Examining China's underground banking system

A 33-year-old Chinese national was detained in Teesside as part of a National Crime Agency investigation into a suspected Chinese underground banking network, according to a report from Britain's National Crime Agency (NCA) on August 4 of last year. The inquiry was allegedly tied to "the alleged laundering of criminal cash through so-called daigou shopping, where high-value retail items such as watches, jewellery or designer goods are purchased in the UK and then shipped to China to be re-sold," they continued.

As compliance experts, we are all aware of the duties that the Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 place on any company that falls within its purview and that these obligations are expanding. Companies that do not live up to the high requirements face harsh regulatory fines. High-profile London law firm Mishcon de Reya agreed to pay a fine of £232,500 in January 2022 for failing to perform proper due diligence on four linked clients and failing to give personnel with the necessary training.

Although legal firms are conversant with the regulations themselves, it is not always easy to put them into effect. Anti-money laundering (AML) risk decisions usually rest on assessments of what constitutes enough and sufficient due diligence, what could or might not be suspicious, and what is or is not standard corporate practice. These decisions can be particularly difficult if you are working with a person or organization that is located abroad and has a different language, culture, and set of business customs.

Chinese shadow banking is not a recent phenomenon. The "underground money shops" of China have their origins in the ancient vassal republics of China that issued their own unique currencies and compelled visiting traders to convert their currency money at "exchange shops" upon arrival and departure. In order to avoid the need for real cash to travel at all, commerce along the Silk Road between China and Arabia developed a demand for brokers at the endpoints of the main trade routes who were willing to settle each other's obligations. In many Arabic and South Asian nations, the practice of using dependable middlemen to settle debts is known as "hawala," and it is also referenced in Islamic hadith. Although it may appear strange to Western eyes, the exchange and payment of loans in order to facilitate commerce served as the model for contemporary banking in many respects.

Therefore, contemporary subterranean banks in China are a fresh incarnation of an ancient institution that have rediscovered and adapted historic informal value transfer methods for contemporary use.

China has just recently come under scrutiny as a potential source of money laundering. Chinese Underground Banking and "Daigou" was the title of a report released by the National Crime Agency (NCA) in October 2019. It underlined the threat and, in particular, the role that daigou shopping plays in the transfer of money across jurisdictions. In a joint statement released in July of this year, MI5 and the FBI highlighted the danger the Chinese Communist Party poses through espionage, technology theft, and the abuse of academic and professional ties. As a result, the benefits of promoting Chinese investment and industry present difficult questions about how money moves across international borders and where it comes from, or its ultimate use.

China's official banking system continues to be essentially unsuited for purpose, with glacial bureaucracy and excessive delays posing obstacles to cross-border trade and commerce, despite the country's spectacular economic progress. The implementation of strict foreign exchange regulations in an effort to stop Chinese citizens from fleeing the country with their newly earned riches is one of the factors contributing to this. As a result, many smaller companies seeking to deal with Western nations are compelled to use alternate methods of transferring money.

With a variety of methods to transfer value from one jurisdiction to another, underground money shops offer a quick, reliable, and trustworthy international transfer service, though they are illegal. They draw a wide range of clients, including small business owners, people purchasing foreign real estate, parents paying for their children's international schooling, members of organized crime organizations, and corrupt politicians who want to move their money abroad and out of China's reach.

It is helpful to conceive of the Chinese underground bank as a loose conglomeration of many services designed to move value from point A (in China) to point B rather than as a physical location (perhaps a London property sale). Diverse methods are employed by underground bankers to transfer money. Borders like the one separating Guangzhou from Hong Kong are traversed by organized smuggling gangs that move money and goods. More sophisticated networks transmit money below the reportable limit via Chinese bank accounts to a large number of "money mules," typically Chinese university students with UK bank accounts who are willing to accept and send money in exchange for minor rewards.

Even more skilled are those with higher-level business connections who can organize the transfer of money through bigger, ostensibly legitimate commercial enterprises by inflating or under-inflating invoices, fabricating false paper trails, or shipping goods with the sole intent of transferring value between jurisdictions (a practice known as trade-based money laundering, or TBML).

But perhaps the oldest methods are also the most successful. The finest underground bankers, like the old Silk Road traders, try to transfer debts rather than move money, using money in China to pay bills in China and money in London to pay payments in the UK. Even if it is doubtful that the funds deposited into your bank account will be the same ones you withdraw from an ATM on the weekend, the presence of cash pools in many jurisdictions and constant trading in both directions imply that the actual funds never need to traverse international boundaries.

