg Group, ICC and BAFT in 2017[4] indicate that “the majority of world trade is carried out under ‘Open Account’ terms, whereby the buyer and seller agree to the terms of the contract and goods are delivered to the buyer followed by a clean or netting payment through the banking system”. In such situations, financial institutions have limited knowledge regarding the underlying reasons for the transfers, and can only perform standard sanctions screening and activity monitoring. However, if the bank is involved in other aspects of the transaction such as facilitating credit or providing other trade finance services, it might have a more thorough understanding of the customer business activity and rationale for payment (due to paper-based characteristic of trade finance, as previously mentioned).
MAS guidance highlights the importance of risk assessment and due diligence in anti money laundering and counter terrorism financing (AML/CTF) controls over trade finance. In order to effectively perform sanction controls and understand the nature of the trade, banks should obtain additional information from a client regarding the nature of cargo, vessels, trading partners and ports of landing. If a customer is reluctant to provide aforementioned information, it might be an indication of foul play, and banks should refrain from facilitating such transactions. When higher risk is noted, banks should verify the information provided through reliable sources to mitigate risks related to common methods of trade-based money laundering such as over/under invoicing, multiple invoicing, short/over shipping, obfuscation of the type of goods or phantom shipping, as outlined in FCA report[2].
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The FCA concludes that the majority of the banks they evaluated “are not taking adequate measure to mitigate the AML/CFT risks in their trade finance business”. In the same report, the FCA outlined the necessity of better training of staff and identification of higher risk customers.
MAS guidance provides a list of potential red flags associated with trade finance, which could be leveraged for an effective risk evaluation, such as transactions involving the use of repeatedly amended or frequently extended letters of credit without legitimate commercial reasons or series of cross border transactions in the same goods between related companies[5] and FATF designates some jurisdictions as ‘higher risk’ due to financial crime activities or export/import restrictions. Banks should flag any commodity shipment to, from or through such jurisdictions as potentially posing a higher risk.
Any discrepancies or missing information in available documentation, unusual business patterns that do not make economic sense, unusual destination or unusual shipment route can also be potential indicators of AML/CFT risks in trade finance.
Any indication of a third party involvement, same addresses, offshore locations, shell companies or complex ownership structures might be an attempt to hide true source or destination of shipment or payment. Banks should understand the nature of the underlying commodity and recognize dual-use goods. Such assessment requires expert knowledge which should be periodically provided in the form of internal training to all staff.
The FCA noted that most of the compliance staff and Money Laundering Reporting Officers (MLROs) they investigated had very limited understanding of the particular risks posed by trade finance. Banks lacked procedures and controls specific to trade finance, while they usually have very sophisticated control over sanction regimes.
Banks should make sure their compliance officers understand trade-based money laundering and can identify and assess all risks. Deploying an instant screening tool is necessary, but this must be backed up by manual checks performed by expert staff, who are able to properly assess the rationality of the observed activity. Enhanced Due Diligence should be applied when necessary, to have a full picture and understanding of the client’s business. Suspicious Activity Reports should be raised not only if sanction breach was identified, but also for any suspicious behavior concerning trading activity.
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Other products drawing increased attention from industry stakeholders are loans and mortgages because of its vulnerability to real estate related money laundering. In its ‘Advisory to Financial Institutions and Real Estate Firms and Professionals’, the Financial Crimes Enforcement Network (FinCen) classifies the real estate market as particularly attractive for money launderers due to the fact that the purchased property appreciates in value over the time, which protects the buyer from market instability and allows for the laundering of large amounts of the illicit funds with use of a limited number of transactions[6]. Additionally, money laundering through real estate is believed to require a relatively lower level of expertise and sophistication compared to other laundering methods[7].
The scale of the abuse of real estate market for the purposes of money laundering is represented by the findings of law enforcement agencies across the globe.
The problem is particularly accentuated in Australia - in its 2012-13 Annual Report, the Australian Federal Police (AFP) notes that it managed to restrain residential property valued at AUD5 million as part of an investigation in March 2013. In the course of the whole project, the AFP restrained an estimated AUD8.1 million in property[8][9].
