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Money laundering through China:Systemic weaknesses are facilitating global financial crime

By Anastasia Kouloganes and Xiaodan Quan

REUTERS/Kim Kyung-Hoon

2Money laundering through China: Systemic weaknesses are facilitating global financial crime

Innate vulnerabilitiesSystemic weaknesses within China’s financial system have been in the spotlight in recent years as a result of multiple money-laundering investigations spanning the globe. China has responded to increased pressure and criticism that the mainland is “becoming a hub for international money laundering” through steady and ongoing improvements to its AML framework, but Beijing’s primary concern is countering the outflow of money from the Chinese financial system.

The broader issue of money laundering through the Chinese financial system remains a major international concern, because innate vulnerabilities within China’s financial system continue to facilitate global crime. Some pertinent examples follow:

Chinese banks abroadInternational branches of Chinese banks are also under investigation due to alleged connections to international money laundering schemes. Over the past decade, several Europol operations across the EU have begun to uncover sprawling networks of Chinese nationals engaged in money laundering and other illicit activities.1

These individuals are active in a variety of legitimate business ventures, for example, textile factories or restaurants, often having left the mainland determined to turn a profit to send home to family members. Others are involved in illicit business opportunities such as prostitution or narcotics trafficking. While the owners of the legitimate businesses may launder money in order to avoid paying local taxes, the owners of businesses offering illegal services are more likely to launder all profits in order to avoid detection.2 Investigations have revealed situations where individuals used wire transfer companies and local branches of Chinese banks to move illicit funds into mainland accounts. For example, the Industrial and Commercial Bank of China (ICBC) Spanish branch is under investigation for alleged association with money-laundering activity carried out by a criminal network reportedly headed by Chinese entrepreneur Gao Ping.3 Exposed in 2012, the massive network was found to be involved in drug trafficking, prostitution, extortion and other illicit activities, ultimately laundering their proceeds through over 15 companies and bank accounts.4 ICBC services were reportedly used to transfer the funds to China, eventually resulting in the arrest of five ICBC directors in 2016.5

The clash between the Chinese and Western legal frameworks is worth mentioning here: Not only does it appear that the money-laundering network had an easier time moving funds through the banks because of their comparatively vulnerable AML frameworks, but money laundered into accounts in the mainland is said to “disappear” from the point of view of European investigators as a result of privacy and secrecy within the Chinese financial system.6

1 Including: Operation Yellow Dragon, Operation Shadow, Operation Emperor, Operation River of Money, and Operation Snake2 https://usnews.com/news/business/articles/2015/06/05/money-laundering-investigation-stymied-by-china-italy-says?page=2&offset=40 ;

https://imf.org/external/pubs/ft/scr/2016/cr1643.pdf3 https://reuters.com/investigates/special-report/icbc-spain-chinese/4 https://politica.elpais.com/politica/2012/10/18/actualidad/1350590711_935588.html#sumario_85 https://europol.europa.eu/newsroom/news/directors-of-chinese-bank-arrested-in-spain-in-money-laundering-probe;

https://reuters.com/article/us-icbc-spain-investigation/spain-probes-icbcs-european-unit-over-money-laundering-idUSKCN1BM2CV6 http://ibtimes.com/china-obstructed-huge-money-laundering-investigation-italy-report-1953922

3Money laundering through China: Systemic weaknesses are facilitating global financial crime

7 http://lepoint.fr/faits-divers/exclusif-fin-de-cavale-pour-l-escroc-gilbert-chikli-19-08-2017-2150944_2627.php8 http://readingeagle.com/ap/article/ap-investigation-china-launders-cash-of-foreign-criminals9 http://timesofisrael.com/how-a-french-israeli-grifter-became-a-money-laundering-pioneer-in-china/ ; http://lepoint.fr/faits-divers/exclusif-fin-de-cavale-pour-l-escroc-gilbert-chikli-19-08-2017-2150944_2627.php10 http://readingeagle.com/ap/article/ap-investigation-china-launders-cash-of-foreign-criminals

The Gilbert Chikli caseGilbert Chikli, widely credited with pioneering the fake CEO scam, is said to have admitted that he impersonated top executives and intelligence agents to convince bank employees to transfer large sums of money into his accounts. He is accused of tricking many big corporations around the world into paying him $1.8 billion in just over two years. He was arrested on such charges in August 2017 in Ukraine.7 During an interview with the Associated Press in March 2016, he reportedly boasted that he had laundered 90% of the stolen money through China and Hong Kong.8

Chikli is said to have admitted using a variety of methods to launder his stolen money. For example, that he hired a Chinese citizen to pose as the representative of his front company in China and then wired money directly to the accomplice’s Chinese bank accounts. In exchange, the accomplice took a commission of 5% and sent the remaining money to other mainland accounts controlled by Chikli.9

Chikli is also quoted saying he used import-export schemes to launder money. After transferring illicit funds, often to Hong Kong, he would withdraw cash and bribe Chinese vendors. He would then buy small amounts of merchandise with highly inflated receipts and send most of the cash to other bank accounts he controlled. It is then suggested that he ultimately sold the goods and collected the money in an Israeli bank account, using the “legal” paper trail to legitimize all of the profits.10

REUTERS/Beawiharta

4Money laundering through China: Systemic weaknesses are facilitating global financial crime

Trade-based money launderingTrade-based money laundering (TBML) is also commonly used by launderers operating through the Chinese financial system. In many cases, dirty money is sent to accounts in China, often first crossing several borders via wire transfer companies, casinos or other accounts in small amounts before eventually being deposited into a mainland account.

At the same time, a company connected with the scheme in the United States or elsewhere offers money exchange and import/export services to legitimate companies seeking to import goods from China. Taking advantage of the competitive exchange rates offered, the lawful companies use the exchange company as a middle man.

The illicit money in the Chinese bank – the origin of which is often unclear as a result of account layering – is used in mainland China to purchase goods, such as toys or clothing, to send to the importer. The “clean” cash paid to the exchange company by the importer is then paid to the criminal group behind the money-laundering scheme.

A case in point involved three Colombians based in Guangzhou, who used TBML through China to launder over US$5 billion for Spanish and Mexican drug smugglers.11 The Guangzhou Enterprise passed the dirty money through bank accounts in Hong Kong and China to fund purchases of counterfeit goods in China, which were then shipped to Colombia (and elsewhere) and sold.12

This case highlights an important issue, namely that foreigners opening bank accounts and businesses in China can create weak points that can be exploited by criminals. While a select few banks have access to extensive global risk information, many Chinese banks are only accessing local or country-level data. Thus, previously convicted criminals or suspects may still be able to open accounts in China and participate in TBML and other illicit activities.

11 http://readingeagle.com/ap/article/ap-investigation-china-launders-cash-of-foreign-criminals12 https://justice.gov/usao-edny/pr/three-members-international-organization-money-launderers-largest-drug-cartels-arrested

REUTERS/Andy Clark

5Money laundering through China: Systemic weaknesses are facilitating global financial crime

The Guangzhou Enterprise case was far from an isolated example. The 14K ( K) and Sun Yee On ( ) triads are suspected of working with Mexico’s Sinaloa cartel and other drug trafficking groups to provide precursor chemicals for narcotics in exchange for cash, small arms and use of the cartel’s smuggling routes into the U. S.13 Between 2005 and 2011, Los Angeles-based toy store, Woody Toys Inc., was found to have used a TBML scheme through China to launder narcotics proceeds for Colombian and Mexican traffickers.14 These are just a few examples in which the export/import flows from China to the U. S. and other countries are exploited.

13 http://scmp.com/news/hong-kong/article/1403433/hong-kong-triads-supply-meth-ingredients-mexican-drug-cartels14 https://ice.gov/news/releases/co-owner-los-angeles-area-toy-company-sentenced-drug-money-laundering-case

Money laundering is a global operation and each criminal or group may launder their money slightly differently. For cases in which the Chinese financial system is used, dirty money is passed through multiple accounts around the world, either through an exchange or through a criminal’s accounts, and ultimately ends up in a Chinese account. From there, the funds are often used to purchase goods. These goods may be sold in China at inflated prices and the invoices used to legitimize the funds, which are then transferred to the launderer’s account outside of China. In other cases, the purchased goods are shipped to the country or region of the launderers, often with inaccurate shipping invoices to lower fees. Upon arrival, an importer sells the goods to legitimize the funds.

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1 Drugs from Latin America and the Caribbean are trafficked to the United States and sold.

2 Proceeds from these transactions are passed through multiple accounts around the world before being sent to Hong Kong and finally, China.

3 The funds are often withdrawn in cash by exporters and used to purchase goods such as clothes and toys.

4 Goods are sent to Latin America or the United States and are sold. The now-legitimate profits are used to pay for the trafficked narcotics.

6Money laundering through China: Systemic weaknesses are facilitating global financial crime

China’s existing AML framework While China has made some progress in developing its AML and Counter Terrorist Financing (CTF) frameworks, it nonetheless lags other nations.

The beginning of 2007 saw a major milestone when the People’s Bank of China (PBC) issued its anti-money laundering law and China joined the Financial Action Task Force (FATF), spurring the country’s gradual advances in AML infrastructure. Banks in China are now required to provide tellers with training on AML procedures and the China Anti-Money Laundering Monitoring and Analysis Center (CAMLMAC, established in 2004) continues to develop. This center receives information on large value transfers and suspicious transactions reports (STRs) from all banks and financial institutions in China and investigates suspicious activity.

However, while banks do submit STRs, the system faces a magnified version of a challenge faced by AML frameworks internationally: The system’s efficiency is lacking. One study of AML activity between 2007 and 2013 found that China had 187 times as many STRs as that of the UK and 32 times that of the U.S. This may seem acceptable given the population differences in each country; however, the same study noted that the UK has opened roughly five times more money-laundering cases than China based on these STRs.15

Tracking financial activity has also proven difficult. Unlike Western countries, 65% of Chinese monetary transactions are cash-based. This poses a significant challenge to financial institutions when conducting Enhanced Due Diligence (EDD), because even though customers are required to share their income and revenue sources with bank employees, many provide inaccurate information.

The concept of Politically Exposed Persons (PEP) is also still foreign to many Chinese bank employees.16 It is challenging for banks to find sufficient information to perform thorough know-your-customer checks; banks often do not have a comprehensive database to check or verify names.17 Considering the current widespread corruption the government is working to reduce, PEPs pose a significant risk for the banking industry.

Progress is further hindered by the fact that there is no system for different banks to share information – STRs are only shared with CAMLMAC for further investigation. Without interbank cooperation, some high-risk individuals flagged or banned by a bank in China may still be able to open bank accounts at alternate banks.

Many small banks, such as lower-tier or city-wide financial institutions, are likely to face more significant challenges in screening clients, providing comprehensive training to staff at all levels, implementing real-time monitoring and setting up AML departments to prevent money laundering.

15 http://dx.doi.org/10.1108/JMLC-01-2015-000416 https://theasianbanker.com/assets/media/dl/whitepaper/Asian%20Banker%20White%20Paper%20-%20China%20Anti-Money%20Laundry%20(English).pdf17 http://tech.theasianbanker.com/assets/media/dl/whitepaper/Asian%20Banker%20White%20Paper%20-%20China%20Anti-Money%20Laundry%20(English).pdf

7Money laundering through China: Systemic weaknesses are facilitating global financial crime

A lack of cooperation A further issue exacerbating the problems outlined is the apparent disconnect between Chinese investigative AML groups (such as CAMLMAC) and local law enforcement. Bank employees are trained to recognize the signs of money laundering and specialist groups within the banks and PBC investigate cases picked up by employees, but only local law enforcement can enforce AML laws and permanently stop these crimes.

Arrests and prosecutions for money laundering are rare, and even fewer are reported in the media. One researcher was only able to find 60 convictions for money laundering between 2007 and 2013, a paltry number considering that over 24,000 STRs were filed in 2013 alone.18 Of the convictions that were reported openly, many appear to be cases in which money laundering is only a predicate offense paired with other criminal charges, such as drug trafficking. This is likely due to the fact that China does not have a law enforcement entity, such as the U.S. Office of Foreign Assets Control,19 specifically mandated to investigate and prosecute financial crimes like money laundering.

As demonstrated by ongoing cases in Europe, prosecutors outside of China have experienced considerable difficulty gathering information. The money trail seems to vanish once it has entered the mainland financial system, resulting in complications in both proving that laundering is occurring and preventing authorities from tracking and stopping TBML and other illicit schemes.20

It seems that this lack of cooperation is driven by a number of factors. Several ongoing cases in Europe primarily center around state-owned Chinese banks, presenting a direct conflict of interest for state-to-state cooperation in these cases. In addition, China’s views regarding information privacy as it relates to both individuals as well as private and state entities differ from that of some Western states, which plays a significant role in information-sharing challenges, regardless of state-owned enterprise (SOE) involvement. China often considers information a state or trade secret.21

Despite these challenges, some initial cooperative agreements do exist between China and other countries and could be used as a foundation to develop a more comprehensive information-sharing system. For example, the U.S. Financial Crimes Enforcement Network (FinCEN) and CAMLMAC signed a Memorandum of Understanding MoU in December 2015 to establish a framework from which to expand the cooperation between the US and Chinese financial intelligence units (FIUs).22 China has also been a member of FATF since 2007 and quickly addressed many of the identified AML deficiencies in the mutual evaluation report.23

However, China is still not a member of the Egmont Group, an organization that acts as a platform from which 154 member FIUs exchange intelligence related to money laundering and terrorist financing.24 At best, China has anti-money laundering MOUs and information-sharing agreements with Russia, South Korea, France, Japan, Australia,25 and at least 38 other countries.26 While these agreements are undoubtedly a step in the right direction, cooperation with fewer than a quarter of the world’s countries is paltry, given the international nature of money laundering.

Critically, there does not seem to be a path to cooperation between China and LAC countries, which is perhaps one of the reasons that cartels and other money launderers in that region continue to use the Chinese financial system.

18 http://dx.doi.org/10.1108/JMLC-01-2015-000419 http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN026942.pdf20 https://merics.org/fileadmin/user_upload/downloads/China-Monitor/Merics_China-Monitor_36_Law-Enforcement.pdf21 http://globalinvestigationsreview.com/insight/the-investigations-review-of-the-americas-2017/1067465/managing-cross-border-investigations-involving-china-

and-hong-kong 22 https://fincen.gov/news/news-releases/fincen-and-chinas-camlmac-sign-memorandum-understanding-023 http://fatf-gafi.org/countries/#China ; http://www.fatf-gafi.org/countries/a-c/china/documents/follow-upreporttothemutualevaluationreportofchina.html24 https://egmontgroup.org/en/content/about ; https://egmontgroup.org/en/membership/list?field_region_value=asia_pacific25 http://fmprc.gov.cn/mfa_eng/xwfw_665399/s2510_665401/t1412580.shtml26 http://mt.sohu.com/business/d20170113/124208903_556900.shtml

8Money laundering through China: Systemic weaknesses are facilitating global financial crime

Looking aheadWith firm rhetoric from President Trump on placing American interests first, the international community has begun to fear the creation of a vacuum in global economic leadership – one which Beijing may position itself to fill. In response to those rising fears, Chinese President Xi Jinping demonstrated Beijing’s desire to play a greater global role during his speech at the World Economic Forum in Davos, highlighting the issues the world currently faces and what the international community must do in response.

China’s ambitions of playing a leadership role were not suddenly sparked at Davos. China has been seeking various ways to cast itself as a trustworthy and reliable global power: In January 2016, China set up the Asian Infrastructure Investment Bank (AIIB), a new multilateral financial institution founded to bring countries together to address the daunting infrastructure needs across Asia. Although it mainly has a regional focus, its members are from all over the world.

Moreover, in 2014, China unveiled its most ambitious initiative: the One Belt and One Road (OBOR) strategy. This huge connectivity project aims to link China’s trading partners together through both the development of land and maritime routes, creating a range of business and investment opportunities.

Chinese financial institutions are also recognizing the appeal of expanding into the international market. The China Construction Bank and the Bank of Communications have both made international expansion a priority in recent years and smaller banks are likely to follow suit,27 seeking to reap the financial benefits of China’s OBOR initiative and other global economic developments.

REUTERS/Alex Grimm

27 http://scmp.com/business/banking-finance/article/2024676/chinese-banks-sail-uncharted-waters-they-expand-globally

9Money laundering through China: Systemic weaknesses are facilitating global financial crime

Of particular concern is that, if more banks do enter the international market, money launderers will have even more avenues for illicit activity for as long as the vulnerabilities inherent within the Chinese financial system remain.

A further concern is the growth of Chinese diaspora communities in Africa as a result of Chinese development projects and business ventures throughout the continent that could ultimately result in increased illicit activity between the two countries. At the end of 2015, there were over 250,000 Chinese workers on the African continent.28 Although current numbers are difficult to estimate, some of these individuals will likely become residents, settling down and potentially forming new networks that could begin to take advantage of the even more vulnerable AML standards in African nations.

While China has made efforts to improve overall AML standards since the early 2000s, the anti-corruption drive promoted by President Xi Jinping over the past five years has been the government’s primary focus within the realm of financial crime and money laundering specifically. Thus any agreements or improvements to the financial system are likely to block illicit flows of money out of China, as opposed to any funds moving through the system. Nonetheless, any improvements to AML policies and overall financial system integrity are valuable, even if they are unable to stop all activity of international money launderers.

Some policies and programs prompted by the anti-corruption drive may still improve AML regulation as a whole, even if indirectly. For example, China is currently developing an electronic social credit system in which each citizen has something similar to a credit score.29 While it has received criticism both in and outside of China (because it also may incorporate information related to social and political activity), if any system is established throughout the mainland, it may be used by the AML branches in banks to screen customers. This would be a major improvement compared to the current system of inadequate database checks in place.

28 http://sais-cari.org/data-chinese-workers-in-africa/29 http://economist.com/news/briefing/21711902-worrying-implications-its-social-credit-project-china-invents-digital-totalitarian

10Money laundering through China: Systemic weaknesses are facilitating global financial crime

ConclusionAs Chinese banks seek to expand their collective global footprint, they are dedicating more time and resources to compliance with local and international regulations. We should certainly not ignore China’s progress in the AML and CTF arena, but vulnerabilities still remain.

As they strive to progress still further, Chinese banks would benefit from access to comprehensive databases and rigorous research, including, for example, information on PEPs across the globe and up-to-date sanction and narrative sanction lists from relevant authorities. Access to quality research and reliable information would not only enable Chinese banks to better understand and mitigate risk, but should also reduce the risk of regulatory action, which can lead to severe reputational damage.

Ultimately, continuing regulatory gaps are likely to negatively influence China’s wider global political and economic objectives. Urgent action is needed if China is to close the loopholes that continue to facilitate global crime.

Author biosAnastasia Kouloganes is a specialist research analyst covering transnational organized crime, terrorism and threat finance for Thomson Reuters World-Check. She holds a B.A. in Government & Politics and Chinese from the University of Maryland.

Xiaodan Quan, a certified Anti-Money Laundering Specialist (CAMS), is a senior research associate covering threat finance in the Middle East and the Greater China Region for Thomson Reuters World-Check. She holds an M.A. from Elliott School of International Affairs at the George Washington University.

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