BG: 7 Signs To Spot A House Of Cards

Statistics will proudly boast that international trade is valued in the trillions of dollars each year. This is the world of international trade where invoices, warehouse trust receipts and bills of lading are exchanged between producers and end users of essential commodities such as grains, metals and oil.  These bits of paper are passed through numerous hands before reaching the end users as traders and their banks place themselves in the trade flow adding multiple layers of liquidity on a single cargo. This world of documents solely reliant on the purported truth of the representations contained on its face is blind to the world of the physical movement of goods. The two worlds are disjointed, moving at different speeds and involving different actors, creating the potential for synthetic trades or sometimes even fake trades. The prevalence of multiple financing cannot be understated: for every high-profile trade fraud case such as the Qingdao scandal in 2014 and Access World in 2017, there are numerous others handled in private arbitrations by lawyers like myself.  With the wheels of international trade turning increasingly on monetizing documents rather than goods, what more can be done to shed some light on the murky world of paper shuffling in international trade?

What is the problem?

With an increasingly connected world wiping out arbitrage opportunities on price margins, traders have turned to structuring their trades to leverage on credit positions to create margins. Documents such as a bill of lading or a warehouse receipt are treated as title documents to the goods. These documents are then used as security or monetized for credit terms from other buyers or borrowing facilities from banks. Put another way, credit is effectively the new commodity and the underlying goods are just ancillary. But the shrewd trader knows a better way of making money – the trader can “roll” these title documents such that these documents are monetized through a string of buyers before returning to the original seller. The diagram below provides an example of how a circular trade is carried out on paper while physical goods are moving to a completely different end buyer.

In a voyage between West Africa or South America to Asia (which consumes a significant proportion of global commodities), a trader has several weeks to “roll” its title documents. With a warehouse receipt, the lead time is months. As long as the title documents are returned before final delivery to its final buyer, no one is the wiser of this synthetic sub-trade. The opportunity and indeed the reward to multiple finance the same cargo, couldn’t be greater.

Revenue is booked across the string of buyers, banking lines utilized – everyone is a winner in this game of musical chairs. As long as the music keeps playing.

But every now and then the music stops because there is a liquidity crunch, typically when a trader overleverages itself.  After the smoke has settled and the mirrors broken, we find some bewildering trade flows with the banks caught blind, holding on to worthless title documents that have been duplicated numerous times over.

With fake title documents, a phantom trade can be created in parallel to a real trade using the same details of an actual voyage but with different buyers. By the time, this “mirror” trade is detected, the cargo is often untraceable or consumed leaving different banks to the realisation that they have all financed the same cargo

Why does it happen?

The short answer as you can expect, is that trade fraud generally happens because of a desire to create liquidity rather than as an orchestrated master plan targeted at specific companies. At the heart of multiple financing, lies three key ingredients. First, there must be credit, typically in the form of multiple lines of financing through numerous banks all of which are unable to identify if they are lending for the same cargo due to a combination of a lack of a central repository and traditional banking secrecy laws. Second, title documents like bills of lading continue to exist predominantly in physical paper form. A “negotiable” bill of lading often used in trade effectively operates as a blank bearer cheque as the buyer’s name will be deliberately left empty to facilitate negotiation to any third party. Given the ease of which a party can manipulate the information on a bill, it astonishes me that banks are still in the practice of lending money off the back of copies instead of originals of such documents. Third, there needs be a string of traders involved each sat in different countries to exploit fragmented information gaps. As bills can be manipulated easily, each pair of hands it passes through increases the risk of fraud. Add to that, a few of the world’s largest trading houses and trading banks into the chain and a phantom trade now gains credibility. Surely, if the documents have passed through these large institutions, they must be legitimate?  Too much comfort is placed on the documents if they pass through these institutions and not enough scrutiny on how these documents originated in the first place. A large institution in a phantom trade flow is instrumental as it serves to deflect attention — for an easy margin these institutions can unwittingly give a phantom trade a veneer of legitimacy. The smoke and mirrors are now in place.

The Solution

With banks and insurers losing astronomical sums in multiple financing cases, is there a solution in sight? Blockchain with all its potential has yet to change this facet of international trade. Yes, there have been numerous platforms created based on the fundamental blockchain technology of an immutable distributable ledger so that a single cargo cannot be tacked twice by users on the platform. Unfortunately, therein lies the biggest challenge with blockchain – for it to reach its full potential to eradicate multiple financing, it will require a significant amount of participation from the world’s trade finance banks and trading houses. Instead of waiting for blockchain to change international trade, a better approach would be for banks and traders to spend more time on the transaction due diligence than being distracted by easy margins.

After years of analysing trade flows, here are 7 red flags to look out for:

  1. The Conduit Trader

Who is the conduit trader? There is no one particular give away but a combination of signs may suggest a trade is not in the business of physical cargo. The conduit trader is not a product specialist – it may trade steel today and oil palm tomorrow and then cashew nuts the day after. It’s spike in revenue in a short period may be telling. It will not know what type of carrier is needed to carry specific products or the average voyage time of the trade route. Put simply, it will not know the operational aspects of physical trading which increases the probability of its role being a conduit for shuffling paper documents – a set up that can be done with just a handful of staff and a small office space in the trading hubs of Singapore, Dubai or Switzerland to get access financing.

  1. Credit Insurance

Credit insurance serves a critical function in international trade. However, where an insured is unable to convince a bank to finance it without credit insurance, it raises issues on the inherent credibility of the transaction.

  1. Unrealistic Margins

It may seem simple enough but in today’s world of trading, if a trader is confident of pulling off unusually big margins or an opportunity for a once in a lifetime undervalued cargo, then perhaps there is some truth in the old adage that if it is too good to be true than it probably isn’t.

  1. High Sea Sales

High Sea Sales are a common practice of international trade where goods are bought and sold while on the water. Such practices however create challenges to a party seeking to verify the authenticity of the trade and the feasibility that it hasn’t been financed by someone eslse.

  1. Discrepant Documents

I am often approached to determine whether a bill of lading is fake or forged. This is a notoriously difficult task to undertake conclusively but the suite of documents presented for payment contain representations that could and should be tested.

  1. Transaction Due Diligence

A combination of factors operate in tandem to lull a lender into taking its eye off the transaction due diligence. Maybe it’s the lure of margins from a trader with phenomenal growth or an unblemished trading record. Why is a smaller trader placed between two large traders who already know each other? Who originated the transaction? Can each party justify its role in the chain? Questions which I often ask when things go wrong, would be better placed at the due diligence stage of an on-boarding.

  1. Copy BLs

Copy BLs are surprisingly still very much part of trade finance. The obvious refrain is trust – parties trust that a trader that presents a copy bill will back it. The problem is that few have stopped to ponder if their institutional counterparts could have also been duped in this merry-go-round of bills.

A house, even that of cards, is not built overnight. If you would look hard enough, the signs will often be there.


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