"Flying money" may land in U.S.

There have been some recent interesting and interconnected events dealing with Chinese capital flight that bankers need to know about:

• FinCEN targets two cities. The Treasury organization issued Geographic Targeting Orders (GTOs) that will temporarily require certain U.S. title insurance companies to identify the natural persons behind companies used to pay “all cash” for high-end residential real estate in New York City and Miami. 

• North of the border—and beyond. A report from FINTRAC, the Canadian financial intelligence unit (FIU), says the overly hot real estate market in many Canadian cities poses a “significant risk” for criminal activity.

Similar concerns have been voiced in Australia, the United Kingdom, and other desired locales. News articles report that Chinese investors are paying cash for properties and driving up the cost of real estate.

• Economic exodus. There are worries about the Chinese economic outlook, including the plummeting stock market and a real estate bubble. Paltry returns on savings accounts, the Chinese government clampdown on corruption, and various other factors are combining to encourage savvy Chinese to send wealth out of the country.

Yet how can capital flight occur when the Chinese central government mandates capital controls, limiting Chinese citizens to taking out about $50,000 per year?

How money’s leaving China

One Chinese investor said he doesn’t really worry about limits on sending money abroad.

“The Chinese are known for finding all sorts of channels for sending their money out of the country,” he explains.

These methods include:

• Tapping political and personal connections.

• Using the transfer quotas of friends and family members to get money over the border.

• Channeling funds through gaming and junkets, particularly to Macau.

• Using the special relationship with Hong Kong that serves as a financial conduit to the rest of the world.

• Obtaining special services, allegedly offered to select customers by Chinese banks to funnel money abroad.

However, I suspect that much of the illicit Chinese outflow—including some transfers used for the high-end purchase of real estate—are related to underground finance and its corollary trade-based money laundering (TBML). In China, historically and culturally, trade-based value transfer is used to “balance the books” or settle accounts between underground brokers. Much of this is done via “counter-valuation.” 

For example, Global Financial Integrity, the nonprofit research organization, estimates that for the decade ending in 2011, illicit financial outflows from China primarily in the form of trade-misinvoicing (a form of trade-based laundering) were approximately $1.08 trillion.  

There are additional estimates that gross capital outflows from China have totaled more than $1 trillion from mid-2014 to the end of 2015. This prompts some questions: How much of this is related to underground finance? Is underground finance facilitating money laundering and the Chinese investment boon into foreign real estate? 

Unfortunately, there is little information available. The subject deserves scrutiny.

“Flying Money”

Chinese underground finance has evolved over many centuries. It has existed long before the advent of modern “western” banking. Today, similar to hawala and other better known “alternative remittance systems,” Chinese systems are primarily used to transmit wages.

Law enforcement and regulators have no wish to interfere with hard-working immigrants sending money “back to the home country” to help support extended families. Yet, unfortunately, these financial systems are abused by criminals to move, transfer, and launder illicit proceeds. They are attractive because by their very nature they are opaque. Underground financial systems avoid government scrutiny, taxes, and countermeasures, such as the filing of financial intelligence.

It is believed that fei-chien—sometimes known as “flying money”—was invented during the T’ang Dynasty (618-907 AD). At the time, there was a growing commodity trade within China. Some historians believe it was the rice trade and others the tea trade that were the catalysts for the new financial system.

Ironically, as opposed to modern-day practice, the transfer schemes were not invented as an underground method of evading the grasp of authorities but rather as a tool to facilitate taxation.

Merchants sold their goods and then brought their revenues to provincial “memorial offering courts.” The government collected taxes. In turn, the merchants were issued certificates for the remaining value of the commodity sales. When the merchants returned to their home provinces, they would present the certificates to the provincial government for payment. Thus the fei-chien system became an efficient way of payment via trade-based value transfer. Completing transactions in this way spared both the merchants and government the risk of transporting large sums of money.

Over the centuries, the system continued to evolve. Chinese workers increasingly migrated to other provinces and then overseas. Their families back home generally needed financial support. Expatriate Chinese businesses began to develop side businesses of remitting money back to China.

“System” exported internationally

The international Chinese diaspora spread the indigenous financial system further still. Today, modern Chinese businesses as well as “Chinatowns” and “China shops” are found around the world.

