and Money Laundering Risks
Free ports and free trade zones (FTZ) are special-status areas in which the tax and customs rules that are applicable within the surrounding jurisdiction do not apply. Usually established to stimulate economic activity, free ports and FTZs offer certain financial advantages to companies that operate within them, however, they also present opportunities for criminals to exploit their relaxed regulatory environments to move illegal funds around the world or finance terrorist activities.
Accordingly, financial institutions that deal with free ports and FTZs must understand the regulatory responsibilities of doing so and how to implement suitable AML/CFT measures in order to detect and report customers that are attempting to launder money.
What is a Free Port?
Free ports and free trade zones (FTZ) have existed for centuries in locations around the world and famous examples including Livorno, Genoa, Hamburg, Singapore, and Hong Kong. While located geographically within a host country, free ports and trade zones legally exist outside it and so usually allow companies to manufacture, store, import, export, and re-export their goods while deferring or avoiding standard tariffs, duties, and taxes.
There are currently around 3,000 free ports and trade zones in hundreds of countries across the world. The European Union hosts 83 free ports within its 21 member states, while the UK recently proposed opening new free ports and special economic zones as a way of strengthening its post-Brexit economy.
The emergence of free ports around the world has been accompanied by criticism from regulators, pointing out the increased criminal risks that they bring. The European Commission recently characterized free ports as “the new emerging threat” and encouraged a greater regulatory focus on them, including more robust applications of AML/CFT legislation and an increase in independent audits.
The minimal regulatory requirements of free ports and FTZs offer legitimate businesses certain commercial advantages but also allow criminals to evade the AML/CFT scrutiny that would usually be imposed on them. Banks and financial institutions that deal with free ports and FTZs should be aware of the following money laundering risks:
AML/CFT standards: The AML/CFT legislation applied in free ports may have been in place for a long time and may not have kept pace with the AML/CFT regulatory landscape, leaving the port administrations open to emerging money laundering or terrorism financing methodologies. Similarly, new types of business may fall outside the scope of a free port’s AML/CFT legislation, allowing companies in those sectors to operate without regulatory scrutiny. Regulatory disparity adds to the AML challenge: many countries do not apply the same AML/CFT regulations to goods or transactions within their free ports and criminals may be able to exploit that disparity to disguise or move illegal goods and funds.
Oversight: Firms that operate within free ports and FTZs may be able to do so without the robust regulatory and administrative oversight they would receive elsewhere. Authorities within a free port may be hindered by the bureaucratic complexity of their special environment and be unable to track shipments of goods with the same diligence and accuracy that they would in their surrounding jurisdiction. Similarly, jurisdictional confusion between national authorities may slow down or delay investigations into suspected money laundering activities. Deficiencies in direct oversight often allow criminals to use free ports to move illegal goods and funds with the appearance of legitimacy.
Vulnerable goods: Certain categories of goods moving through free ports and FTZs are particularly vulnerable to money laundering. The volume and frequency of shipments of those vulnerable goods make them an attractive target for criminals seeking to engage in trade-based money laundering and associated methodologies. Types of goods that present elevated risks of money laundering in free ports include:
- Cigarettes and alcohol: High tariff items such as cigarettes and alcohol are often used in smuggling schemes because of the increased profits that can be generated by not paying tax on shipments. Free ports and FTZs offer opportunities for criminals to move items like cigarettes and alcohol into countries while avoiding high duty and tax rates.
- Luxury goods and IPR violations: In environments with high volumes of goods, it can be difficult for customs officials to verify the contents of individual shipments. Criminals may seek to import luxury goods into a free port, re-package or relabel them and then export them to a third country free from any connection to their originating country. Similarly, criminals may seek to move items with intellectual property right (IPR) concerns by exploiting irregular or inadequate inspection schedules.
Electronic items: Shipped in high volumes, electronic goods may be used in carousel VAT fraud schemes in which criminals claim back tax illegally. Free ports are particularly useful for storing large amounts of electronic goods: the more that can be stored, the more illegal tax can be claimed back by criminals.
Governments, financial institutions, and businesses must work together to prevent the exploitation of free ports and free trade zones by criminals.
The AML/CFT vulnerabilities of free ports often stem from weaknesses in FTZ administrative governance and the information sharing procedures with national authorities. Accordingly, banks and financial services firms that deal with free ports and FTZs should seek to address those vulnerabilities in their risk-based AML programs, adjusting their regulatory response in proportion to the level of risk their customers present. Broadly that means implementing the following measures:
- Appropriate customer due diligence to identify and verify the customers with which they are doing business in a free port. CDD should extend to beneficial ownership of customer-entities and involve enhanced due diligence for higher risk customers.
- Transaction monitoring measures to detect suspicious financial activity, including unusual transaction patterns and transactions with high risk countries.
- Sanction screening to ensure that customers are not featured on international sanctions lists and similar watchlists.
- Screening for politically exposed persons (PEP) who might present a greater risk of being involved in money laundering.
- Monitoring for adverse media stories that involve customers and that might indicate that their money laundering risk profiles have changed.
Free port governance: The governance of FTZs is typically handled by private companies or by public-private partnerships, but the extent to which those entities are expected to enforce the laws and regulations of national authorities is often unclear – and may significantly affect the AML risk that a free port presents. Disparity between the regulations of international jurisdictions and different FTZs adds to the complexity of the AML/CFT challenge.
In response, many international organizations have urged the harmonization of global customs procedures in free ports and FTZs. The World Customs Organization, for example, has set out the SAFE framework, a series of global recommendations to strengthen the effectiveness of customs controls against threat of international terrorism and organized crime. Similarly, the OECD has made commitments to increasing the transparency of FTZs in its member states. In October 2019, it created the Code of Conduct for Clean Free Trade Zones, a series of recommendations that free port and FTZ administrators must implement in order to qualify as a ‘Clean Free Trade Zone’. The Code emphasizes the need for protocols governing digital record-keeping and information sharing between administrators and national authorities.
Firms may seek to use regulations and recommendations such as the OECD’s to inform their AML process and evaluate the level of money laundering risk that a given FTZ-based firm presents.
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Disclaimer: This is for general information only. The information presented does not constitute legal advice. ComplyAdvantage accepts no responsibility for any information contained herein and disclaims and excludes any liability in respect of the contents or for action taken based on this information.
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