Trade Finance trimmed (4).pdf

74// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved //75 In this fourth revolution, often referred to as ‘4IR’, economies are facing a range of new technologies that combine the physical, digital and biological worlds and which will impact all disciplines, economi...

74// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved //75 In this fourth revolution, often referred to as ‘4IR’, economies are facing a range of new technologies that combine the physical, digital and biological worlds and which will impact all disciplines, economies and industries.78 These advancements, note many observers, have the potential to dramatically change the way that humans interact, introducing efficiency gains to personal and business lives. Adoption of and readiness for 4IR is evident in a number of government and trading bloc policy papers of some of the more advanced economies. Figure 15: The Fourth Industrial Revolution (4IR) “For our part: yes, we hold data on thousands of clients across the globe, covering not just their cash activities, but also their trade, investment, securities services operations and much, much more. But, even if a business based on commercialising this data stored in our systems became too valuable to ignore, we will have to co-create this proposition with clients and share the fruits of that business accordingly. If data is the new oil, then our clients would likely want to own the rights to the crude in the seabed, and we would become the provider of the drilling platform, the refinery, as well as many other downstream services.”75 10.2 Industry 4.0 In his book published in 2017, The Fourth Industrial Revolution, Professor Klaus Schwab, Founder and Executive Chairman of the World Economic Forum (WEF), maintains that “we are at the beginning of a revolution that is fundamentally changing the way we live, work and relate to one another”.76 The WEF’s Center for the Fourth Industrial Revolution aims to bring market participants together to ensure governance around these technologies is “stable, interoperable, predictable and transparent”. At the January 2018 WEF Annual Meeting in Davos-Klosters, Deutsche Bank was announced as a new partner.77 Customer expectations are shifting Products are being enhanced by data, which improves asset productivity New partnerships are being formed as companies learn the importance of new forms of collaboration – compete and collaborate Operating models are being transformed into new digital models Financial institutions Fintech Issues Issues Inertia of tradition Slow budget process Regulatory/legal/ compliance Short-termism Client base Speed to market Transformation New forms of collaborative solutions Trust Capital Source: Adapted by David Meynell from The Fourth Industrial Revolution by Klaus Schwab (Executive Chairman, World Economic Forum) 79 76// A Guide to Trade Finance Figure 16: Timelines of 4IR 1760-1840 Railroads, steam power, mechanical production 1867-1914 Electricity, assembly line, mass production 1965-1999 Mainframe computers, personal computing, digital electronics, internet 2000-? Mobile internet, IoT, AI, machine learning, advanced robotics, nanotechnology, energy storage, quantum computing, autonomous vehicles, 3D printing Size, speed, scope Virtual and physical systems globally interact and cooperate Source: Adapted by David Meynell from The Fourth Industrial Revolution by Klaus Schwab (Executive Chairman, World Economic Forum)80 In his interview with Deutsche Bank’s flow (The power of ten, March 2019), ASEAN Deputy Secretary General Aladdin Rillo explained how the digital revolution affects everyone in ASEAN, across businesses and government and how the whole of ASEAN is committed to embracing the 4IR.81 Copyright© 2020 Deutsche Bank AG. All rights reserved The UK government published a policy paper, Regulation for the Fourth Industrial Revolution, in June 2019, in which it sets out its plan for regulating businesses for 4IR while retaining agility and entrepreneurship.82 The aim will be to create an outcome-focused, flexible regulatory system that enables innovation to thrive while protecting citizens and the environment. In addition, this will be matched with clarity for business through better use of regulatory guidance, codes of practice and industry standards. The paper makes the point that regulation has a powerful impact on innovation. It can stimulate ideas and block their implementation, it can increase or reduce investment risk – and steer funding towards valuable research and development or tick-box compliance. It can also influence consumer confidence and demand and determine whether firms enter or exit a market, the paper notes. In Germany, meanwhile, the Federation of German Industries makes a similar point that companies investing in Industry 4.0 technologies and the creation of new business models are highly dependent on regulatory frameworks, as legal provisions can help or impede the adaption of new digital solutions and the cooperation with companies