Sanctions Risk in Supply Chain Financing

Supply Chain Financing in South East Asia continues to grow significantly, off the back of increased trade activities in the region. Based on the World Trade Organization statistics, total merchandise trade (imports, exports and re-exports) between the ASEAN nations and the rest of the world increased by 41% from USD 753 billion to $2.4 trillion between 2001 and 2010 (1) . This significant increase in trade volume provides greater opportunity for financial institutions to engage in financing trade deals, with many international banks establishing branches in South East Asian countries. There is also increased opportunity to engage in trade based money laundering activities as a result. With regulatory screening requirements established by their home countries, capital used to finance these activities are at risk of being frozen if any suspicious cargo is detected.

The UK Financial Conduct Authority (FCA) recognized that the increase in trade volume increased this potential for money laundering. In July of 2013 a fairly sobering report was issued on the state of bank’s control of financial risks related to Trade Finance.(2) They met with 17 major UK based and branches of foreign banks, including Asian banks and observed the following: “Majority of banks….are not taking adequate measures to mitigate the risk of money laundering and terrorist financing in their trade finance business.” While the report was UK based, many Asian banks took note of the findings and the potential regulatory enforcement consequences that come along with failure to comply with Anti Money Laundering regulations. It is important to understand the link between Trade Finance and potential money laundering. Goods shipped between countries are typically financed by banks with Letters of Credit (L/C). Money can be laundered through inaccurate representation of goods on these L/Cs; misrepresentation of the true value of the goods shipped; shipping prohibited or dual use goods; unloading of goods at sanctioned ports of calls – all activities that allow integration of illicit funds into the legitimate financial system.

A trade based money laundering identification process needs to account for these different scenarios. Recent market activity has highlights the need for identifying prohibited or dual use goods. Certain goods can be used for dual purposes and depending on how used or where shipped can be classified as a prohibited good. Graphite is a fairly common industrial commodity with many uses, such as automotive parts. Graphite is also a commodity used to moderate nuclear reactions. This dual use good when shipped to a sanctioned country like Iran or North Korea becomes a prohibited good. Graphite appears as listings in the EU Dual Use goods list. In fact there are over 260 pages of goods listed in this report that are deemed dual use in nature.

Many countries now see the shipment of dual use goods as a money laundering concern or potential risk for the creation of weapons of mass destruction. . Sanctions by US and European regulatory authorities on Iran are well known. China recently published a 236 page list of “dual-use” equipment, chemicals and technologies that it said could be used to build “weapons of mass destruction” in North Korea. The items on the list could be used for both civilian and military purposes and include nickel powder, radium, flash X-ray generators and microwave antennas to name a few. China is now taking a firm stance against North Korea which now requires Chinese and other exporters using Chinese ports or Chinese banks to screen against this list and flag potential dual use goods.(3) Failure to comply will result in freezing of the goods mid shipment, confiscation by the authorities or heavy fines and potential jail terms.

Given the case for the increased need to screen dual use goods, banks have to review their trade based money laundering policy. Banks traditionally only checked that the documentation was in order – they would ensure the Uniform Customs and Practice (UCP) rules were followed and not the goods themselves. If the bank uses the SWIFT network, they may also screen their MT700s for sanctioned entities. This however is still insufficient and exposes the bank to many risks. There is potential for unusual or inconsistent shipments. An exporter of toys inexplicably begins shipping raw materials; there may be an unusual number of intermediaries or changes in party names; there may be changes to payments to third parties or location mid shipment or there may be inconsistent quantity of goods compared with containers used. All these scenarios are red flags that need to be reviewed. Developing the required policy and training procedures to identify these scenarios will be necessary to follow a best practice trade based money laundering policy. Due diligence is ultimately required to be effective.

How can financial institutions mitigate these risks? The FCA report identifies good practices to adopt:
1) Governance and management information: Roles and responsibilities for managing financial crime risk in trade finance are clear and documented.
2) Conduct a Risk assessment: Banks should complete a financial crime risk assessment for their trade finance business that gives appropriate weight to money laundering risks as well as sanctions risks.
3) Developing the appropriate policies and procedures: Bank staff should consider financial crime risks specific to trade finance transactions and identify the customers and transactions that present the highest risks at various stages of the transaction.
4) Ensuring proper due diligence: The bank’s procedures are clear on what checks are necessary and in what circumstances for non-client beneficiaries or recipients of a letter of credit.
5) Training and awareness: Provide training around trade specific money laundering, sanctions and terrorist financing risks.
6) AML procedures: A formal consideration of money laundering risk is written into the operating procedures governing LCs. The money laundering risk in each transaction is considered and evidence of the assessment made is kept. Detailed guidance is available for relevant staff on what constitutes a potentially suspicious transaction, including indicative lists of red flags. ‘Level 1’ trade processors are employed with good knowledge of international trade.

Trade based money laundering presents a new risk to supply chain financing activities. It is important to recognize that the increased volume of trade comes along with increased risk of money laundering. While the intent of regulators to manage these risks are clear, there continue to be operational issues that challenge the effective implementation of these policies in financial organisations. However, today’s geopolitical reality requires preventative measures to be implemented ensuring the booming trade finance activities in Asia continue to grow and prosper.


1) World Trade Organization statistics