The Financial Action Task Force refers to the physical movement of goods through the trade system as one of the 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.

This is often achieved through the misrepresentation of the price, quantity or quality of imports or exports, which is a potentially lucrative exercise. For example, there was a US$45bn gap between the United Nations Comtrade database on international trade’s valuation of China’s exports to the US in 2022 and the US Bureau of Economic Analysis valuation of imports from China over the same period.

Trade finance products can be perceived as being more prone to fraud than other forms of lending, whereas the reality is they offer a level of visibility and control which other financing products cannot. The opportunity to identify fraudulent behaviour is potentially increased where commerce is financed through trade finance products, as opposed to overdraft or revolving credit facilities.

However, most of the global trade is conducted on ‘open account’ terms where bank finance is not involved.

“Fictitious invoicing and double or multiple financing frauds are relatively common where fraudsters create fake documentation (or manipulate legitimate documentation) to obtain financing,” explains James Yates, Global Head of Product Risk, Global Trade and Receivables Finance at HSBC.

Fraud tends to increase when particular sectors or markets experience challenging times. Some of the more notable instances in recent years have been concentrated in the commodity trading sector where a combination of price volatility and demand and supply shocks have proved challenging.

“Commodities markets where there is no pricing benchmark create a situation for traders to take advantage and hike the prices contractually to obtain a higher volume of borrowing,” notes Ram Arapally, Executive Vice President Business Development at trade finance solutions provider Triterras.

One solution would be for lenders to hire trade experts in those commodities, although that has obvious cost implications. A longer-term solution would be state sponsored programmes to establish digital exchanges that indicate daily pricing of every commodity in the market.

There are many products in the agricultural, petroleum, metals, pharmaceutical, polymers and textiles industries that can be disguised as superior and more expensive and cannot be detected unless they go through complex tests.

“Such frauds typically have accommodation arrangements between the buyers and sellers,” says Arapally. “In the long term, a digitised supply chain to track and trace the source from the manufacturing base could be a solution.”

Obtaining finance by creating a web of arms-distance companies established by either an individual or group of individuals or trade houses, syndicating to form a large network of cross-border companies that participate in trading activities with an intent to boost their balance sheets – which in turn can be leveraged to obtain large loans at banks and other financial institutions – is another form of trade finance fraud.

“The funds raised through such loans are typically diverted for other non-trade related activities to obtain quick returns or manage existing working capital issues within the companies, and history has indicated that often such diversion of funds leads to defaults,” says Arapally. “The solution here could be a strict and higher tax regime to deter formation of such companies and imposing stricter audit rules that can provide more insight to banks and lending institutions.”

Strong customer due diligence is the cornerstone of fraud risk management, concludes Yates. “Through the lifecycle of a client relationship, multiple reviews and controls are undertaken to continue to understand clients’ trading patterns and activities, underpinned by major investments in fraud detection technology.”