abroad. Therefore, governments have to set the right framework that facilitates innovation and cross-border cooperation in the area of Industry 4.0.83 //77 78// A Guide to Trade Finance 10.3 Big Data and Internet of Things (IoT) In 2016, a report from IBM Marketing Cloud, 10 Key Marketing Trends For 2017, noted that 90% of the data in the world at that time had been created in the previous two years. The task in this new era of data and digital services is therefore to distil this data into something that has a practical purpose. In other words, transforming data into information, using information to gain knowledge, and ultimately using knowledge to achieve wisdom and drive meaningful improvements to services. This ability to interpret data in new ways will lead to improved product development, speedier time to market, enhanced risk mitigation, superior market and client evaluation, and better innovation.84 There is perhaps no more exciting evolution than the IoT which embeds sensory and wireless technology within objects, making it possible to digitally transfer ownership of all kinds of physical property. The technology has an additional benefit in that it also provides the ‘object’ with the ability to transmit data in respect of identity, existing condition and the environment in which it is based. It is estimated that the IoT will have 50 billion sensors connected to the internet by 2020 and one trillion by 2025 – all transmitting data to each other.85 Copyright© 2020 Deutsche Bank AG. All rights reserved In the trade world, advantages could be obtained in a number of scenarios including: “ Tracking of goods in transit; “ Checking atmospheric and environmental conditions of goods in transit; “ Discovering problems encountered with goods in transit at an earlier stage; “ Access to pre/post-inspection information and updates; “ Immediate awareness of exact date and time of departure and arrival of goods; “ Potential reduction in fraud and corruption; “ Simplified administration; and “ Cost reduction. The IoT will need, by default, a ‘ledger of things’ and this is where blockchain will play an important role in tracking and validating the data.86 The EU published its ideas and actions for “a digital transformation that works for all” on 19 February 2020, noting “digital is a key enabler to fighting climate change and achieving the green transition”.87 Further details are available in the following white papers, available as links from the press release (see note 87): “ Communication: A European strategy for data “ Artificial intelligence: A European approach to excellence and trust 10.4 Distributed ledger technology (DLT) including blockchain Blockchain can be regarded as a decentralised or distributed ledger for validating and recording transactions. As in the physical world, whenever a transaction is initiated, it requires validation and authentication. However, as opposed to the physical world where such authentication is handled by a trusted third party (often a financial institution), the pending transaction is broadcast to a network of decentralised users (defined as ‘miners’) who, using specialised software, compete to verify and authenticate the cryptographic key added to a transaction. In essence, the ‘miners’ are verifying and confirming a bookkeeping record. For this activity, known as ‘proof of work’, they receive a reward in bitcoins.88 //79 80// A Guide to Trade Finance Figure 17: Validating transactions in the blockchain Advantages of blockchain validation Distributed (decentralised) ledger for validating and recording transactions – no need for a trusted third party – ‘ledger in the cloud’ A network of computers validates, verifies and authenticates the transaction – decentralisation of trust – private or public Transfer of ownership (digital assets): contractual agreements; commercial, notarised, insurance and other types of documents and certificates Data sharing/transparency/tracking/release of goods/reduced administration Smart contracts – programmable activation once certain criteria have been met – ‘if this happens, then do that’ Digital letter of credit – the benefits of a secure trusted instrument without paper or manual intervention Summary of process Initiates a transaction Buyer Network Centralised and trusted third party Block completed and broadcast for ‘proof of work’ Completed block Exchanging value without the need for an intermediary Processing Transaction accessed to build a validated block Verification Shared ledger Analysis Validation Authenticity verified Authentication Completed transaction is recorded in the blockchain No longer a need for two (or more) institutions to record and monitor a transaction, leading to a dramatic reduction in cost and time Source: David Meynell In trade finance, there have been some insightful use cases.89 One example is Danish container shipping giant Maersk and technology provider IBM announcing in October 2019 that Global Container Terminals in North America had joined their TradeLens supply chain platform underpinned by blockchain