OPTIMIZE RISK RETURN WITH TRADE INTELLIGENCE. REDUCE TRADE LOSSES BY DETECTING COLLUSION BETWEEN COUNTERPARTIES AND THEIR SUPPLIERS.

1 EXECUTIVE SUMMARY

Despite throwing armies of compliance personnel at mountains As early as 2006, the Financial Action Task Force (FATF) noted of trade documents, banks can remain vulnerable to significant that “the international trade system is clearly subject to a operational losses and potentially crippling regulatory fines. wide range of risks and vulnerabilities that can be exploited Banks are able to detect collusion within networks of complex by criminal organizations and terrorist financiers. In part, corporate structures and supply chains with exceptional these arise from the enormous volume of trade flows, which accuracy, and without reliance on massive amounts of obscures individual transactions; the complexities associated notoriously poor quality trade data. As trade continues to with the use of multiple foreign exchange transactions and expand into new and more profitable markets with new diverse trade financing arrangements; the commingling of customers, risks increase. Banks will optimize their profits legitimate and illicit funds; and the limited resources that when they can effectively analyze the risks of financial crime, most customs agencies have available to detect suspicious minimize their exposure to losses, and intelligently apply risk trade transactions.”1 The Wolfsberg Group of eleven global weighting to their trade portfolios for maximum returns. banks declared that “increasingly regulators and international bodies view trade finance as a ‘higher risk’ area of business for , terrorist financing and, more recently, for EXPANDING MARKETS, transactions related to potential breach of international and national sanctions, including the proliferation of WMD.”2 INCREASING RISKS

Counterfeiting in trade is worth approximately USD $600 billion every year accounting for 5-7% of world trade, according to “Counterfeiting in trade is worth the Counterfeiting Intelligence Bureau of the International Chamber of Commerce Commercial Crime Services (https:// approximately USD $600 billion icc-ccs.org/). Criminal organizations are circumventing existing every year accounting for 5-7% regulatory controls with ease, leaving banks vulnerable to trade-based money laundering, terrorist financing, fraud, of world trade, according to credit risk and tax evasion. These dangers are exacerbated the Counterfeiting Intelligence for banks seeking profits away from the saturated investment grade corporate markets by financing small and medium-sized Bureau of the International enterprises (SMEs) and expanding into new geographies. Chamber of Commerce Increasing margins and volumes come at a price however, and these banks will encounter a substantial increase in risk Commercial Crime Services.” and potential losses. Varying legal and accounting standards not only increase onboarding costs in new countries, but provide more camouflage for criminals posing as genuine businesses. SMEs tend to offer substantially less public information, financial history, and third party analysis than their large corporate counterparts. This opaque environment provides criminals with a tantalizing opportunity to access financing while hiding amongst legitimate firms. Recent events such as fraudulent Chinese metal financing known as the ‘Qingdao scandal’ have brought these issues into sharp focus and alerted banks to the huge potential costs of conducting business without developing more robust financial crime analytics.

1Trade Based Money Laundering 23 June 2006 Financial Action Task Force / Groupe d'action financière http://www.fatf-gafi.org/media/fatf/documents/reports/ Trade%20Based%20Money%20Laundering.pdf

2The Wolfsberg Trade Finance Principles (2011) The Wolfsberg Group (, Bank of Tokyo-Mitsubishi UFJ, , , , , , HSBC, J.P. Morgan Chase, Société Générale, UBS) http://www.wolfsberg-principles.com/pdf/standards/Wolfsberg_Trade_Principles_Paper_II_(2011). pdf

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THE CURRENT CHALLENGES

Data quality is a key problem for banks’ compliance operations today. Most banks have built their existing detection systems based on the five FATF scenarios outlined in the Wolfsberg Trade Principles Paper II (2011). This traditional approach focuses on identifying falsified information through comparison of various paper and scanned documents and logical deductions (e.g. a shipment route does not match the nature of the transaction). Most banks struggle with the burden of compliance due to poor quality in the vast amounts of detailed information required for traditional transaction monitoring, as outlined in figure 1.

While systems consistently capture good quality data regarding the primary parameters of a deal (like the deal value, and names of the buyer and seller firms), more specific fields are frequently unavailable or inconsistently recorded.

