by P. Mukundan

In this difficult financial environment, the trading community faces special challenges - from penalties for not respecting sanctions against suspect countries to hijackings and letter of credit frauds. This article discusses the effect of these developments on cargo owners, traders and trade finance banks.


With regard to sanctions, Iran is a prominent country targeted by the Anti Money Laundering/Countering Finance for Terrorism (AML/CFT) requirements set out by the OECD's Financial Action Task Force (FATF) in their report of 18 February 2010. It noted Iran's failure to act on the recommendations set out by the FATF in its last two reports and called upon other countries to protect themselves against the weaknesses in the Iranian financial system.

Recent discussions to monitor the threat of nuclear proliferation by Iran have brought the issue of sanctions once more to the fore. Lists of sanctioned entities and persons have been put out by the US Treasury's Office of Foreign Assets Control (OFAC). Similar lists have been published by the UK and European Community.

Iran has an active economy with a substantial volume of international trade, and interesting and sometimes complex schemes have emerged to bypass sanctions imposed on the country. Unwary banks can find their services being exploited for this purpose.

Sanctioned entities in Iran include shipping companies and some banks. Shipment of containers on board these vessels or the use of designated banks could breach the sanctions. In response, the sanction busters have changed vessel names, container numbers and carriers on the documents presented under trade finance instruments. Some of the sanctioned vessels have been flagged out to other jurisdictions.

In high-risk transactions, banks and traders should verify the identity of the vessel through its unique IMO number. Container numbers should be checked for their authenticity. The International Maritime Bureau provides services to its members to run these checks. Superficial checks may fail to detect the true nature of the transaction.

Somali hijackings

As of 21 July 2010, there had been 104 vessels attacked off the Somali Coast during the year, of which 27 vessels were hijacked and 549 crew members taken hostage. The vessels range from fully loaded VLCCs, bulk carriers, product tankers and general cargo vessels.

When a vessel is hijacked, cargo owners face long delays before the cargo finally reaches its destination. In the case of perishable cargoes, this can significantly devalue the cargo. It is worth ensuring that such a risk is covered under the cargo insurance policy.

Shipowners will try to pass on the costs of additional insurance in freight charges for vessels sailing through this area. These additional costs can involve insurance premiums for maritime kidnap and ransom policies. Alternatively, charterers may be asked to agree to the BIMCO Piracy clause, under which all the costs of the hijacking are met by the charterers - this can run into well above USD 5 million today.

It is wise to consider these risks and how they may be mitigated before the voyage is underway.

"Financial engineering" schemes

The restricted availability of trade finance could become worse if the findings of the Basel Committee on Banking Supervision are implemented. In a consultative document entitled "Strengthening the Resilience of the Banking System", the committee graded trade-related financing as a higher-risk activity which required far greater capital adequacy limits for the banks concerned. The report proposed that the leverage ratio, the CCF Factor trade-related contingencies, be increased from its current 20 per cent to 100 per cent.

If these proposals prevail, this would offer rich opportunities for fraudsters, who offer imaginative financing schemes to traders desperate to find funding for their businesses. Some of these schemes have all the hallmarks of traditional frauds with the usual clutch of red-flag terms and flowery phrases, which are essentially meaningless.

These proposals should normally be easy for banks to identify and avoid. The more dangerous risk for the bank is when trusted customers having the confidence of the bank abuse the credit provided for trade finance to further clever, unrelated schemes. These schemes, dressed up as trade finance, have nothing to do with payment for internationally traded cargoes. In one such scheme, for example, the purpose was to help the companies' partners weather temporary cash flow difficulties.

The trusted customer engages in these schemes, because he stands to earn substantial fees for his efforts. For banks, the problem arises when these customers provide funds on the basis of false or incomplete representations.

A typical recent scenario occurred when a substantial trader agreed to receive a letter of credit from a company in financial difficulty, purportedly for payment of a cargo, deferred for, say, 365 days. The letter of credit called for presentation of copy documents. Taking advantage of its market reputation, the trader convinced a third bank to discount the L/C. From the proceeds it "bought" back the documents from the buyer at a substantially lower price than he sold it. Meanwhile, the cargo was sold to a genuine buyer who paid the trading company through a proper trade L/C against the genuine original documents. In this way, the company in financial difficulty acquired access to credit for 365 days.

The scheme began to unravel when the first buyer was unable to pay on the deferred due date. The bank discounting the L/C now faces substantial losses.

Some of these schemes have been referred to as "financial engineering" by their proponents. But one of the unforgettable lessons of the 2008 financial crisis is that the world needs fewer of these convoluted financial schemes - which invariably involve some form of deception against banks - and more of the simple, upfront financial products needed to keep the wheels of international commerce turning.

Straightforward structured trade finance where goods exist and are shipped from the seller to the buyer is a solid, secure financial product supported, at least in part, by the security in the goods themselves. It is the dubious and complex financial schemes that give trade finance a bad name and may have, in part, prompted the Basel Committee to propose onerous conditions.

Rules such as the UCP that govern the instruments of trade finance may need to recognize the possibility of their abuse and guide participants to identify and prevent it if we are to strengthen the case for self-regulation. When voluntary, contractual rules do not do so, this creates the justification for external regulators to act.

Other examples

In some recent cases, a number of suspicious B/Ls were referred for checking to the IMB in respect of containerized shipments of household items from the Arabian Gulf to North Africa. All parties to B/Ls - including the NVOCC - were the same. No container numbers were listed on the B/L, which in itself is always a cause for concern, although such documents are considered to be compliant under the UCP. The carrying vessels did exist but were trading elsewhere at the time of the alleged shipments.

The carrier on the B/Ls had been previously referred to the IMB on a number of occasions concerning containerized shipments on the above route. In most instances, the documents were found to be false. One shipment from late 2006 related to the alleged shipment of 14 containers of electrical appliances. On this occasion, container numbers were present on the B/Ls. Only one of the container numbers was genuine, but this particular box was headed elsewhere and was not en route to the discharge port. It would appear that as one bank discovered the true nature of the documents, the shippers moved on to other unsuspecting banks.

Earlier this year, after an absence of almost three and a half years, the IMB witnessed the return of one of the one of the most prolific international fraudsters reported by the Bureau. Unlike the previous example, the carriers in this particular series were always different. The transaction related to the containerized shipment of steel scrap from Antwerp to Karachi - a commodity and route this fraudster had used in the past. As in past frauds, the shipping documents looked convincing but bore all the hallmarks of previous fraudulent presentations.

In this instance, the fraudster went to great lengths to add credibility to the shipment by creating a phony carrier's website to enable unsuspecting cargo owners to track the status of their cargoes. This site, interestingly, stated that the containers had all been loaded as per the B/L. However, independent checks done by the IMB quickly confirmed that this was incorrect. The presence of a convincing container-tracking website highlights the degree of sophistication employed by would-be fraudsters and underlines the need for independent verification of the documents.

In a similar series of frauds involving steel scrap cargoes from South America and Northern Europe bound for Asian ports, the IMB identified a number of false trade documents. The stated vessels and containers were not at the ports of loading on the stated dates, although they were regular callers at these ports. The vessels and containers existed but were on different voyages.

The independent checking of shipping documents forms an integral part of the services offered by the IMB to its banking members. The routine, random selection of documents for authentication not only protects the banks from unwittingly lending their names to such schemes, but can also assist in demonstrating to financial regulators that the bank has procedures in place to try and identify illicit activity. The IMB Information Department aims to respond to such enquiries within one working day of receipt.

P. Mukundan is Director of ICC Commercial Crime Services, of which the International Maritime Bureau is a specialized division.
His e-mail is