Hidden Risks in Trade Finance: More Regulation, Costly Fines

Trade finance is key to maintaining a competitive and productive world economy. However, the increasing burden of regulatory compliance means, arguably, that banks and corporates face the most challenging time in the history of trade finance. While the cost of capital makes it increasingly difficult for banks to compete, investment in compliance tools can ultimately save them money. Being compliant is essential for staying in business, as the financial penalties for contravention grow more punitive. Trade finance is in danger of becoming a high-risk activity, as the complexity of transactions and the huge volume of trade flows provide an attractive backdrop for criminal activity.

The Pressure on Business Processes

Regulatory demand for compliance places pressure on business processes. This is particularly difficult in trade finance, due to the need to comply with various regulations imposed by different jurisdictions. The Know Your Customer (KYC) process and regulation to enforce embargoes continue to place a heavy load on trade bankers.

Until fairly recently, compliance in trade finance was limited to the examination of documents. Nowadays, added to this is extensive screening – against multiple country lists – of numerous data elements embedded in ancillary documents, regardless of their role in the letter of credit (LC) and international guarantee. The traditional view that the main risk within trade finance is one of fraud has been superseded by a modern three-part categorisation of risk – namely embargoes; terrorist financing (including fraud); and sanctions/proliferation financing.

Dual-use Goods

In addition to regulators, the inter-governmental Financial Action Task Force (FATF) set up in 1989, the Wolfsberg Group – an anti-money laundering (AML) initiative set up by major international private banks – and the Joint Money Laundering Steering Group (JMLSG) have all drawn attention to the potential misuse of international trade finance, as a means by which criminal organisations and terrorist financiers can disguise the movement of money. In addition the European Commission (EC) has set out new policies to adapt export controls; for example over dual-use items, which represent a significant portion of EU trade with strategic partners.

It is a cause for concern that systems and controls over dual-use goods are inadequate at most banks, which risk discovering that they have not taken adequate measures to mitigate the risk of embargoes enforcement and terrorist financing in their trade finance business. There is significant pressure on banks and financial service organisations such as SWIFT to align and comply with an array of restrictions, which affect banking, shipping, insurance, ports, goods, commodities and raw material transactions. Already, in 2012, EU regulation required SWIFT to withdraw services to Iranian banks, which were subject to EU sanctions. Similar measures may soon be brought into force elsewhere.

What are the Challenges?

Trade finance can be used to hide the illegal movement of funds; for example by misrepresenting the price, quality or quantity of goods, or even faking their existence. It is essential that all banks involved in the business of trade finance deploy adequate systems and controls to prevent breaches from taking place. To survive in this fragile environment, banks must find a way to assemble the various pieces of the jigsaw by making use of streamlined, harmonised processes and smarter application of technology; for example by screening all fields in a SWIFT MT700/760 series message at various stages in the life of an LC and international guarantee, as well as vetting all incoming or outgoing payments for sanctions purposes.

Sanctions have now become a political weapon in foreign policy, leading to trade finance business coming under increased pressure from increasingly stringent compliance and regulatory requirements. Both financial institutions (FIs) and corporates must ensure they have the necessary solutions and processes to enforce embargoes, whether they are imposed on countries, FIs or goods. Sanctions are an integral part of foreign policy and as regulations tighten, countries are moving towards a zero tolerance policy for FIs that contravene them.

Compliance is not as easy as it might appear. The challenges are many and apply not only to banks, also extending to:

  • Detecting vessels flying under a flag of a country under strict embargo.
  • Ensuring that the ports of departure, transit and arrival are not in a country under embargo.
  • Corporates willing to trace the origin of their products to: (1) Enforce embargoes on countries, (2) Protect image and reputation by ensuring that their suppliers and co-contractors comply with ethics policies; for example, that they are not involved in child labour or sub-standard working conditions.
  • Corporates prohibited from importing and exporting goods subject to embargo. For example, they may be used as a political weapon to ensure that goods listed as hi-tech and/or highly strategic are not exported to specific countries

Violations of trade embargoes and trade sanctions are punishable by imprisonment and high fines. Most of the multi-million dollar penalties recently levied on several banks were linked to financing trade with countries under embargo.

Filter and Control

Fundamental to addressing the real and present challenge of compliance, is the ability to gain a consistent, centralised and flexible approach across the trade business. This involves both responding to changes and also rolling-out regional variations, rules and screening workflows within a highly auditable and flexible technology framework across global trade finance operations. To have adequate systems and controls that prevent breaches demands the ability to gain insight at every stage of a trade finance instrument’s lifecycle. It also requires being able to run up-to-date filtering and sanctions screening on incoming and outgoing payments. This involves more dynamic screening that can be integrated at any point of a trade transaction.

Combining the expertise of best-in-class trade finance platform providers with well-established screening and compliance solutions can provide a powerful way to solve the complexities of compliance in trade finance, bringing the consistency, completeness and control needed to ensure the bad guys don’t impact your business.


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