technology.90 10.5 Smart contracts In the world of international trade finance, contractual agreements can be agreed between any combination of parties in a trade transaction: buyer; seller; bank; insurance company; government entity; chamber of commerce; shipper /carrier /charterer; inspection, analysis and health companies/organisations; etc. Having access to real-time data would facilitate the formulation of contracts and documents on an automated basis provided that the underlying required criteria is verified by the blockchain, thus producing what is known in blockchain terminology as a ‘smart contract’. Smart contracts include programmable activation once certain criteria have been met, i.e. ‘if this happens, then do that’. A smart contract would not require the intervention of an intermediary such as a bank or a lawyer, as it has removed the need for the trust of a ‘third party’ by basing the trust element upon a secure mathematical code. The code underlying the contract would execute when a triggering event occurs rather than drafting a contract on a case-by-case basis. Initiation Transaction broadcast for processing Seller Copyright© 2020 Deutsche Bank AG. All rights reserved Book keeping 10.6 Artificial intelligence (AI) and machine learning AI in smart devices simulates intelligent behaviour in order to make decisions with minimal or no human intervention, extracting data, digitising data, learning from the data and analysing the data to make a decision or provide a prediction.91 //81 82// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved “Clients’ expectations are changing along with technological development, and they now expect even more personalised services. AI can perform analysis of client data to determine client needs – using the insights gleaned to offer more tailored products and services, as well as automated and predictive resolution of service issues.” They continue, “For instance, a bank algorithm could identify when a corporate client has surplus liquidity in a low-yielding account and recommend a fixed term deposit or money-market fund that would offer better returns. For banks, this not only means a chance to provide a better, more tailored service to their clients, but also potentially to recommend other products in the bank’s catalogue that can add value. Breaking down the silos of data, and creating more dynamic ways of accessing it, will make banks the standout financial service providers in an increasingly fragmented industry. On the client side, it’s equally advantageous – promising a higher level of service and optimised treasury functions.” Improving data capability is likely to prove to be of immense benefit to supply chains and, by default, to supply chain financing, particularly when enabling analysis and decisions from data collected by the IoT, allowing for automated and digitised trade finance documentation, combined with support for smart contracts. Regulatory and compliance teams would also obtain benefit from reduced human intervention. Machine learning is the science of getting computers to learn and act like humans do, and improve their learning over time in an autonomous fashion, by feeding them data and information in the form of observations and realworld interactions.92 Whilst the terms AI and machine learning are often used interchangeably, AI represents a much broader concept than machine learning. AI enables devices to act intelligently; machine learning feeds data to devices and allows them to learn for themselves. As the authors of the Deutsche Bank white paper, Regulation driving banking transformation93 pointed out in October 2018: 10.7 Multi-banking and SWIFT messages It can be difficult and awkward for corporates to manage advices of export documentary credits received from multiple banks in paper format and via different bank portals. As highlighted by SWIFT, despite an overall trend towards trading on open account terms, traditional trade instruments remain a key component of a bank’s finance offering. With this in mind, SWIFT supports banks’ finance offerings with standardised corporate-tobank trade messaging.94 Many leading trade banks have extended SWIFT MT7xx standards to the corporate world through the MT798 ‘Trade Envelope’ solution, thereby ensuring improved automation and efficiency via access to multiple banks.95 //83 84// A Guide to Trade Finance 10.8 ICC initiatives In June 2017, the ICC Banking Commission (now enveloped under the umbrella of the ICC’s Finance for Development Hub) launched the “Digitalisation in Trade Finance Working Group”. The aim of the Group is to identify strategies to overcome the constraints of digitalising trade finance − such as a reliance on paper-based practices, a lack of recognition of the legal status of electronic documents, uncertainty over standards, and a general lack of clear legal and regulatory frameworks.96 The Working Group is the coordinating body on all work by the ICC Banking Commission related to the digitalisation of trade finance, with a mandate to identify