Last month, Italy’s Guardia di Finanza announced that they were investigating a Chinese underground banking network suspected of laundering millions of Euros derived from organised crime, mafia drug trade and Russian oligarchs.
In a similar case last August, the National Crime Agency arrested a 33-year-old Chinese national in in northern England linked to “the alleged laundering of criminal cash through so-called Daigou shopping, where high value retail items such as watches, jewellery or designer goods are purchased in the UK and then shipped to China to be re-sold”.
For many financial professionals, underground banking is an unfamiliar phenomenon. The 2019 NCA report “Chinese Underground Banking and ‘daigou’” first highlighted UK law enforcement concern about “CUB” as a money laundering threat and only in the past few weeks have legal sector regulators LSAG published specific guidance on the topic.
For those firms captured by the Money Laundering Regulations, the benefits of engaging with Chinese business must be weighed against the risk of handling funds whose origin may be unclear and which may have been transferred through opaque processes.
What exactly is Chinese Underground Banking?
Chinese underground banking has a long history. “Underground money shops” can be traced back to brokers known as “exchange shops” established to exchange currencies used by different city states in ancient China.
Commerce between China and Arabia along the Silk Road trade routes required the ability to pay for goods further afield. Traditional money transfer became known in Arabic speaking countries as hawala and is mentioned in the Islamic hadith. In essence, underground banking is a centuries-old process, repurposed for the modern age.
Transferring money out of China, even for legitimate purposes, can be challenging for both personal and business customers, due to the inefficiency of China’s official banks and the strict currency controls imposed to prevent capital flight. Many Chinese customers are therefore driven towards informal methods of moving funds.
Underground money shops provide a reliable and efficient international transfer service used by both personal clients moving money overseas and small businesses trading internationally. They also, inevitably, attract those wishing to avoid official scrutiny to move the proceeds of crime and corruption.
It is often inaccurate to think of an “underground bank” as a physical premises. Underground banking is really a catch-all term for a loose collection of services and techniques to move money between locations.
This includes cash smuggling, the use of multiple bank accounts to break large sums down into amounts below the reportable limits and the use of commercial activity to disguise the movement of funds, for example by over- or under-invoicing or moving goods solely for the purpose of transferring value, a process known as Trade Based Money Laundering or TBML.
However, some of the most effective techniques are ageless. In the same way as Silk Road traders would “exchange debts” and pay one another’s bills to avoid moving currency or gold along ancient trade routes, regular trade in both directions may mean that no money has to move at all.
Trusted intermediaries will simply use the cash available to them in London to pay local debts, while cash in Guangzhou is similarly used to pay debts in China. The arrangement is no more unusual than that which allows you to have your salary paid into an account in Birmingham and draw it out with a bank card in Manchester.
Daigou, which has also been linked to underground banking, is simply a type of online shopping. A high demand for Western commodities, particularly fashion brands, has generated a lucrative market in which Chinese customers order goods from a personal shopper based abroad, often entrepreneurial Chinese students taking orders over social media.
Many “daigouers” have a strong online presence and a profile similar to Western “influencers”. Whilst not an illegal activity, the popularity of daigou (simply meaning “buy on behalf of”) has led to it being co-opted by underground bankers as an alternative form of TBML.
Red flags and reporting obligations
China’s bureaucratic and inefficient banking system leaves many customers searching for alternative means of moving funds internationally and a central risk of underground banking is that money transferred is mixed with funds derived from crime and corruption.
Some potential indicators of Chinese underground banking are:
- Transfers of money from multiple origin accounts in China
- Transfers of money in sums just below the reportable limit (currently US$50,000)
- Money received via multiple UK accounts
- Payments from third parties
- Use of an intermediary, agent or corporate structure not directly connected to the client
- Money transferred from unusual locations not directly connected to your client, e.g. Fuqing or Wenzhou in Fujian Province which have a long tradition of underground banking.
You should consider submitting a SAR if you suspect that your client has used underground banking services. You can add clarity and context in your report by making clear:
- That you suspect the use of underground banking services
- The nature of the client
- The nature of the transaction
- What due diligence you have conducted
- Any information you have gathered concerning the client’s original source of funds and source of wealth and which may help to contextualise the transaction
Providing as much detail as possible will assist in identifying crime and corruption, reduce the chance of legitimate clients being associated with criminality and improve wider understanding of underground banking.
In respect of due diligence obligations, Chinese passports and official identity cards provide reliable information about personal clients and detailed information is often available online about registered Chinese businesses, although mostly in Chinese.
Clients whose income has been generated legitimately may be able to provide evidence (again probably in Chinese) of source of funds and/or source of wealth in the form of bank statements and officially stamped paperwork, although the trail may go cold as funds disappear into the informal transfer process and re-emerge from an apparently random third-party account.
So far as understanding official Chinese paperwork is concerned, paying for appropriate compliance advice and translation services is likely to be a worthwhile investment in more significant, high-risk transactions.
Whilst there are risks associated with underground banking, it is important that these risks are properly understood and seen in their broader cultural context. It is critical to UK business that we are able to engage constructively with an important and growing customer base.
Only by building a better understanding of China and Chinese customers can we properly identify and mitigate risk and capitalise on the opportunities presented by Chinese trade and investment.
Laurence Howland, lead consultant of How Compliance Ltd, is the Director Risk and Compliance of Buckles Solicitors LLP prior to which he spent three years as a Senior Financial Investigator with the SRA. He served 30 years with HM Revenue & Customs as an accredited financial investigator and between 2010 and 2014 was the UK’s Fiscal Crime Liaison Officer appointed to the British Embassy in Beijing.
How Compliance Ltd provides a specialist legal compliance service offering bespoke solutions to compliance challenges, including support with the preparation of a Firm Wide Risk Assessment, the implementation of Policies, Controls and Procedures to meet key compliance requirements and the delivery of mandatory training in accordance with the requirements of AML and financial crime legislation.
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