Navigating Shifting Trade Compliance

John Ladany

Head of Market Management, Trade Services

Correspondent Banking Group

Agenda

• The Compliance Environment

• Elements of a Trade AML Program

• Case Studies

• What Comes Next?

Polling Question #1

Does your institution have a specific AML standard for Trade?

A. Yes

B. No

The Compliance Environment

• We are all responsible for:

– “Know Your Customer”

– Documenting our institution’s due diligence efforts

– Reporting suspicious transactions

• Concerns about potentially suspicious transactions must be escalated

…yet the anti-money laundering/anti-terrorist financing procedures at US banks are under intense scrutiny by our regulators, resulting in:

consent decrees, fines of billions of dollars, additional reporting requirements, look back investigations, and other penalties

Employees at Citi — and banks everywhere — have a duty to safeguard their firm’s business

and reputation

The Current Environment

Greater Regulatory Risk (Perceived)

$1.6 trn shortfall in

trade finance globally

“De-Risking”

• Shedding of Correspondent Banking Relationships

• Erosion of trade networks

• Removal of some business lines

Financial institutions are terminating or restricting business relationships with certain sectors/ jurisdictions/entities/individuals due to the perceived risks

1. The global fragmentation of AML, ATF, and sanctions regimes is a driver

2. FIs are also uncertain as to the risk tolerances of their regulators

3. The cost of compliance is a contributing factor

$400 bn

Asia

$225 bn SS Africa

Key Elements of a

Good Trade AML Program

Know Your Customer

• Who the client is will vary by transaction type:

• This can be further complicated by co-applicants and other named parties

– Is each co-applicant obligated to reimburse for drawings under the L/C?

– Is the other named party affiliated or unaffiliated?

Trade Product Client

Export L/C Issuing Bank or Exporter

Import L/C Importer/Applicant

Standby L/Cs & Guarantees Issued Applicant

Export Documentary Collection Exporter

Import Documentary Collection Importer

As a general rule, banks must ensure that clients utilizing their trade products and services have met the applicable customer identification program and KYC requirements

Polling Question #2

For which of the following does your bank require a KYC file in order to advise an export L/C?

A. L/C issuing bank

B. L/C beneficiary

C. Both

Citi’s KYC Decision Making Guidelines for Export L/Cs

Criteria Met Criteria Not Met Not Relevant

Issuing Branch’s • PAC • NESS Check

1. All branches of a bank entity in the home country are covered by the KYC on its head office

2. Issuing bank could be a branch or a subsidiary

3. The one-off exception is by issuing entity, so there can be a one-off for a bank’s branch in Hanoi and separately for its branch in Toronto, for example

4. The subsidiary must be wholly owned by the parent/head office on whom Citi has compiled the KYC file, and the answer to q uestion 9 on the Wolfsberg Questionnaire must be positive

5. For the head office on whom Citi has compiled the KYC file, the answer to question 9 on the Wolfsberg Questionnaire must be positive

KYC on First Advising Bank

KYC on Beneficiary

Confirmation/ Standby

Protective

?

KYC on Originating

Country

KYC on Head Office

Export Advising

?

Scenario

1

Scenario

2

Scenario

3

Scenario

4

Scenario

5

One-of f

Ongoing

Note 2

Note 1 Issuing Bank

Notes :

Note 5

Note 4

Branch

CONDITIONAL Sub

CONDITIONAL Branch

Sub

Note 3

Note 1

Monitoring Trade Transactions

Screening

• A bank’s trade operations must screen its transactions against the applicable SDN and sanctions lists

• This includes not just the content of SWIFT messages received, but all the related documents, too—the individuals, entities, goods, vessels, etc. listed therein

• Based upon Citi’s global presence, our CitiScreening system incorporates more than 500 such lists from governments and multilateral agencies around the world

Red flags

• Banks must also perform a review of all trade transactions to determine if there are any risk indicators (“red flags”) present that are typically associated with money laundering, terrorist financing, economic sanctions, bribery, or other illicit activity

• This may involve manually comparing each item to:

– FFIEC BSA/AML Examination Manual Trade Finance Red Flags List

– Financial Action Task Force Trade-Based Money Laundering Typologies

– Wolfsberg Trade Finance Principles

– Proprietary red flag listings

• High risk businesses

• High risk products

• High risk countries

• A red flag analysis is the minimum amount of due diligence required before a transaction may be executed; trade personnel should always be encouraged to use their expertise and experience to evaluate each transaction on its merits and to escalate any potential concerns

Examples of Trade Red Flags

L/C and Collection Specific

•L/C does not provide a description of the good, services, or technology being furnished •L/C or collection fails to call for presentation of transport documents •Payment to be made to the beneficiary’s account held in a country other than its stated locations •L/C transfer or assignment of proceeds request names a transferee or assignee in an offshore financial

Trade Related Documents

•Future dated bill of lading •Obvious alterations to any third party document(s) without proper authentication •B/L describing containerized cargo, but without container numbers, with sequential numbers, or with non-standard numbers

•Shipping documents show weights and measures inconsistent with the goods shipped or method of shipment

General for Trade

• Trade transaction involves an unusual intermediary, or too many intermediaries •Trade transaction appears unusual in light of the customer’s normal business activities •Unusually favorable payment terms, such as an interest rate far above the market •The quantity of goods exceeds the known capacity of the shipping container or tanker or other vessel

General Inquiries

•Customer requests an unusual degree of confidentiality •Customer reluctant to provide clear answers to routine financial, commercial, technical, or other questions • Inconsistent, insufficient, false, or suspicious information provided by the client •Approach from an unknown party whose identity is not clear, appears evasive, and/or whose references are not convincing

Trade Red Flags – FFIEC BSA/AML Exam Manual

Items shipped that are inconsistent with the nature of the exporter’s business (e.g., a steel company that starts dealing in paper products)

Exporters conducting business in high-risk jurisdictions

Exporters shipping items through high-risk jurisdictions, including transit through non-cooperative countries

Exporters involved in potentially high-risk activities, including activities that may be subject to export/import restrictions (e.g., equipment for military or police organizations of foreign governments, weapons, ammunition)

Obvious over- or under-pricing of goods and services

Obvious misrepresentation of quantity or type of goods imported or exported

Obvious misrepresentation of quantity or type of goods imported or exported

Exporter directs payment of proceeds to an unrelated third party

Shipment locations or description of goods not consistent with letter of credit

Documentation showing a higher or lower value or cost of merchandise than that which was declared to customs or paid by the importer

Significantly amended letters of credit without reasonable justification or changes to the beneficiary or location of payment (any changes in the names of parties also should prompt additional review)

High Risk Businesses and Goods

• These are businesses likely to use trade services/finance products, perhaps for illicit purposes

• They may, of course, be involved in legitimate trade transactions

– But a combination of red flags—from the earlier lists plus the type of business—may be sufficient to raise suspicion and warrant additional investigation and/or reporting

• Banks need to be develop and implement such listings. Here are some examples from Citi’s own guidelines:

– Commodities middlemen (e.g., cement, sugar, fertilizer, urea, coal, iron ore)

– Import/export and trading companies (e.g., brokers, agents)

– Gem/jewel/precious metal dealers

– Scrap metal dealers

– Wholesalers, distributors, and retailers of consumer electronics

– Car/boat/plane/truck/motorcycle dealers and brokers (new, used, parts)

– Liquor distributors

– Telemarketers

– Textile businesses

– Art and antiques dealers

High Risk Countries

• Banks must recognize the inherent geographic money laundering and terrorist financing risk of certain countries and territories

• The inclusion of a high risk country(ies) in a trade transaction represents an additional red flag(s) to be considered

• Citi’s proprietary listing of such countries is based upon a number of factors, including:

– Non-cooperative countries or territories designated by the FATF

– Countries designated as a “primary money laundering concern” pursuant to the USA PATRIOT Act’s Section 311

– Countries with no AML laws and/or implementing regulations, as identified by the US State Department’s International Narcotics Control Strategy Report (“INCSR”)

– Countries posing a terrorist financing risk, based on country descriptions in the INCSR

– Uncooperative tax havens, as identified by the Organization for Economic Co-operation and Development

– Issuers of offshore banking licenses or offshore financial centers, as identified by the International Monetary Fund and INCSR