ways to overcome the abovementioned obstacles. Main objectives include: “ To evaluate existing ICC rules in order to ensure they are ‘e-compliant’. “ To develop a set of minimum standards for the digital connectivity of service to providers. “ To examine the legal and practical issues related to the validity and value of data and documents in digitised form. 10.8.1 ICC eRules In late 2017 a sub-group was established, under the auspices of the Digitalisation Working Group, to address the ‘e-compatibility’ of ICC rules for trade finance and ensure they are e-compliant.97 Subsequent to the initial evaluation, it was concluded that two pieces of work needed to be taken forward: 1. To update the existing version 1.1 of eUCP in order to ensure continued digital compatibility. 2. To draft eURC in order to ensure continued digital compatibility for presentation of electronic records under Collections. These new eRules, which came into effect on 1 July 2019, provide rules for banks operating in today’s increasingly digital trade finance system. The eRules will be continually monitored and updated to reflect future technological developments and trends that emerge in trade finance. By embracing a paperless future, the ICC seeks to safeguard the applicability of traditional trade solutions in a digital environment. Copyright© 2020 Deutsche Bank AG. All rights reserved “It will require a great deal of willingness on both sides for full transformation to be achieved” The ICC has committed to ensuring that the eRules remain relevant and applicable to banks and other trade finance institutions. An article-byarticle analysis has been made available by the ICC on its website.98 10.8.2 Uniform Rules for Digital Trade Transactions In addition to the launch of the eRules, the ICC Banking Commission Executive Committee also approved a proposal to draft a new set of rules under the working title “Uniform Rules for Digital Trade Transactions (URDTT)”. The objective of the URDTT is to develop a high-level framework outlining obligations, rules and standards for the digitalisation of trade finance. The approach taken in the drafting of the URDTT is to produce rules that are agnostic as to the medium used to handle the digital trade, although the digital trade must be conducted using electronic records and not paper. 10.8.3 Electronic Bills of Lading (eBLs) The ICC Banking Commission, on the recommendation of the Legal Committee, appointed Clyde & Co LLP to conduct a survey on the legal status of eBLs, whether in the form of an electronic record or in paper format when converted from an electronic record.99 The survey covered the following ten jurisdictions: UK (English law), USA (NY law), Germany, Netherlands, United Arab Emirates, China, Singapore, Brazil, India and Russia. Although electronic documents are already in existence, it is questionable whether or not the rights and liabilities under an eBL can be transferred without specific contractual agreement. //85 86// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 11 Financial crime 11.1 Definition and overview The Wolfsberg Group, ICC and BAFT describe financial crime as money laundering, the financing of terrorism and weapons proliferation, breaking of sanctions, financial fraud, financial crimes such as tax evasion and other predicative offences related to trade products and services.100 Either through active or passive participation in financial crime, a bank can, on occasion, find itself in a situation where not only is there a potential legal and regulatory implication as well as cost, but also where irreparable damage may occur to its reputation. It should be noted that reputational risk could have far greater consequences for a bank than the mere imposition of a financial penalty. Each bank should maintain internal guidelines that advise staff of the regulatory requirements for the handling of trade finance transactions and how to look out for suspicious transactions that could be fraudulent or subject to money laundering or terrorism financing; in other words all sorts of financial crime (see Section 11.9). What is it that makes trade finance a particular target for criminals? The problem exists in the fact that the very nature and complexity of trade finance transactions, and the huge volume of trade flows that exist, can hide individual transactions and help criminal organisations to transfer value across borders. As a result of this, every organisation involved in trade finance holds responsibilities with regards to the prevention of financial crime. 