FATF Typologies Data Points Required Over & Under Invoicing • Good type • Unit price • Number of Units

Multiple Invoicing Majority of the data points on an invoice typically including details of trade loan applications from multiple banks

Short & Over Shipping • Invoice goods type • Invoice unit price • Invoice number of units • Shipping goods type • Shipping unit price • Shipping number of units

Deliberate Obfuscation of Goods Type Accurate and detailed population of all goods details on all transactions to effectively flag anomalies (vague or missing descriptions of goods are typical in this scenario)

Phantom Shipping • Source port • Destination port • Carrier • Departure date • Arrival date • Feed from shipping data provider (e.g. Lloyds, IHS) • Transhipment details • Container numbers • Good details

Figure 1: Traditional compliance data requirements for typologies outlined in the Wolfsberg Trade Principles Paper II of 2011

2 3 Even in the unusual cases that data is of good quality, banks generally very experienced,” but warned that “trade processing face a shortage of skilled personnel to effectively assess the staff in most banks made inadequate use of customer due information. Given the volumes in trade, extremely large teams diligence information gathered by relationship managers or of personnel would be required to manually evaluate vast trade sales teams.”3 amounts of paperwork using specialist skills and knowledge (what’s a reasonable price for a ball-point pen or sunglasses More sophisticated criminal groups target the massive or a widget?). Banks require skills which are impossible volumes offered by international trade and receivables finance to consistently acquire or scale to the growth of the trade by identifying ‘red flags’ published by regulators and designing business. These barriers to automation lead many banks to malicious strategies to consistently bypass these controls. randomly sample documents, leaving them vulnerable to risks Whether we are looking for trade-based money laundering, of immeasurable losses and fines. fraud, credit risk or tax evasion, the key to uncovering these risks is identifying collusion between the participants. A genuine buyer will not buy goods which are heavily overpriced, and nor will a genuine supplier sell goods well below market THE REGULATORS’ VIEW price. Collusion between the buyer and the supplier is the key to successful financial crime and exploiting banks, as The United Kingdom's Financial Conduct Authority (FCA) demonstrated by the scenarios in figure 2. published a thematic review in July 2013 entitled Banks’ control of financial crime risks in trade finance which found that “banks generally need to improve management information so that senior management are aware of how financial crime risks are evolving in this type of business,” concluding that “many banks relied heavily on the fact that trade processing staff were

Collusion Required? FATF Typologies Fraud/Credit Motive Money Laundering Motive

Over & Under Invoicing Always Always

Multiple Invoicing Often Often

Short & Over Shipping Always Always

Deliberate Obfuscation of Not Applicable Not Applicable Goods Type

Phantom Shipping Always Always

Figure 2: Role of collusion in detecting fraud and money laundering typologies

3Thematic Review TR13/3 Banks’ control of financial crime risks in trade finance July 2013 Financial Conduct Authority http://www.fca.org.uk/static/documents/ thematic-reviews/tr-13-03.pdf

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The Asia Pacific Group (APG) produced a typology report on To effectively identify collusion, sophisticated network analysis money laundering in trade which defines “red flags with regard techniques can be used to visualize a company within their to corporate structures” warning banks to monitor any trade corporate group and within the supply chain in which they which “reveals links between representatives of companies operate. By aggregating company and individual details exchanging goods i.e. same owners or management. TBML together with transactional activity, banks can identify a wide [Trade Based Money Laundering] requires collusion between range of collusive behaviors: from a buyer and supplier at the traders at both ends of the import/export chain.” The APG same operating address, to complex networks of subsidiaries report provides several insightful case studies including one involved in a wide range of criminal activity. Furthermore, based on information from Macao, China noting that “the banks can identify round-tripping of funds and complex layering veneer of international trade was created to conceal collusion behaviors involving numerous companies and individuals by among related companies located in different jurisdictions. The analyzing transactional activity at a network level. A relatively trade finance mechanism of raising bank loans (trade credit) small and well-trained team of specialists can then monitor against fake invoices could occur due to limitations to verify the and investigate collusion across large trade finance portfolios credibility of overseas suppliers.”4 using technology which networks the data and automatically calculates and prioritizes alerts.

DETECTING COLLUSION Identifying collusion is the key to succeseful mitigation “By aggregating company and of financial crime risk, and data quality is not a hurdle to successful detection of collusion in trade finance. While the individual details together with compliance data requirements are onerous for traditional transactional activity, banks can transaction monitoring, collusion can be identified from a few simple data points. Network analytics to detect collusion identify a wide range of collusive requires only core deal information: the customer, amount, behaviors ... ” date, usance, and the counterparty’s name, country and bank. This level of data is consistently captured today in operational trade systems for business purposes, and can be easily and consistently leveraged to detect collusion and investigate financial crime. THE OUTLOOK Banks can enrich customer counterparty data with external The business of trade finance and the technology that it company sources and use links to external watchlists. uses are increasing in complexity; it is within this complex Matching counterparties to names on lists can safeguard web of networks that intelligent criminal organizations can against individuals or firms with links to known terrorist and best camouflage their collusive misdeeds. The Bank for criminal organizations. However, it is extremely difficult to International Settlement recently stated that “Global banks clarify the actual identity of a bank’s deal participants within see supply chain finance, under which banks manage the complex corporate structures and behind deliberate attempts collection and funding of receivables within a network of firms, to camouflage identities of company directors and ultimate as an important new area of activity, and focal point of current beneficial owners. This can be achieved though, by creating a competition.”5 As various areas of the business grow in size single entity view by cross analyzing individual and company and complexity, enticing opportunities increase for criminals. names against known data such as company registries, credit data, and a firm’s online presence.