– A country’s level of perceived corruption, as evidenced by their score on Transparency International’s most recent Corruption Perception Index

Goods/Services Descriptions

• Letters of credit need to have a description of the goods or services covered to ensure they comply with governmental regulations, export controls, anti-money laundering requirements, and other bank-specific policies

• Therefore, L/Cs which merely cite a purchase order number, a contract number, a proforma invoice number, or a cryptic acronym are not sufficient

• Additional due-diligence should be performed when the parties are military and where goods are not clear or have a potential lethal end-use

• Although standby L/Cs may not specifically state the types of goods, banks still need to ensure that they understand the underlying transaction, and that all contracts and references are identified

Red Flag Decision Grid

HIGH

E S C A L A T E

IF MORE THAN ONE

RED FLAG IS PRESENT WITHOUT MITIGATING

QUALITATIVE FACTORS

R I

S K

L E

V E

L

Negative news screening for

ALL L/C

beneficiaries and exporters

with 2 or more Red Flags

DO NOT ESCALATE

for single a Red Flag (e.g., country,

product, value),

unless obviously

suspicious.

LOW

When To Escalate a Transaction Due to Number and/or Type of Red Flags

RISK RANKING RED FLAGS:

ALWAYS Escalate

HIGHEST RISK COUNTRY

INVOLVEMENT

Cuba, Iran, Syria, Burma Northern Sudan, Yemen: These single country Red

Flags will warrant escalation

Sample escalation flow

for red flag and

screening hits:

• Level 0 – Trade

operations

• Level 1 – Trade in

business controls

• Level 2 – Country

compliance

• Level 3 – Subject

matter experts

(including country AML

compliance officer,

regional AMLCO,

global AML, AML

counsel, global

sanctions compliance,

global anti-bribery and

corruption compliance,

sanctions and boycott

counsel, etc.

Case Studies

Polling Question #3

How many red flags are present in the following scenario: A jeweler located in Kuwait buys diamonds from a diamond district jeweler in New York City?

A. 1

B. 2

C. 3

D. 4

Handling Multiple Red Flags

A jeweler (high risk business) located in Kuwait (high risk country) buys diamonds (high risk goods) from a diamond district jeweler (high risk industry) in New York City

• An initial review of this transaction yields at least four red flags, as noted above

• However, upon further review, it is determined through publicly available information that the Kuwaiti jeweler is a well known and reputable retailer who is legitimately purchasing diamonds for wealthy clients, in reasonable amounts, from a licensed wholesale jeweler in the US who banks with [Citi/B of A/JPM]

• This further due diligence sufficiently mitigates the red flags, with the residual risk considered low enough to process the transaction

General guideline: Do not escalate for a single red flag (e.g., country, product, value) unless the transaction is obviously

suspicious. If several or more red flags are present, without mitigating qualitative factors, then escalate

Handling Multiple Red Flags

To: Level 2 Risk

Subject: AML CONCERN REF. 123456789/S-123456-789123, APPLICANT: JOHN DOE TRADING COMPANY, LAGOS, NIGERIA, BENEFICIARY: JOHN JONES-SMITH, LLC, ADDIS ABABA, ETHIOPIA, ISSUING BANKISSUING BANK: FOREIGN CORRESPONDENT BANK ABC, VALUE: USD 6,437,500.00

Dear Level 2,

This is an export L/C in which the goods, “Sugarcane”, are moving to Nigeria. The following are the red flags observed:

a. Goods are inconsistent with Beneficiary’s business line.

b. Port of loading not provided in the L/C.

c. The price per unit of the Sugarcane appears to be high.

d. High risk countries: Nigeria and Ethiopia.

Thank you and best regards.

To: Level 1 Risk

Subject: RE: AML CONCERN REF. 123456789/S-123456-789123, APPLICANT: JOHN DOE TRADING COMPANY, LAGOS, NIGERIA, BENEFICIARY: JOHN JONES-SMITH, LLC, ADDIS ABABA, ETHIOPIA, ISSUING BANKISSUING BANK: FOREIGN CORRESPONDENT BANK ABC, VALUE: USD 6,437,500.00

Dear Level 1,

a. Goods are inconsistent with Beneficiary’s business line. A D&B search on the Beneficiary confirms that it is involved in the export and import of sugarcane and sugar products.

b. Port of loading not provided in the L/C. The amendment received from the IB confirmed that the port of loading is Addis Ababa, Ethiopia.

c. The price per unit of the Sugarcane appears to be high. The unit price provided is consistent with the current market price available online.

d. High risk countries: Nigeria and Ethiopia.

Because all red flags are resolved, we can clear this transaction. Please proceed.

Over-Invoicing

Background

• $5 million transferable L/C issued by our correspondent at the request of Bureau of Health, West African Country

• To be confirmed by Citi

• For the supply of medical goods by Medical Sourcing

LLC, the middleman

Documents are presented to Citi for payment

• Supplier A as the second beneficiary presents invoices for $180,000

• Medical Sourcing substitutes an invoice totaling $500,000

• Citi’s trade operations compares invoices from multiple suppliers to the one from Medical Sourcing, and verifies a 330% average markup for the same goods

Further investigation

• Medical Sourcing is a small company, with no history of multi-million dollar hospital contracts

• The consulting firm that is the Bureau of Health’s agent may be familiar with Medical Sourcing

• This consulting firm may have influenced the selection

of Medical Sourcing as the supplier

What happened

• Citi asked the issuing bank to clarify the price discrepancies with its applicant

• The response from the IB was vague, and Citi follows up with emails

• Without providing any further details, the IB asserts that it is comfortable with the transaction and asks Citi to proceed

Citi declined to proceed, added the various entities to our internal AML hot list, enhanced our due diligence for certain

West African countries, reviewed our AML procedures for transferring L/Cs, and considered a regulatory filing

Fraud Prevention

The most frequently identified red flags for fraud:

– “Funds are good clean, cleared, unencumbered, earned ,and of non-criminal origin“’

– “Top 50 western bank“ or “top 25 prime bank

– Proof of product (“POP”) or “confirm POP” or “bank POP”

– “Proof of product/ownership bank to bank on activation of LC. This is not negotiable as it is standard procedure required by the banking fraternity“

– “Shall be by 100% confirmed, irrevocable, transferable, divisible, revolving LC“

– Any safe world port (“ASWP”)

– Irrevocable corporate/confirmed purchase order (“ICPO”)

– Proof of funds

– Fully funded, revolving, irrevocable, transferable, confirmed, documentary L/C (“FFRDLC”)

– Ready, willing, and able (“RWA”) letter

– High Yield Investment Program (“HYIP”)

– ICC promissory notes

– 3039/3034 format for L/Cs or guarantees (AKA “London short form”)

– Irrevocable bank purchase order (“IBPO”)

Other fraud prevention techniques:

• Track the actual shipping vessel

movement using available data bases (e.g.,

Lloyds)

• Validate the container number (if

applicable) using the shipping company’s

numbering algorithm

• Follow this helpful “rule of thumb”: A 20

foot container has a capacity of 25 metric

tons/33 cubic meters, and a 40 foot

container holds up to 30 MTs/67 CMs

Polling Question #4

Which of the following in a trade transaction could be a red flag?

A. Payment of proceeds to an unrelated third party

B. Kyrgyzstan

C. Scrap metal

D. ICC promissory note

E. All of the above

What Comes Next?

Quality Assurance Testing

• The OCC has mandated that Citi begin testing the resolution of items escalated by our Trade operations to our Trade in business controls (L0 to L1)

• Starting in May 2015, this will involve independently verifying the documentation and rationale used for the L1 dispositions

• On a daily basis, in Trade, Citi experiences approximately:

– 13,000 OFAC/SDN hits

– 145 potential AML/fraud cases

• We will sample 1% of the daily OFAC and 10% of the daily AML/fraud exceptions, with 60% of the selections coming from high risk geographies and businesses/products

Price Verifications

• This is another concern of the OCC

• It is a standard procedure when Citi suspects over- or under-invoicing

• Verification is easy enough when the goods are oil, soybeans, corn, and the like

• But if the goods are a unique item, spare part, not widely traded, etc., then it becomes difficult to impossible

• In such cases we rely on the reasonableness of the transaction with respect to the client’s regular business

Thank you