Caribbean Trade Law and Development

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  • Are AML (Anti-Money Laundering) requirements hindering SME access to trade finance?

    Are AML (Anti-Money Laundering) requirements hindering SME access to trade finance?

    Alicia Nicholls

    Trade finance is the lubricant which facilitates the smooth conduct of international trade transactions. It allows traders to manage the commercial, country and currency risks inherent in cross-border trade transactions. In other words, trade finance is what helps importers pay for goods and services and ensures exporters are paid in full and on time for goods and services rendered internationally.

    A recent World Trade Organisation (WTO) report highlighted that “up to 80 per cent of global trade is supported by some sort of financing or credit insurance”. Although bank-intermediated trade finance instruments, such as documentary letters of credit and documentary collections are major types of trade finance, inter-company credit is also of importance.

    Trade Finance Gaps

    Despite the centrality of trade finance to global trade, the above-mentioned WTO report entitled “Trade Finance and SMES: Bridging the Gap in Provision” found that access to trade finance was not geographically uniform. This is supported by the  Asia Development Bank’s 2015 Trade Finance Gaps, Growth, and Jobs Survey which highlighted that “the global trade finance gap stands at $1.4 trillion, $693 billion of which is in developing Asia (including India and the Peoples Republic of China)” and that “while availability of trade finance has improved, gaps have become more concentrated”.

    Equally striking but not unsurprising is the large gap in access to trade finance between SMEs and MNCs. According to the WTO Report, “globally, 52 per cent of SMEs see requests for their trade finance rejected, against 7 per cent for MNCs”. Even more disconcerting is that “in some large developed countries, up to a third of SMEs face such challenges.”  In the aftermath of the Global Financial and Economic Crisis of 2008, small and medium sized enterprises (SMEs), particularly in Africa and Asia, have found accessing credit for trade increasingly difficult. The Caribbean was not mentioned in the WTO Report but 41.6% of respondents in Latin America identified ease of trade finance as a major obstacle to company’s exports, second only to Africa where 66% shared that view.

    SMEs are important drivers of trade, as well as generators of employment and economic activity. An OECD report stated that SMEs account for 60 to 70 per cent of jobs in most OECD countries. In developing countries, particularly small island developing states like the Caribbean, the majority of businesses would be classified as SMEs. Advances in technology have made new opportunities possible for SMEs. They generate growth and employment, which means trade is not just the domain of multinational corporations (MNCs) anymore. Access to trade finance is vital for SMEs not just to engage in international trade but to expand and to capitalise on market access openings created by trade agreements.

    In the aftermath of the Global Economic and Financial Crisis, banks have become a lot more conservative in their lending practices. SMEs lower access to “good collateral” and often shorter credit histories make them riskier prospects than established companies.  In cases where trade finance requests are rejected, SMEs either have to find an alternative source of financing the transaction or abandon it altogether. SMEs also often lack information on the trade finance options available to them.

    AML/Trade Finance Nexus

    According to the WTO Report, 41.4% of respondent banks cited anti-money laundering and know-your-customer (KYC) requirements as a barrier to providing trade finance. Moreover, the International Chamber of Commerce (ICC) identified the main regulations affecting Trade Finance as the Basel Accords on capital adequacy, liquidity and leverage, as well as regulations relating to AML/KYC/KYCC and sanctions.

    There are three main methods of laundering illicit monies are through the financial system, physical movement of proceeds across borders and through the international trade system. In regards to the latter, the FATF in its 2006 paper raised the importance of combatting trade-based money laundering (TBML).

    In its 2008 Best Practices Paper the FATF defined Trade-based money laundering and terrorist financing (TBML/FT) as:

    “the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimize their illegal origin or finance their activities.”

    Common techniques include over or under-invoicing, multi-invoicing, false descriptions of goods and over and under-shipments if goods.