11.2 Money laundering Money laundering encompasses any act, or attempted act, to conceal or disguise the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources.101 For trade-based money laundering, it can be described simply as the misrepresentation of the price, quantity or quality of an import or export. There are three distinct phases to the act of money laundering: “ Placement – the initial entry of the ‘dirty’ money or proceeds of crime into the financial system, exchanging it for clean money, i.e. travellers’ cheques. “ Layering – electronic movement of funds in multiple constant transactions in order to obscure the audit trail and cut the link with the original crime. “ Integration – funds that are invested or merged in legitimate noncriminal activities and subsequently re-directed as ‘clean’. It is unlikely that trade finance products will be used by money launderers in the placement stage of money laundering, except where funds are used to collateralise the issuance of a bank undertaking. However, they could be used in the layering and integration stages of money laundering as the enormous volume of trade flows obscure individual transactions and the complexities associated with diverse trade financing arrangements that facilitate the commingling of legitimate and illicit funds. 102 //87 88// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 11.3 Terrorist financing 11.4 Proliferation financing Terrorist financing involves the solicitation, collection or provision of funds to support terrorist acts or organisations. Funds may stem from both legal and illicit sources.103 The FATF working group on terrorist financing and money laundering (see Section 11.9 for more detail on FATF) has proposed the following definition of proliferation financing: “The act of providing funds or financial services which are used, in whole or in part, for the manufacture, acquisition, possession, development, export, trans-shipment, brokering, transport, transfer, stockpiling or use of nuclear, chemical or biological weapons and their means of delivery and related materials (including both technologies and dual-use goods used for non-legitimate purposes), in contravention of national laws or, where applicable, international obligations.”105 A common feature of terrorist financing and money laundering is the disguising of the ultimate destination of the funds and dual-use goods (see Section 11.5). The Financial Action Task Force (FATF) defines the risks of terrorist financing as a function of three factors: “ Threat: criminals, terrorist groups and their facilitators, their funds, as well as the past, present and future money laundering or terrorist financing activities. “ Vulnerability: factors that represent weaknesses in systems or controls or certain features of a country. “ Consequence: refers to the impact or harm that money laundering or terrorist financing may cause and includes the effect of the underlying criminal and terrorist activity on financial systems and institutions, as well as the economy and society more generally. The consequences of money laundering or terrorist financing may be short or long-term in nature and also relate to populations, specific communities, the business environment, or national or international interests, as well as the reputation and attractiveness of a country’s financial sector.104 In addition, ICC’s Policy Statement, published in June 2019, How does global trade and receivables finance mitigate against proliferation financing, provides useful guidance for financial institutions in identifying high-risk customers and transactions in relation to proliferation finance related to weapons of mass destruction.106 Proliferation differs from money laundering in several respects. The fact that proliferators may derive funds from both criminal activity and/or legitimately sourced funds means that transactions related to proliferation financing may not exhibit the same characteristics as conventional money laundering. Furthermore, the number of customers or transactions related to proliferation activities is likely to be markedly smaller than those involved in other types of criminal activity such as money laundering. 11.5 Dual-use items Dual-use items are goods, software, technology, documents and diagrams which can be used for both civil and military applications. They can range from raw materials such as sugar (which can be used in explosives manufacturing as well as foodstuffs) to components and complete systems – such as aluminium alloys, bearings or lasers. They could also be items used in the production or development of military goods, such as machine tools, chemical manufacturing equipment and computers.107 Most countries have legislation and control procedures in place for the export of such items.108 //89 90// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved 11.6 Sanctions 11.7 Fraud Sanctions are trade controls that can be (and are) imposed by the UN, the EU Council, or individual countries – such as the US via its Office of Foreign Assets Control (OFAC) – for political or economic reasons. The Charter of the UN refers to sanctions as “measures not involving the use of armed force’, including a ‘complete or partial interruption of economic relations.”109 There is no single definition that is used globally to describe the act of ‘fraud’ but the following from the Oxford English Dictionary may come close: “Wrongful or criminal deception intended to result in financial or personal gain”. Most sanctions will include a rationale as to