In its study on money laundering through real estate, Australian Transaction Reports and Analysis Centre (AUSTRAC) - Australia's financial intelligence agency - lists the use of loans and mortgages among the techniques most commonly used for the purpose of abusing real estate sector for money laundering[10]. According to the study, loans and mortgages are used in order to obscure the source of illicit funds and to integrate them into assets of high value. AUSTRAC noted that such loans are taken out as a cover for laundering criminal proceeds and are commonly repaid with lump sums or with cash amounts just below the reporting threshold (so called “structured” cash amounts) in order to ensure anonymity of the depositor. This technique also allows for the commingling of illicit funds with funds of legitimized source.
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The increasing number of findings related to cases of money laundering through real estate have resulted in intensified efforts to introduce appropriate legislation that would enable law enforcement agencies and other stakeholders to prevent such abuses. Even though real estate agents are not themselves subject to the AML/CTF monitoring, certain transactions related to the real estate industry such as loans, deposits or withdrawals are usually routed through financial institutions which are subject to the AML/CTF regulations. through these financial institutions, authorities are granted some visibility into potential money laundering through real estate.
Keeping to the Australian example - a number of Australian states have introduced guidelines in order to further strengthen controls on the real estate industry. Already in October 2012, the Government of New South Wales issued guidelines on combating identity fraud and scams in the real estate industry[11]. The government of Western Australian has strengthened controls by introducing guidance notes that recommend increased scrutiny on verification of the real estate broker’s clients identity and their authority to give instructions when dealing with a particular property[12]. Moreover, the Australian Government is currently working on the second tranche of anti money laundering regulations which will relate to real estate agents[13], as recommended by FATF in its Mutual Evaluation Report of Australia[14].
Australia is not the only country in Asia Pacific targeting money laundering through real estate. For example, the Parliament in Singapore has recently passed the Developers (Anti-Money Laundering and Terrorism Financing) Bill[15]. The new law requires developers to conduct due diligence checks on their clients and apply appropriate record-keeping controls. The developers are also obliged to disclose requested information to law enforcement agencies in cases where investigations or criminal proceedings are launched.
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Appropriate AML regulations can assist in preventing and suppressing money laundering regardless of the banking products selected by the launderers. Often recent and upcoming legislative changes - as per presented examples for the Asia Pacific region - are targeted to address the identified vulnerabilities of specific banking products to money laundering.
Increasing the awareness of the necessity of the thorough understanding of the particular risks posed by various products, as well as extending of catalogue of businesses being subject to AML regulations and imposing more stringent requirements on the background checks of customers of these firms that need to be conducted allows the impacted businesses to develop a holistic understanding of the actions undertaken by their clients and to inform relevant authorities of specific activity that does not appear to be legitimate.
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Supporting team:
Magdalena Kowalska, Maciej Janas, Alicja Zysnarska, Joanna Borkowska, Aparna Chandrasekar and Jack Holder
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Footnotes:
[3] The European Commission (2018), “Dual-use Trade Controls”, Brussels, Belgium
[4] The Wolfsberg Group, ICC and BAFT (2017), “Trade Finance Principles”, United States
[7] AUSTRAC (2015), “Strategic Analysis Brief Money Laundering Through Real Estate”, Australia
[8] Australian Federal Police (2013), “Annual Report 2012-2013”, Australia
[9] In 2012-2013, the AFP was also involved in a “Project Wickenby” along with Australian Taxation Office (ATO), the Association of Corporate Counsel (ACC), Australian Securities and Investment Commission (ASIC), Australian Government Solicitor, Commonwealth Director of Public Prosecutions and Australian Transaction Reports and Analysis Centre (AUSTRAC) that targeted tax evasion schemes - Australian Federal Police (2013), “Annual Report 2012-2013”, Australia
[10] AUSTRAC (2015), “Money Laundering Through Real Estate”, Australia
Other bibliography:
ACCUITY (2018), “Navigating Trade Finance: How Should Banks Monitor Suspicious Shipping Activity?”
Oracle Corporation (2017), “Trade-Based Money Laundering: a Comprehensive Approach to Combat TBML”
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