Another mechanism that emerged from China's economic miracle is Daigou. The demand for pricey Western goods is rising in China, and business-minded Chinese students and workers abroad are now catering to this lucrative market by advertising Western-branded apparel, cosmetics, jewelry, and other goods, accepting online payments, and sending the goods back to Chinese customers. Chinese social media platforms like WeChat are frequently used for marketing and sales management, and the most successful daigouers achieve a position resembling that of Western social media influencers. Daigou is not inherently illegal; the word simply means "to buy on someone's behalf." Nevertheless, the informal transfer of large sums of cash and commodities offers opportunities to underground bankers who have either appropriated established daigou networks or have merely borrowed the techniques as a contemporary twist on TBML.

Chinese underground banking, like other unofficial means of transferring value, poses difficult problems for law enforcement and companies attempting to comply with anti-money laundering regulations.

Due to the inefficiency of China's major banks, respectable customers are forced to share financial services with criminals. As a result, money that originated as lawful profits is combined with money obtained via serious crime and corruption as it leaves the underground bank. In instance, if they accuse relatives and friends of utilizing unlawful networks in China to get around financial constraints, clients who are probed about how funds were transferred may be reluctant to divulge their financial arrangements.

Potential red flags for Chinese underground banking include the following:

1. transfers of money from multiple origin accounts in China

2. transfers of money in sums just below the reportable limit (currently US$50,000)

3. money received via multiple UK accounts

4. payments from third parties

5. use of an intermediary, agent or corporate structure not directly connected to the client

6. money transferred from unusual locations not directly connected to your client, or those such as Fuqing or Wenzhou in Fujian Province which have a long connection to Chinese underground banking (as well as Guangdong, Liaoning, Zhejiang, and Jiangsu).

When you have reason to believe that funds may have been transferred through a shadowy institution, you should seriously consider filing a suspicious activity report (SAR) via the MLRO at your company. You can give context to your report by stating that you believe money laundering may be taking place through illicit financial services in addition to the reasons behind your suspicions:

1. The reason for your mistrust

2. the client's nature

3. the nature of the transaction; 

4. the extent of your due diligence; and 

5. any information you have gathered concerning the client’s original source of funds and source of wealth and which may help to legitimise the funds in question.

A SAR report's intelligence picture of how money is transported out of China is improved by adding context and specifics, and money laundering will be correctly identified as such.

Chinese names are not very useful for identifying people because more than half of mainland Chinese share barely 100 family names. Additionally, names are legally recorded in Chinese characters, with many distinct characters frequently being spelled in exactly the same way in English form. Even with a date of birth added, you are still likely to uncover dozens or even hundreds of Wang Jianguos in China who were born on August 1, 1955.

However, it is not impossible to identify and confirm a Chinese client's identity. Individually issued and often trustworthy kinds of identification are passports. They also display the person's name in both Western and Chinese characters. Even more helpful is the person's Chinese identity card, which includes their official ID number. Many official Chinese procedures revolve on this number, which is typically memorized by people while they are young. The number itself communicates private and readily available details about the customer, such as their date and place of birth and gender.

Regarding Chinese corporations, any reliable organization with a global presence ought to be registered online and be able to produce copies of the official business registration documents containing information about the organization, such as its name and principal place of business and the identity of the person authorized to act on its behalf. The Chinese National Enterprise Credit Information Publicity System website provides basic firm information, albeit it is currently only available in Chinese.

The cost of a specialised compliance service with the necessary language skills is likely to be far cheaper than the cost of a regulatory penalty for performing insufficient due diligence, thus companies operating with Chinese clients should take this into consideration. These services may be utilized to carry out efficient ID verification, obtain crucial web data, look up negative Chinese media, and contextualize your interactions with a significant clientele.

Daigou and underground banking have developed a (mostly undeserved) image as illegal activities. Law firms must carefully balance recognizing, managing, and mitigating risk while continuing to interact constructively with new markets, along with the rest of UK business, law enforcement, and government. Proper risk management results from developing awareness, engagement, and eventually informed knowledge and the capacity to deal successfully with your clients rather than from a refusal to connect with higher risk clients or from carelessly abandoning due diligence norms.

By fLEXI tEAM