4APG Typology Report on Trade Based Money Laundering Trade 20 July 2012 Asia Pacific Group on Money Laundering http://www.fatf-gafi.org/media/fatf/documents/ reports/Trade_Based_ML_APGReport.pdf

5Trade finance: developments and issues January 2014 Bank for International Settlements CGFS Paper No 50 (submitted by a Study Group established by the Committee on the Global Financial System chaired by John J Clark, Federal Reserve Bank of New York) http://www.bis.org/publ/cgfs50.pdf

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The FCA’s Director of Enforcement and Financial Crime Tracey McDermott recently stated “banks’ ‘trade finance’ businesses remained particularly vulnerable to abuse by criminal and terrorists and that in some cases the shipments being funded by lenders were just ‘fresh air’” following their 2013 review of 17 financial institutions. “Ms. McDermott said the FCA was ‘considering whether further regulatory action was necessary against some of the banks it had studied, but did not comment on what specific sanctions it could impose.”6

As the industry continues to encourage more prolific use of electronic documentation, improved technology from multi-bank platforms, to bank payment obligations will continue to fuel banks’ expansion into new markets with new clients. Criminals, of course, will use technology to improve their ability to build clandestine networks to disguise illegal transactions, leaving detection of collusion as the most vital tool in the fight against financial crime in trade finance. Banks will profit only when then can accurately detect financial crime, price the risk and onboard the business which will pay them a reasonable return for that risk, using intelligent analytics to avoid criminal networks and maximize returns.

FRE IGHT FORWARDER VOYAGE NO . 164

REGISTRY BANK 3 trades with COMPANY B COMPANY B COMPANY B DIRECTOR TRADE-IMPORT BANK OWNER [51%]

CUSTOMER A

BANK OWNER [87%]

FINANCIAL REGISTRY

COMPANY C COMPANY C transactions between COMPANY A and COMPANY C

Figure 3: NetReveal visualization of a buyer’s corporate network and its supply chain

Author Alex Mettrick works with the NetReveal Corporate Banking solutions in BAE Systems Applied Intelligence. To find out more about us visit: http://www.baesystems.com/tradefinance

6Major banks still vulnerable to money laundering, says top regulator 01 July 2013 Harry Wilson, The Telegraph Banking Editor http://www.telegraph.co.uk/finance/ newsbysector/banksandfinance/10153728/Major-banks-still-vulnerable-to-money-laundering-says-top-regulator.html

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7 ABOUT US

BAE Systems Applied Intelligence delivers solutions which BAE Systems Applied Intelligence USA help our clients to protect and enhance their critical assets 265 Franklin Street in the connected world. Leading enterprises and government Boston departments use our solutions to protect and enhance MA 02110 their physical infrastructure, nations and people, mission- USA critical systems, valuable intellectual property, corporate T: +1 (617) 737 4170 information, reputation and customer relationships, and competitive advantage and financial success. Global Headquarters BAE Systems Applied Intelligence We operate in three key domains of expertise: Surrey Research Park Guildford • Cyber Security – helping our clients across the complete Surrey GU2 7RQ cyber security risk lifecycle United Kingdom T: +44 (0) 1483 816000 • Financial Crime – identifying, combating and preventing financial threats, risk, loss or penalties BAE Systems Applied Intelligence Australia Level 1220 • Communications Intelligence – providing sophisticated Bridge Street network intelligence, protection and controls Sydney NSW 2000 Australia We enable organizations to be more agile, increase trust and T: +61 (2) 9255 0400 operate more confidently. Our solutions help to strengthen national security and resilience, for a safer world. They BAE Systems Applied Intelligence Dubai enable enterprises to manage their business risks, optimize Dubai Internet City their operations and comply with regulatory obligations. Building 17 Office Ground Floor 53 We are part of BAE Systems, a global defence, aerospace PO Box 500523 and security company delivering a wide range of products Dubai and services including advanced electronics, security and T: +971 4369 4369 information technology solutions. BAE Systems Applied Intelligence Malaysia Level 28 Menara Binjai 2 Jalan Binjai, 50450 Kuala Lumpur T: +60 3 2191 3000

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