FATF, Pakistan & TBML

Huzaima Bukhari, Dr. Ikramul Haq & Abdul Rauf Shakoori

There are three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising its origins and integrating it into the formal economy. The first is through the use of the financial system; the second involves the physical movement of money (e.g. through the use of cash couriers); and the third is through the physical movement of goods through the trade system. In recent years, the Financial Action Task Force has focused considerable attention on the first two of these methods. By comparison, the scope for abuse of the international trade system has received relatively little attention—FATF study ‘Trade-based Money Laundering [June 23, 2006]. 

Trade is used as an ally for money laundering by misdeclarations of goods, under-invoicing and over-invoicing—Justice Ayesha Malik, paper read at International Judicial Conference 2012.

The Financial Action Tax Force (FATF) in the above study aptly highlighted that trade-based money laundering (TBML) did not received the attention it deserved. In this report of 2006, at many places actual case studies presented related to TBML in Pakistan. The very first one mentions: “The Pakistani exporter uses the over-invoiced amount to settle the US operator’s outstanding account with his Pakistani counterpart and additionally benefits from a 20 percent VAT rebate on the higher prices of the exported goods”. In this case, rather than simply wiring the funds to his Pakistani counterpart, the US operator convinces a Pakistani exporter to over-invoice a colluding US importer. According to information provided by USA: “Using the international trade system, the US operator was then able to transfer the funds to settle his account using the trade transaction to justify payment through the financial system”. This mal practice and many others are used for TBML.

The Customs Wing of Federal Board of Revenue (FBR) has miserably failed to combat TBML in the light of solid evidence provided by FATF and many other countries [details are available in Khilji, F. (1993), “Comments on “Under-Invoicing of Imports: A Case Study of Pakistan, The Pakistan Development Review, 32, Part II, Winter 1993 and Mahmood, Z. and R. Mahmood (1993), “Under-Invoicing of Imports: A Case Study of Pakistan”, The Pakistan Development Review, 32, Part II, Winter 1993].

It is worthwhile to note that FBR after 15 years of publication of study of FATF added in Customs Rules, 2001 vide SRO 5(I)/2021 dated January 4, 2021 a new chapter XXXVII, titled, ‘FORFEITURE OF PROPERTY RULES’. It has yet not created any workable structure to counter TBML. The TBML is defined “as the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimize their illicit origins”. In practice, according to FATF, “this can be achieved through the misrepresentation of the price, quantity or quality of imports or exports”. Moreover, “trade-based money laundering techniques vary in complexity and are frequently used in combination with other money laundering techniques to further obscure the money trail”.

The worldwide trade systems are exposed to wide range of risks and vulnerabilities that can be manipulated by the terrorist financiers, among others.  As per statistical review 2020 issued by the World Trade Organization (WTO), the volume of the global trade in goods alone is worth US$19 trillion. The figure for commercial services was US$ around 6 trillion in 2019. In view of massive gaps for inconsistent application of customer due diligence across jurisdictions, subjective pricing or multiple-layered trade cycles, lack of expertise in ascertainment of description and value etc, FATF’s recommendations require each state to identify, assess, and understand their Money Laundering (ML) and Terrorist Financing (TF) risks. Every State is mandated under FATF to implement preventative and mitigating measures that commensurate with the identified risks. These measures also include threats and vulnerabilities linked to TBML/ML.

The criteria to implement an effective system to combat TBML requires an assessment of the input provided by various means such as intelligence reports, suspicious transaction reports (STRs), threat assessments, investigation outcomes, economic and social indicators as well as the level of the threat and existing vulnerabilities to the respective nations.

