I am high risk!
These days I seem to stumble into various compliance issues wherever I turn. It is like it has all exploded – it is in everything – it is everywhere.
It actually makes me a bit grumpy. Not that the talk is about compliance issues (that is actually an interesting and challenging topic) – but the fact that the discussions around it seems to be totally “locked” – it is like everybody is saying the same thing over and over again (regardless if it is true) – and only rarely I find any structured approach to the issue.
So for example when the talk hits compliance – and it is related to the trade finance products – one of the first comments you will hear is that “trade finance is high risk” …. When I ask why trade finance is high risk, I am told that it is because of the complex nature of the products and the exotic markets and countries involved in the trade finance transactions.
I have so many comments to this statement I am not even sure where I shall end and begin. But let me try to touch upon some of the main points:
I guess it is fair to say that the trade finance products are “complex” to the people that do not know them. But for the people working with trade finance they are not complex. There may well be single transactions with a complex structure.
I argue that the trade finance products are not as such complex. They are like everything else. If you know it: Piece of cake! If not … piece of complex cake ….
Exotic markets? I guess that depend on how you define an “exotic” market or country. It is fair to say that trade finance is normally used when the counterpart is in a market far away or different from your own. I.e. you want to migrate your counterparty risk.
What is important however is that the products that trade finance is compared to, also has no limitation in terms of market. One can make a clean payment from basically everywhere to basically everywhere.
So the fair statement is that SOME trade finance transactions involve a country that may be defined as “high risk” – for example based on the “Corruption Perceptions Index 2013” (http://cpi.transparency.org/cpi2013/results/)
But on the other hand, so does SOME clean payments!
Then comes the statement of trade finance being “high risk” in terms of commercial crime. This seems to be a well-accepted fact! However I still have not seen any evidence supporting this fact. What I have seen for example is the statistics from the ICC Trade Register. From this you can – as an example – see that the transaction default rate for confirmed export LCs is 0,016% - indicating that it is NOT high risk confirming LCs. The same figure for issuing LCs is 0,020%. I.e. same level.
I know of course that the data in the ICC Trade Register is not directly aimed against commercial crime risk within trade finance. However – it does give an indication of a very LOW RISK product area.
(More information on the ICC Trade Register here: http://www.iccwbo.org/Products-and-Services/Trade-facilitation/ICC-Trade-Register/)
Then of course the counter argument is that there is an AML and CTF risk – i.e. the risk of trade finance products being used for illegal purposes – like laundering money. These cases may never be detected because no one within the trade finance transaction looses money.
That of course is a fair argument – but it is equally fair if applied to the cash management products. Here you can actually argue that the AML/CTF risk in terms of trade finance products is lower than the cash management products. Let me elaborate:
Within trade finance you normally have a rather good overview of the transaction as a whole. For example the issuing bank have made their customer due diligence, they will have the LC application – outlining the transaction (including counterpart, goods and other details of the transaction). Once the documents are presented the bank will have the full documentation of the transaction; i.e. have the possibility to check against red flags, sanction lists etc.
Taking the same example on a clean payment, what the bank will see is the party sending the money, the party to receive it as well as the amount. In other words – the bank will not see the underlying transaction, and have very little chance of detecting foul play.
The argument is NOT that since you see the trade documentation in trade finance transactions there is NO risk! Of course there is a risk – the point is that it is NOT correct to argue that the risk increases because you actually see the documentation. Logically it may be the other way around.
One may even question how suitable the trade finance products are for – for example – anti money laundering. The fraudsters would need to set up a company – that looks “real” in both ends of the transaction. And more than that they would need to be able to “cheat” the banks customer due diligence. Then they would need to “construct” trade finance transactions that looks real … and as said in the beginning – if you do not know trade finance it may be complex – just getting the terminology right may be hard. Last but not least trade finance leave a long paper trail – which is not desirable for a fraudster. I am not saying that it does not happen. It does! I am only saying that it is not likely that the trade finance products are the first choice …
Further on the issue of trade finance being high risk – I have found some quotes that I want to share with you:
In exercising its implementing powers [..] the commission should respect [..] the balance of costs and benefits on a long-term basis in any implementing measures
(EU Directive 2005/60EC)
Trade Based Money Laundering provides an important avenue for disguising funds of illicit origin and for moving value to finance illegal activities
(APG Typology Report)
It does not however believe that currently there is sufficient evident to support an assessment of this area as high risk for AML/Sanctions purposes.
(The Wolfsberg Trade Finance Principles (2011))
In other words – the EU believe that it is possible to find a balance of costs and benefits in preventing anti money laundering. So at least from the perspective of the EU the AML risk is “manageable.”
This seems almost contradictory to the APG Typology Report, which indicate that trade finance is an avenue for disguising funds of illicit origin and for moving value to finance illegal activities. If that really is the case, then I guess the banks should stop doing trade finance!
At the other end of the spectrum is The Wolfsberg Trade Finance Principles from 2011, who simply need to see the evidence that trade finance is high risk.
Okay – I admit the background for writing the above is that it really makes me grumpy that trade finance is classified as high risk – without any sign of evidence or statistics to support it.
I admit also that when doing trade finance the risk of commercial crime is there – no doubt about that. However, if one is to migrate this risk in a good and solid manner, then a detailed and structured approach is required; one that relates to the ACTUAL risk – of the individual step of the individual product.
For example the AML risk is higher for LCs than it is for guarantees, because there is a flow of money in an LC – and there is not in a guarantee.
Likewise the sanction risk is higher on direct collection than it is on a “normal” collection where the documents are forwarded to the collecting bank from the remitting bank.
So simply saying that trade finance is “high risk” does not help in migrating the risk – it only scares people!
As said in the beginning – compliance issues are everywhere. I do not mind that. What I mind is that the bankers talking about this act like “hysterical women.” Screaming how dangerous it is. How complex it is. This is not a good and mature approach. This is an area that must be addressed by every bank – but it must be addressed like any other risk. Which should not be that hard. After all – banks make their money by evaluating risks … so normally they are able to handle that in a structured way.
Please try the same here…..
And take care of each other and the LC.
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