This paper identifies factors that render free-trade zones vulnerable to illicit trade and financial crime and proposes measures to detect and prevent it.
Free-trade zones (FTZs) are designed to attract trade by suspending the collection of customs duties. These incentives are frequently coupled with advantages such as simplified customs inspection procedures, liberalised incorporation regimes and physical infrastructure superior to that available elsewhere in the same country. These features can be attractive to legitimate businesses and criminal groups alike. International organisations such as the OECD, the World Customs Organization, the Financial Action Task Force and the EU have all highlighted criminal risks related to FTZs.
This paper identifies factors that render FTZs vulnerable to illicit trade and financial crime and proposes measures to detect and prevent it. To explore common challenges and responses that transcend countries’ individual circumstances, it examines four country case studies: Morocco, Panama, Singapore and the UAE.
Based on 74 interviews, two research workshops and an analysis of publicly available literature, this paper identifies key challenges faced by the case study countries, which are also likely to apply to other countries that host FTZs:
The lack of consistent international standards and incentives for the policing of goods that pass through FTZs in transit. Ensuring that FTZs are not abused for criminal gain tends to be a secondary national objective, especially if the goods transiting or being processed in an FTZ never enter the host jurisdiction. Although this gives rise to illicit trade risks that adversely impact foreign trading partners, the experience of case study countries suggests that they face much more international pressure in relation to tax competition matters, whereas illicit trade prevention has not been nearly as prominent an issue.
Inadequate understanding of FTZ-related criminal risks in general and financial crime risks specifically, including at the stage of planning and approving the establishment of an FTZ. At a universal level, all logistics hubs – including sea and rail terminals and airports – are vulnerable by virtue of facilitating high volumes of trade at the fastest pace possible. What makes FTZs different, however, is that they operate under liberalised conditions, including simplified customs procedures. These risks are not always taken into account at the stage of planning and approving an FTZ. Even once an FTZ is in operation, disagreements may persist in relation to key facts pertinent to its criminal profile, such as the volume of cash transactions in the zone. This patchy understanding of risk impedes risk-based law enforcement efforts, anti-money-laundering/counterterrorist-financing (AML/CTF) supervision and efforts to prevent sanctions and export control evasion.
Uncertainty in the division of responsibility for the monitoring, governance and regulation of FTZs, including limited information sharing and failure to involve customs agencies in FTZ-level risks assessment. Despite the variety of approaches to FTZ governance, there is in general some degree of reliance by governments on FTZ administrators to operate the zone, who in turn expect FTZ users to abide by the rules. With the multiplicity of other authorities governing the zone in some capacity, from customs agencies to the police, this arrangement requires clarity about responsibilities and effective coordination, including information sharing. Intuitive though they are, these principles are more honoured in the breach than in the observance. For instance, simply because an FTZ administrator is supposed to carry out due diligence on prospective users does not mean that this takes place to a high standard and the administrator has the right staffing, training and IT resources.
The absence of credible monitoring of FTZ administrators and users, as well as the resulting gap in enforcement. With little to no information publicly available on the monitoring of FTZ administrators’ security-related performance, it does not appear likely to entail any more robust approach than having an informal conversation with the administrator if the zone’s activities reflect poorly on the country’s reputation. Similarly, FTZ users frequently operate in the absence of meaningful oversight. In some cases, there is little to oversee to begin with, as FTZ users face no significant obligations to ascertain that they are not facilitating illicit trade when acting on behalf of third parties.
The lack of proportionate sanctions and AML/CTF supervision of FTZ-based businesses that would take account of the risk profile and volume of FTZ activities. Although no less exacting AML/CTF rules tend to apply within FTZs than in the rest of the territory, the volume and diverse nature of activities in FTZs present challenges that compound the usual difficulties of AML/CTF supervision.
Limited cooperation with the private sector. Despite the contribution that logistics companies and intellectual property rights holders can make to FTZ integrity by volunteering information to FTZ administrators and/or state authorities, gaps remain in both incentivising them to do so and providing avenues for regular submission of information. In contrast, the financial sector is both obligated to report suspicious activity and has a formal process for doing so, but regulators do not often tell financial institutions how to recognise suspicious activity relating to FTZs.
These challenges are formidable but not insurmountable. Over the past year, progress has been made, including by the OECD with its Code of Conduct for Clean Free Trade Zones and the World Free Zones Organization – an industry group representing over 600 FTZs around the world – with its Safe Zone certification programme. Advances have also been made at the national level.
To support the implementation of the new international standards, as well as to address other issues identified in the course of the research, this paper makes a range of recommendations in the areas of: policing FTZs; understanding FTZ-related criminal risks; dividing responsibilities in FTZ governance and ensuring coordination; implementing AML/CTF and sanctions measures; and cooperating with the private sector.
By Anton Moiseienko, Alexandria Reid and Isabella Chase, October 13, 2020, Published by RUSI.org