The State Bank of Pakistan (SBP) through FE Circular No. 04 of 2019 dated 14th October 2019 provided a framework to counter TBML and Financing of Terrorism (CFT). The overall framework by SBP addresses the key focus areas by asking the authorized dealers (AD) to maintain screening procedures of customers, their identification and monitoring of trade transactions with related parties, risk profiling of customers and ADs itself, verification of valuation of underlying contracts related to import and exports of goods and services, screening of goods to ensure that items being traded are as per relevant trade policy and procedures, identification of dual use of goods including reporting of suspicious transactions within seven days of determining of their suspicion. This frame work, however, cannot be called a comprehensive document to address the TBML challenges. It mainly focuses at the risk arising from international trade through formal channel. The SBP has not touched the key areas which are more vulnerable to TBML methods used in this region. Our regulatory and enforcement authorities hardly understand dynamics of informal trade what to speak of countering the same.

Pakistan is still struggling to overcome conventional ways of TBML, such as discrepancies between invoices, difference between shipments size, routing of shipment involving number of countries with multiple unconnected subsidiaries, erratic payment method, high risk goods, cash payment etc. Our geographic location and nature of economic activities demand strict measures against TBML/CFT. At present our main challenges are dealing with alternative remittance system, informal trade through Iran, lapses, which are the source to abuse Afghan Transit Trade and countering the Chinese schemes for TBML.

These challenges are negatively impacting our economy substantially. The alternative remittance system transactions are settled through bank to bank wire transfers, cash couriers, trade, mobile payments etc. Largely, our bank officials are not adequately trained to identify the different typologies used for wire transfers to identify the suspicion of transactions. Asia Pacific Group in their mutual evaluation report highlighted this fact that SBP lacks understanding of Pakistan’s overall ML/TF risks, especially those unique to the sectors it supervises.

In addition to alternative remittance system, we are also exposed to Chinese trade-based money laundering schemes. Due to growing trade relations of Pakistan and China after CPEC, there is always a threat of movement of funds using Chinese schemes such as fei-chin and hui-kaun which facilitate underground financial system. In most cases criminals involve fei-chien for overseas business investments, trade-based value transfers etc. Pakistani authorities need to identify the volume of trade through fei-chien and trained themselves to understand the difference between alternative remittance system and fei-chien, so that they could identify and counter those transactions involving these methods.

Afghan transit trade is another source of trade based money laundering. We are failed to control massive smuggling which is draining our revenue generation through customs and border protections activities. Mostly shipped goods are not transported to Afghanistan, however, showed as destined in Afghanistan on paperwork but actually shipment never crossed the borders. In recent Sugar and wheat crisis in Pakistan, opposition parties in Pakistan levelled same type of allegations and blamed the government for its weak controls to stop this practice.

We have fully ignored these area and even SPB through its framework to control trade based money laundering failed to fully comprehend the condition mentioned in FATF guidelines for TBML. Moreover, threshold for reporting of transaction to Federal Board of Revenue is quite unrealistic. Moreover, SBP requires that authorized dealers need to report the suspicious activity within seven days which seems quite difficult for the large financial institutions processes number of transactions every day. This process requires comprehensive investigation, from generating an alert, its investigation and conclusion is a time consuming exercise which require lot of resources. State Bank need to realize this factor and has the responsibility to issue detailed guidelines as per international standards which at one hand build the confidence of investors and on the other hand will ease the burden on financial institutions.

Pakistan’s law enforcement agencies need to enhance their understanding and knowledge of risks related to trade-based money laundering so that they can properly investigate the issues assigned to them. APG mutual evaluation report highlighted the fact that our LEA’s have poor understanding of AML-CFT risk posed to different sectors. This observation was further confirmed by our prime minster while addressing at various international forums that we lack expertise to investigate white-collar crimes. The way forward to overcome on all these issues is setting up an independent entity with sole purpose to deal with all types of financial crimes (a blue print of the entity is listed in a book “Pakistan: Tackling FATF challenges and solutions”) including ML-TF which will collect and consolidate all reports and issue guidelines to each sector. The entity will also share information with law enforcement agencies and seek international cooperation to counter organized crimes which are at one hand impacting our economy and on the other hand ruining our image in the global community.

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Huzaima Bukhari and Dr. Ikramul Haq are lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions.