Global Financial Integrity


A Link in the Chain: Harnessing Blockchain for Trade Integrity 


By Andrew Peters

In March 2020, Global Financial Integrity (GFI) estimated a lower bound of US$8.7 trillion in value gaps identified in trade between 135 developing countries and 36 advanced economies over the ten-year period 2008-2017. This is US$8.7 trillion that is not subject to import or export duties that should ultimately compromise revenue collection to fund education, infrastructure, healthcare and other national and development priorities. This practice is known as trade misinvoicing, the deliberate falsification of the value, volume or type of commodity on invoices submitted to customs in order to illicitly transfer funds between jurisdictions. Illicit actors can also use trade misinvoicing to launder money, in what is known as trade-based money laundering (TBML). 

Customs authorities have an opportunity to establish trade integrity in their country’s trade transactions by shaping distributed ledger technology (DLT) to combat trade misinvoicing. Distributed ledger technologies, blockchain being one, share and verify information across many or multiple devices to increase transparency, reduce risk of tampering and remove the need for a trusted third party. This Centre for International Governance Innovation video explains the impact blockchain can have, because of the way it tracks and stores data, creates trust in the data and removes the need for intermediaries. 

After examining Emmanuelle Ganne’s 2018 World Trade Organization (WTO) study, there are three clear possible techniques for detecting trade misinvoicing with DLT: a) comparing invoices against each other; b) comparing invoices against market rates; and c) comparing values declared to customs with the values in the financial transactions. DLT would allow these documents to be consolidated digitally, such that these checks could be run automatically, cutting down on the amount of time and paperwork for customs officials. The smart contract, a DLT resource that releases funds or conducts other actions automatically when conditions are met, such as goods reaching their destination, could also include automatic payment of customs duties. Two demonstrations by IBM of a DLT international trade transaction and a DLT customs declaration visualize the context of these suggestions. The second half of this piece explores the challenges and opportunities in implementing DLT in international trade. 

The first way customs authorities and smart contracts could use the information available on a DLT platform is by comparing the invoice submitted by the exporter to the invoice submitted by the importer. Depending on the DLT platform, both of these documents should be uploaded and verified on the platform. The smart contract could compare the two documents, adjusting for “cost, insurance and freight” (CIF) and “free on board” (FOB) differences. Most countries report imports on a CIF basis, whereas most exports are reported using the FOB valuation. This CIF/FOB conversion is one of the many challenges in analyzing trade data, along with transshipment and re-export complexities. The use of DLT could potentially improve the quality of trade data available to UN Comtrade, a database of internationally reported trade data. The import and export invoice comparison would allow customs on both sides to identify misinvoicing and charge the correct export or import duties. However, this comparison would not identify “same-invoice faking” where trading partners agree to report the same false value on invoices. Hence the need for the second comparison option.

A second option would be for customs authorities and smart contracts to compare invoices against market rates for that product. This would use the methodology of GFI’s GFTrade tool. Just as customs authorities can do now with GFTrade, the smart contract could compare the invoice value with what that same product is trading for, based on updated official government data from 43 countries. This would identify trade misinvoicing while the shipment is still in the port and allow customs authorities to collect the correct amount of customs duties. Depending on the design that customs authorities decide on, this process could happen automatically without needing case-by-case initiation.

A third option mentioned by Yotaro Okazaki of the World Customs Organization is to have DLT compare the invoices presented to customs and the values sent to the financial institutions involved in the letter of credit process. With customs authorities fully participating in the DLT platform facilitating the trade finance transaction, the smart contract could compare the letter of credit and the invoices to verify that they match. If not, the smart contract could execute payment of the correct customs duties. As Yotaro Okazaki mentions, financial intelligence units, tax authorities and customs authorities could all be viewers or participating nodes on the DLT platform strengthening their abilities to detect trade misinvoicing and TBML red flags. As Ganne says, this would require enhanced information sharing between these government agencies. DLT could facilitate this, but the agencies would also need to work out the legal and practical elements of this information sharing. 

Although DLT is close to tamper-proof, it cannot prevent incorrect information from being uploaded onto the platform. A DLT solution to trade misinvoicing would require verifying the invoice information uploaded onto the system. 

Challenges and Opportunities in using DLT in International Trade

Ganne, in the 2018 WTO study, noted DLT has generated much discussion about possible uses including in international trade, but it is still early and much work needs to be done before DLT can be used widely in international trade. The United States government, through Customs and Border Protection, should be fully involved in pilot programs investigating the efficacy of this technology. Given the important role the US plays in global trade, its government must be fully committed to solving the trade misinvoicing problem and engaged with its trading partners to implement policies that promote trade integrity. 

Indeed, industry players are working on many proofs of concepts, pilot projects and use cases. Maersk and IBM launched their blockchain platform in 2018 and competitors have completed proofs of concept. IBM, Deloitte and Batavia also offer overview videos on their work on DLT in international trade. Key challenges moving forward include whether different DLT platforms can communicate with each other and whether information on DLT is considered legal documentation.

For DLT to be fully implemented in international trade, not only do technological considerations need to be worked through, but all parties involved need to adopt the technology and adapt their workflows. Transportation and logistics providers are leading the way on exploring DLT.  Current pilot projects, trial runs and consortia include the following companies and initiatives: NYK (Nippon Yusen Kabushiki Kaisha), Marine Transport International, Hyundai Merchant Marine Co., Quasa, Blockfrieght and the SAP ocean shipping project. Other actors such as financial institutions, banks, and customs need to be involved for an end-to-end international trade DLT platform to work successfully. Customs has lots to gain by being part of the design process and making sure they can reach their revenue collection mandates. 

As Christine McDaniel and Hanna C. Norberg wrote in their 2019 Mercatus Center study, using DLT in customs procedures can reduce the number of actors in the process and protect both the shippers and customs authorities from illicit activity committed by the other. They also mention that the presence of rent-seeking by industry actors or corruption in customs bureaucracies would undermine the necessary cooperation for adopting DLT in international trade. Some actors in the international trade process may prefer maintaining the ability to conduct trade misinvoicing rather than instituting a platform such as the one described here. There is a risk that this type of DLT resource would work too well for some.

Additionally, Franz von Weizsäcker and Niklas Kossow discuss on KickBack: The Global Anticorruption Podcast that despite the hype cycle around DLT, it is not a silver bullet. But rather, once there is an understanding of the problem and the context, DLT is a meaningful tool for situations with an intense paperwork process, lack of trust and many actors. International trade, especially the intersection of customs and trade finance certainly fits this description. Kossow provides a literature review on digital anti-corruption efforts and highlights potential future research that would increase understanding and implementation of such efforts. Investment in DLT in customs and trade would need a long-term commitment to make the process work and keep it working to yield the benefits of increased transparency and domestic resource mobilization. 

By using DLT to combat trade misinvoicing and illicit financial flows, governments can mobilize their domestic resources to achieve economic empowerment and the UN Sustainable Development Goals. Ultimately, DLT could allow customs authorities to compare and check invoices against the other invoices involved in the transaction, current market price and the letter of credit and other financial transfers. Customs authorities have a chance to seize an important opportunity in the multi-stakeholder cooperation needed for the integration of DLT into international trade. Will they take it?

Andrew Peters is a Summer 2020 GFI intern.