    Regulators in developed countries have been punitive in the fines and sanctions meted out to banks found to be in violation of anti-money laundering (AML) and know your customer (KYC) regulations. One of the unintended consequences is that banks have started to de-risk, that is, instead of identifying and managing risks on a case by case basis, they have sought to avoid risk altogether through cutting off correspondent banking relationships with banks in high risk jurisdictions or refusing to provide trade finance to firms with higher risk profiles. While banks could reduce their exposure through higher levels of KYC/CDD, the increased costs they would incur often outweigh the profitability from these business lines.

    One of the key findings from International Chamber of Commerce research shows that trade finance transactions have low risks of default, with an average default rate of short-term international trade credit of 0.021%, something which makes trade finance a lot less risky than one might originally think.

    The bottom line

    AML and KYC regulations are important for ensuring the stability and integrity of the global financial system and help to prevent trade-based money laundering which has negative consequences for both developed and developing countries. However, care must be taken that these regulations do not undermine SMEs access to trade finance, especially in poor countries. Denial of access to trade finance has implications not just for SMEs’ ability to engage in international trade, but to expand and to contribute to job creation and economic activity, with wider economic and sustainable development implications.

    In regards to improving access to trade finance, the WTO Report made 6 recommendations, namely reducing the limitations in existing multilateral programmes and increase programme size where possible, set a realistic objective for total trade coverage, increasing capacity building support, maintaining an open dialogue with trade finance regulators, improving the capacity of the international community to read markets and predict problems.

    Indeed, there is a role for closer WTO engagement with the Financial Action Task Force (FATF), the global standard-setter for AML/CFT rules, in dealing with the trade finance/AML intersection. Director General of the WTO, Roberto Azevedo, reiterated these sentiments in his speech at a meeting of the WTO’s Working Group on Trade, Debt and Finance where he opined that “greater cooperation between organisations could again lead to better market intelligence, which would enable us to be more responsive to problems as they emerge”.

    According to the informal report published by the WTO Secretariat of the Expert Group on Trade Finance’s Meeting in April, 2016, a proposal was also discussed by the Expert Group in regards to tentatively increasing the amount of trade covered by existing trade finance facilitation programmes operated by multilateral development banks from the current $30 billion to $50 billion, as well as discussions on the need for improved capacity-building in trade finance in developing countries.

    Besides this, official data on trade finance is lacking, and especially so in the Caribbean. As was noted by the Bank of International Settlements (BIS) in a 2014 report, there is no single or comprehensive source of statistics from which one can estimate the size or composition of trade finance markets. Further research needs to be done on financing challenges experienced by SMEs seeking to participate in international trade and on the impact that de-risking is having on trade finance. Such research will be critical in identifying the scope of the problem and in crafting strategies for monitoring and mitigation.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is an international trade and development consultant. You can read more of her commentaries here or follow her on Twitter @Licylaw.

  • What the debate on the Panama Papers forgets

    What the debate on the Panama Papers forgets

    Alicia Nicholls

    No two words have evoked as much emotion and debate internationally in recent weeks as have the so-called “Panama Papers”. The moniker refers to the cache of over 11 million emails, invoices and other documents leaked by a whistle-blower and originating from the Panamanian international law firm Mossack Fonseca.The files reveal the firm’s use of offshore vehicles registered in several offshore financial centres (OFCs) around the world to help thousands of international celebrity, public official and otherwise wealthy clients worldwide in their tax and asset management. The potential fall-out of the Panama Papers for Barbados was one of the topics of discussion by a panel at the Barbados International Business Association’s very informative Update Seminar last week Thursday.

    Read my full article in the Broad Street Journal here.

  • Are Citizenship by Investment programmes sustainable?

    Are Citizenship by Investment programmes sustainable?

    Alicia Nicholls

    The International Monetary Fund (IMF) in its end of mission press release following its recently concluded Article IV Consultation mission in St. Kitts & Nevis highlighted that strong construction activity, driven in part by large real estate projects funded under the island’s Citizenship by Investment (CBI) programme, had contributed significantly to the island’s five percent economic growth in 2015. Although the Article IV report itself has not been made available, the end of mission press release noted as follows:

    “The outlook for 2016 is positive, but remains dominated by developments in CBI inflows. Growth is expected to moderate to 3.5 percent in 2016 and 3 percent, on average, over the medium term, reflecting a tapering of construction activity associated with a potential slowdown in the pace of new CBI applications, given the increased competition from new CBI programs [emphases are this Author’s].”