So is flying money.

Strong Chinese family bonds are incorporated into guanxi, which is an overarching social system of rules that govern relationships and social behavior.

Guanxi is the guarantor of both secrecy and the integrity of the parties to the transaction. Violate its prescriptions and find yourself a social outcast, essentially shunned in all circles.” Guanxi is an integral component of fei-chien. In other words, similar to hawala and other indigenous informal value transfer systems an essential element of fei-chien is trust. It is very difficult for outsiders to penetrate the underground financial networks.

Mechanics of a transaction

Alternative remittance systems have been defined as “money transfer without money movement.”

For example, let’s say Wang in Guangdong province wants to send 1 million Chinese yuan of illicit proceeds to his brother in New York City.

Wang gives the Guangdong “flying money” broker the yuan and in turn receives a code number. He trusts the broker as they have a familial relationship. The “flying money” broker in Guangdong directs his counterpart (perhaps a member of the same family) to pay the equivalent in U.S. dollars (approximately $152,000) upon presentation of the code.

The code could be an expression in a telephone call or a message contained in an e-mail. At times, a playing card or a portion of a currency note with a specific chop, marking, seal, or other physical sign must be presented to the broker as a sign of authentication. Upon receipt of the code, the New York “flying money” broker pays Wang’s brother in New York City.

The money never physically left Hong Kong.

Money “flies” in both directions. Money and value is also sent back to China. Like all immigrant groups, Chinese send money back home to help support their families.

The World Bank estimates that global remittances through official channels like banks and Western Union will reach $707 billion by 2016. Nobody has reliable estimates of remittances through unofficial channels. However, the International Monetary Fund believes, “unrecorded flows through informal channels are believed to be at least 50% larger than recorded flows.” Thus according to the World Bank and IMF estimates, unofficial remittances could be well over $1 trillion.

For example, it is believed that more Chinese have gone to Africa in the past ten years than Europeans in the past 400!  Although this is a generalization, most Chinese in Africa do not keep their money in Africa. They send it back to China. So massive amounts of capital leave China and massive amounts return.

Even though “flying money” largely operates on trust, family, clan, and community ties, the brokers are in business to make money. Occasionally they have to settle accounts. Transactions go in both directions. Using the above example, the New York broker might be running a deficit or a surplus with his counterpart in Guangdong. Various methods are used to settle accounts including banks, cash couriers, and online payment services.

Surplus credits could also be used by a client unrelated to the original transactions. For example, credits could be used for the purchase of foreign real estate. For a fee, the client that wants money outside China pays yuan in China to a “flying money broker” and receives credit in the desired foreign location in local currency.

It all comes back to trade

What is often overlooked is that trade continues to be involved with the settling of accounts. Most “flying money” brokers are directly involved or associated with trading companies. Per trade-based money laundering techniques, invoice fraud and manipulation are employed. There are a variety of techniques. However, the most common are over-and-under invoicing.

To move money out:

• Import goods at overvalued prices or export goods at undervalued prices

To move money in:

• Import goods at undervalued prices or export goods at overvalued prices

As a result, an examination of suspect trade by both law enforcement and the financial community could be the back door into underground financial systems such as “flying money.”

How do the “flying money” brokers profit? Although commissions are paid to the brokers at both ends of the transaction, the commissions are less than banks or traditional money remitters such as Western Union charge. In comparison to large brick-and-mortar banks and money transfer chains, expenses are small. Often the brokers use legitimate businesses as fronts such as restaurants, “China shops,” and trading companies. Of course, in the underground remittance segment of their business they skirt regulations and taxes.

Bankers and compliance officers are constantly urged to “know” their customers. Knowledge and awareness of how underground financial systems operate are essential as well as how they may intersect their financial institutions. Understanding the link to trade-based money laundering and value transfer—the next frontier in international money laundering enforcement—is the key.

About the author

John Cassara is a former intelligence officer and Treasury Special Agent and the author of the recently released book, Trade-Based Money Laundering: The Next Frontier In International Money Laundering Enforcement, Wiley, 2015. The book is his source for portions of this article. More information can be found at www.JohnCassara.com

Cassara’s latest book was reviewed by Banking Exchange blogger John Byrne. Read “Money laundering’s other face.”