The increase in documentation fraud which has adversely impacted financial institutions operating within the trade finance space is an unwanted development that blockchain technology can mitigate.
The types of lending most frequently seen in the trade financing space, including letters of credit, revolving credit facilities as well as guarantees have proven susceptible to fraud. An example of this is where an unscrupulous trader approaches a financier for funding based on the value of the stock/inventory held in a warehouse and the alleged sales of such stock/inventory committed to by a prospective purchaser. In this example, the financer may wish to take security over the inventory. The security may be in the form of a pledge or security cession or assignment over the receivables/claims which the trader may have against a third party purchaser (based on invoices shown). The financier will take a view on, amongst other things:
- the quantity of inventory delivered (or as may be delivered) to the particular warehouse;
- whether or not such inventory was previously encumbered;
- the value of the committed sales to a third party (based on the invoices provided); and
- whether or not such invoices have been previously ceded or assigned in favour of any other third party creditor.
There are cases where these invoices are forged and cessions/assignments duplicated. The result is that the same assets are used to elicit financing from different financial institutions.
It is precisely this risk that has caused leading banks to tighten their due diligence checks and bolster their risk mitigation strategies. We now look at an example below.
Case Study: Hin Leong
The bankruptcy of Hin Leong, one of Singapore’s largest oil trading led to chaos and concern in the market.
It is reported that an employee of Hin Leong forged a document purporting to be issued by a particular company, stating that Hin Leong had transferred a large quantity of barrels of gasoil to another company. That the company secretly sold off a large quantity of the barrels it held in inventory which it used to pledge as collateral for its loans. The forged document was used to secure almost USD60m in trade financing from a financial institution. Following further investigations, a number of other irregularities were uncovered, including inventory shortfalls, overstating asset values, the concealment of derivative losses, manipulation of accounting entries, the use of fabricated documents to facilitate bank transfers (the documents included bills of lading, invoices, swap trade tickets and other trade documents). It is reported that these forged documents caused the banks to advance financing to the company. This was ostensibly achieved by selling and repurchasing cargo at a loss, forging documents and selling the same inventory to multiple parties.
The Hin Leong controversy is one of many in the trade finance space. With this ongoing trend, we expect to see more stringent risk management and compliance measures put in place by financial institutions when engaging in trade finance transactions.
Is digitisation and platforms the solution?
We have previously explored the digitisation of trade finance and the application of a blockchain to record transactions and sequencing (Digitisation of Trade Finance).
The ability to have direct communication with banks and financiers on a single digital platform will mitigate the risk of fraud as duplications and falsehoods could be more easily identified. A blockchain linked platform will have one single, immutable source of the truth. A number of digital trade platforms have already been developed, and many are in process – some with a view to accommodating also the smaller traders.
In our follow up articles, we will further explore blockchain security and other digital solutions as could be used to combat fraud.