    Two main things are clear from this paragraph and indeed from the entire press release. Firstly, St. Kitts & Nevis’ CBI programme, which has been in existence since 1984 and was the first of its kind, has contributed significantly to the island’s recent macroeconomic performance at a time when some Caribbean countries are still seeing sluggish GDP growth. Secondly, the IMF has concerns about the sustainability of this  CBI-led growth. This is reflected in the lower GDP growth rate projected for 2016 and for the medium term. It raises the question of how sustainable a role can CBI programmes play in fostering growth and development in the host country.

    Citizenship by investment programmes or jus pecuniae (economic citizenship) remain a controversial topic in the Caribbean. Despite this,  given the high level of indebtedness of many Caribbean countries, the need for economic diversification, the fickle nature of foreign direct investment inflows and limited access to concessional borrowing, Caribbean countries are increasingly considering their attractiveness. In January this year, St. Lucia recently joined four other Caribbean countries (Antigua & Barbuda, Dominica, Grenada and St. Kitts & Nevis) as the fifth Caribbean state currently operating a CBI programme. Each of these programmes differs in terms of fees, types of qualifying investment and admission and other qualification criteria.

    If managed well, CBI programmes can be an important source of targeted foreign direct investment and other foreign exchange inflows. They can also be alternative means of financing infrastructure projects which might be otherwise unattractive to most private investors. As an example, the Government of Dominica recently announced that its West Bridge project under the Roseau Enhancement Project will be financed through its CBI programme. Without private sector-led involvement, such projects would require use of government’s tax coffers, borrowing or public-private partnerships. Construction activity pursuant to these projects, where provided for, contributes to economic activity and generates employment. High Net Worth Individuals (HNWIs) and their families  also bring with them expertise, contacts and know-how to the businesses which they establish. CBI programmes can to some extent contribute to poverty reduction by creating employment and creating infrastructure in rural communities.

    Growing global demand for Second Passports

    There is also no disputing that global demand for second passports is increasing. Contrary to popular belief, this demand is not fuelled in the main by nefarious purposes but by HNWIs either fleeing political or economic instability in their home countries or seeking the greater mobility a less restrictive passport could bring. Caribbean passports, for example, rank among some of the least restrictive passports outside those of metropolitan countries.

    A growing and increasingly mobile Chinese, Russian, Middle Eastern and African HNW class, and continued instability in the Middle East, are two of the major developments to watch. Turning to this hemisphere, Fortune reports  that 2015 was the third straight year in which a record number of US citizens renounced their US citizenship. Besides the onerous reporting requirements under the Foreign Account Tax Compliance Act (FATCA), the main factor is that under US law,  American citizens or resident aliens living or travelling outside the  US are mandated to file taxes in the US in the same way as those resident in the US. Moreover, if media reports are to be believed, that number may jump depending on the outcome of the presidential election this fall! It is therefore no surprise that citizenship planning is a multibillion dollar global industry.

    Sustainability issues

    While it is unlikely that global demand for second passports will abate anytime soon, there are concerns about the sustainability of these programmes not just because of the inherent reputational risks to the host countries if applicants are not thoroughly vetted, the implications for loss of visa-free access with third states, but also the security implications in the context of the free movement of persons as envisioned under the CARICOM Single Market and Economy. For example, St. Kitts & Nevis had to revamp its programme after the US and Canada raised concerns. The latter revoked visa-free access  to Kittitian nationals. I have touched on these issues in previous articles so my main focus here is on issues of economic development.

    Like all inflows, CBI  revenue inflows are not guaranteed and could leave a country in the lurch if there is a sudden drop in inflows due to competition from other CBI programmes globally. It is a concern that the IMF rightly raised  in its Article IV end of mission press release in regards to St. Kitts & Nevis. Even so, market and size constraints mean there is only so much real estate and tourism construction activity which can take place in a small country at once, and concerns have been raised that increased demand for luxury real estate could drive up the general price of real estate, making it unaffordable to ordinary persons.

    The CBI programmes in the Caribbean are direct citizenship programmes, which means that once all fees are paid and due diligence requirements met, a qualifying investor is granted citizenship on the basis of a one-time qualifying investment and is not required to be resident in the country for any period of time prior to applying for citizenship or afterwards. A slight exception is that under Antigua & Barbuda’s CBI programme  an investor may lose citizenship if he fails to spend at least 5 days in Antigua & Barbuda during the period of five calendar years after having obtained citizenship. Five days out of a possible 1,826 days is hardly any time and only applies after citizenship is obtained.

    This may be contrasted with residence-to-citizenship programmes, such as the US’ EB-5 programme, which require a period of residency before an investor may apply for citizenship. The lack of a residency requirement means there is no incentive for the investor to reside in the new country of citizenship or contribute through expenditure, tax paying or otherwise once he receives citizenship.

    Some countries seek to address this by establishing a relationship with their new citizens. In this article on the Government of Dominica’s website, the Prime Minister of Dominica is reported to have visited and addressed several new citizens of Dominica in Europe, Asia, Dubai and the Arab Emirates and “impressed upon them the importance of their contributions for the development and modernization of [their] country.”

    Another option could be to do like Malta did and introduce a one-year residency requirement. A drawback is that this would increase the waiting time for the potential investor, making such a programme less competitive.  While one could argue that this has not hurt Malta which is currently  ranked as the top global residency and citizenship programme on Henley & Partners’ Global Residence and Citizenship Programs 2016 report, I believe that its  visa-free access to 168 countries, including EU citizenship, offsets any negative fall-out from having a residency requirement.

    Conclusion

    To go to the heart of the question posed in this article,  CBI programmes have their benefits. The revenue  inflows and the economic activity generated make the macroeconomic fundamentals of a country look good. However, they should not be relied on exclusively as an engine of inclusive growth and sustainable development.

    Careful planning is needed to ensure that investment under CBI programmes is steered towards targeted growth areas and sectors which can boost economic diversification and growth. To some extent we are already seeing this being done. CBI-funded projects in St. Kitts & Nevis are adding to the appeal of the island’s tourism product. St. Lucia is using its programme in order to develop its luxury tourism and real estate sectors. However, this should be done in a sustainable way in order to boost development and at the same time having a minimal adverse human and environmental impact.

    The IMF has also made a very interesting suggestion in its above-mentioned press release that the categories for qualifying investments under the Citizenship by Investment regulations be broadened to include renewable energy, education and health. This merits consideration by policy makers. However, promoting investment in these sectors would require more marketing as their profitability for investors may not be immediately apparent.

    The IMF also recommended the need for a prudent framework that “would help build resilience to a sudden stop in CBI inflows, and facilitate the accumulation of fiscal buffers necessary to address natural disaster shocks and absorb unforeseen financing needs if tax performance disappoints after a slowdown in CBI inflows”. The Fund also emphasised that a Growth and Resilience Fund using savings from the CBI programme should be established which could be used as a contingency buffer in the case of natural disasters.

    Besides these very timely suggestions, it would be useful if Caribbean countries released more data about the operation of their programmes. For example, periodic impact assessments should be done on the operation of the programmes and made publicly available, highlighting their contributions, challenges and whether they have met their targets. Such an exercise would not only assist policy makers in their policy planning but also show the public that CBI programmes are not a cloak used by unsavoury characters to conceal their illegal activity but are a policy tool to assist in development. I would also add that countries should continuously evaluate and monitor, and where necessary, revise their due diligence frameworks, to ensure the integrity of their programmes.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is a trade and development consultant with a keen interest in sustainable development, international law and trade. You can also read more of her commentaries and follow her on Twitter @LicyLaw.

