Trade Finance compliance checks – and the price of chili seeds
Regulatory compliance in Trade Finance is one of the hot topics – and over recent years there have been many discussions as to whether Trade Finance as an area it to be considered as high risk.
This issue has been discussed a number of times, for example in the lcviews White Paper 01/2015 (version 1.0 reads:
“The premise for this document is that it is misleading to label Trade Finance as being particularly risky. Although, Trade Finance activity is sometimes referred to as being “High Risk”, it is misleading to consider activities under this as “High Risk” per se. As described in chapter 1, “Trade Finance Risk evaluation”, the level of risk will depend on how the products are being used by the individual bank; and this risk-based approach should be the basis for the controls that the individual banks have in place.”
(Source: http://lcviews.com/index.php?page_id=472)
However, also in the details there have been many “battles”. One of them relates to the pricing of the goods covered by the Trade Finance transaction. The price of the goods come into play because it is deemed a Red Flag because it may potentially be an element in money laundering.
The discussion about the goods gained pace after the release of the FCA document TR/13, which seems to suggest that the compliance staff (as part of the transactional due diligence check) should verify that the prices of goods on trade invoices are reasonable.
Following the release of the document, many banks argued that it is not realistic that the bank should perform systematic price checks.
March 2015 BAFT released the “Guidance for Identifying Potentially Suspicious Activity in Letters of Credit and Documentary Collections”. This document includes 16 Red Flags that should be considered in order to identify any unusual and/or suspicious activity. In this document Red Flag #7 aims to target “Obvious over or under pricing of goods”. The guidance from BAFT aim for a balanced approach, and end with the following wording:
“… bank personnel should take reasonable care to try to identify any blatant or obvious pricing irregularities that may indicate the pricing is inconsistent with the goods being shipped”
Recently the International Chamber of Commerce, have issued a Policy Statement dedicated to the topic. The document is titled: “Financial Crime Compliance Checks on the Price of Goods in Trade Transactions – Are Price Checking Controls Plausible?” It is drafted by the ICC Executive Board and prepared by the co-chairs of the Financial Crime Risk & Policy group, Graham Baldock and Graham Finding (HSBC).
The key messages of the document are:
Quote
1: Price Checking, beyond a common sense check for manifestly unusual pricing, is extremely challenging for Financial Institutions to carry out when processing trade documentation.
2: It is not plausible for a Financial Institution to develop a binary financial crime control for price checking and automated systems have, to date not proved to be effective.
3: Even where publically available pricing information is available (such as for commodities) price checking remains challenging due to the multiple factors which constitute the final price of the underlying commodity in a transaction.
Unquote
The document is very clear, precise and well written. There are many good points made throughout the document. The main view represented in the document is that the checker may be instructed to check if the total price of the goods in question is manifestly unusual.
“Manifestly unusual price” is defined as follows:
A price considered as one that is outside of what can be judged to be reasonable and regular given the circumstances of the transaction and the level of information available to the checker.
The document offers the following example:
“… a new luxury car will not cost less than USD 1,000 or the unit price of any fresh vegetable will not exceed USD 250. As a result, experienced Trade Operations staff will generally be able to ascertain that a shipment of 100 kilograms of chili seeds should not cost USD 6 million. However, they will struggle to assess that a shipment of new luxury branded handbags should probably cost more than USD 350 apiece.”
Notwithstanding the above, the document makes it clear that “the checker will often lack information related to contractual agreements between buyer and seller, time of price fixing, Incoterms, relative positions of buyer and seller, or goods quality considerations, all of which influence the contract price. Additionally, document checkers or operational employees are never product specialists.”
Bum!
In my view, this ICC Policy Statement is spot on – and it is my hope that it can solve/end many discussions with compliance people and regulators.
In the past, I have been a bit disappointed about the (lack of) activity of the Financial Crime Risk & Policy group. However, with this document I rest my case – and can only urge/hope that many similar documents come from that group.
Thanks a lot for this one! And do remember to take care of yourself and the LC.
Kind regards
Kim