why they have been imposed and their proposed aims. Sanctions can prohibit dealings with not only specific countries or companies, but also individuals and property. Sectoral sanctions can identify individuals operating in sections of a sanctioned economy, such as those published by OFAC regarding persons operating in sectors of the Russian economy.110 Sanction lists will often include names of known terrorist organisations or individuals. The concerned regulatory body can impose a substantial financial and/or economic penalty if a sanction regulation is ignored or not applied to its full extent. Sanction issues continue to cause problems in trade transactions, including those that are subject to ICC rules. This necessitated, in 2014, the release of an updated sanctions guidance paper by the ICC Banking Commission.111 The paper focuses on three main issues: “ Impact of proliferation of sanctions clauses in trade finance-related instruments subject to ICC rules. “ Specimen sanctions clauses encountered in practice. “ Recommendations for best practices. “The concerned regulatory body can impose a substantial financial and/or economic penalty if a sanction regulation is ignored or not applied to its full extent” In Section 15(4) of the UK Theft Act 1968, ‘deception’ refers to “any deception (whether deliberate or reckless) by words or conduct as to fact or as to law, including a deception as to the present intentions of the person using the deception or any other person”. In simple terms, this means that fraud includes any intentional or deliberate act to deprive another of property or money by guile, deception or other unfair means. Fraudulent trade transactions have existed since trading began many thousands of years ago. All parties involved in trade need to be aware of the potential for fraud: “ Buyers run the risk of paying for sub-standard, or even non-existent, goods; “ Sellers run the risk of not receiving funds despite having shipped goods according to the contract; “ Banks run the risk of being involved in a fraudulent transaction and suffering an ensuing financial loss. Lord Diplock (1907−1985), an English judge, made reference to fraud in documentary credit transactions as: “documents that contain, expressly or by implication, material representations of fact that to his [the issuer’s] knowledge are untrue”.112 As with financial crime, banks need to introduce processes, procedures and/or guidelines for the identification and internal escalation of fraudulent transactions in order to minimise any potential financial loss. Identifying fraudulent documents often comes down to experience – the look, the feel, the content and the layout of the paper.113 //91 92// A Guide to Trade Finance Copyright© 2020 Deutsche Bank AG. All rights reserved The ICC Commercial Crime Services is based in the UK and has a specialist Financial Investigation Bureau (FIB) that “conducts enquiries and investigations into matters associated with money laundering, fraud and suspect documents”.114 It also provides training on how to spot suspicious documentation. 11.8 Red flags There exist certain features in trade finance transactions that may provide a warning sign that closer attention is required. These include: “ No requirement for an original or copy transport document and/or pre-accepted discrepancies. “ Inconsistency with customer strategy and/or unnecessarily complex structure and/or non-standard clauses. “ Excessive client pressure and/or avoidance to provide clarity. “ Description of goods not matching, and/or military or potentially dualuse goods. “ Inconsistent shipment locations/quantity of goods exceeds known capacity of containers or usual form of packing. “ Changes of address. “ Unusually favourable payment terms. The above list is not exhaustive and each bank should ensure it has its own comprehensive list and guidelines.115 The FATF has also identified 42 red-flag indicators that are routinely used to identify trade-based money laundering activities. These cover the following areas: “ About the client “ Source of funds “ Choice of lawyer “ Nature of the retainer 11.9 Industry groups A number of international bodies have been established to combat financial crime, with part of their focus being to provide tools to help prevent and/or identify suspect transactions. Many countries have a financial intelligence unit (FIU) that will provide information on current money laundering and terrorist financing trends.116 11.9.1 The Financial Action Task Force (FATF) The FATF is an inter-governmental body established in 1989 by the Ministers of its Member jurisdictions. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. The FATF is therefore a “policy-making body” which works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas.117 11.9.2 The Wolfsberg Group The Wolfsberg Group is an association of thirteen global banks whose aims are to develop financial services industry standards, and related products for Know Your Customer, Anti-Money Laundering and Counter-Terrorist Financing policies.118 //93