  • CARICOM countries continue fight against bank de-risking

    CARICOM countries continue fight against bank de-risking

    Alicia Nicholls

    The countries of the Caribbean Community (CARICOM) are continuing their fight against bank de-risking practices which are resulting in the restriction, threat of, or outright termination of correspondent banking relations with banks and wire transfer providers in the Caribbean region.

    Onerous global and national regulatory requirements (such as anti-money laundering and combating the financing of terrorism standards), burdensome compliance costs and the stringent sanctions for breach of these regulations are increasingly leading banks in metropolitan countries, particularly in the United States, to de-risk, that is, avoid risk by discontinuing business with whole classes of customers without taking into account their levels of risk, as opposed to managing and mitigating risk. While other countries are also experiencing this disquieting phenomenon, the Caribbean appears to be the most affected region according to a World Bank survey conducted last year.

    There are a number of other factors influencing de-risking decisions. Besides risk and reward considerations, added to the mix is the growing perception of the Caribbean as a “risky” place for financial transactions. The unwarranted attacks against legitimate offshore financial centres in the Caribbean in the wake of the Panama Papers scandal will no doubt unfortunately add fuel to the fire. The net result is an increasing unwillingness of international banks to continue correspondent banking relationships with banks and wire transfer providers in the region.

    Belize has been the hardest hit so far by bank de-risking, but other Caribbean countries are also being affected. In the International Monetary Fund (IMF)’s Caribbean Corner publication of September 2015, it was reported that “[a]lready at least 10 banks in the region in five countries have (as of June 2015) lost all or some of their CBRs, including two central banks.” This number has grown.

    At the meeting of the Financial Stability Board in Tokyo in March this year, Barbados’ Central Bank Governor, Dr. Delisle Worrell, reporting in his capacity as co-Chair of the Financial Stability Board’s Regional Consultative Group for the Americas, highlighted that eight correspondent banking relationships in Barbados’ international business sector have already been severed. He further warned that the lack of correspondent banking services could lead individuals to utilise unregulated channels, thereby limiting transparency and adding further risk to international transactions.

    The loss of correspondent banking relationships disrupts the processing of financial instruments, such as credit card transactions and cheques,  needed for trade, investment, tourism and remittance flows, and would effectively de-link regional economies from the international financial system. It also has humanitarian and poverty eradication consequences as well. Remittances are the “bread and butter” for many poor families who depend on earnings made by breadwinners abroad. In light of the serious threat posed to the region’s economic, financial and social stability by de-risking, CARICOM heads of government took the decision to raise the issue not just bilaterally but in multilateral fora.In March Caribbean countries sought the Organisation of American States’ support.

    Last week, Prime Minister of St. Kitts & Nevis, Dr. Timothy Harris took the lead during an important consultation with officials from the US State and Treasury Departments in Washington DC raised the serious impact de-risking was having on regional economies. The issue was also raised at the recently concluded Ninth UK-Caribbean Forum. The Ministers noted at paragraph 9 of the Communique:

    The Caribbean therefore called on the UK to continue to work with international
    partners to address this global phenomenon, and to encourage banks which
    provide correspondent banking services, and regulatory authorities, to take
    into account the efforts being made by Caribbean countries and financial
    institutions to implement international regulations and to mitigate risks.

    The full communique from that meeting may be viewed here.

    The Caribbean Association of Banks has also been playing a critical role in lobbying efforts. At the Association’s recently held CEO Forum on May 3rd, parties came together “to explore potential solutions and develop a set of actions in response to this threat”. According to the press release, the Forum “discussed and agreed” on the following possible solutions:  the establishment of a clearing institution in the US, alternative Payment Methods and alternative Correspondent Banking Relationships. The forum also established a six member committee to advance these recommendations. The full press release from the CAB’s CEO Forum may be viewed here.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is a trade and development consultant with a keen interest in sustainable development, international law and trade. You can also read more of her commentaries and follow her on Twitter @LicyLaw.