Money Laundering vulnerabilities of Free Trade Zones

Financial Action Task Force

Groupe d’action financière

FATF Report
Money Laundering vulnerabilities of Free Trade Zones
March 2010

THE FINANCIAL ACTION TASK FORCE (FATF)
The Financial Action Task Force (FATF) is an independent inter‐governmental body that develops and promotes policies to protect the global financial system against money laundering and terrorist financing. Recommendations issued by the FATF define criminal justice and regulatory measures that should be implemented to counter this problem. These Recommendations also include international co‐operation and preventive measures to be taken by financial institutions and others such as casinos, real estate dealers, lawyers and accountants. The FATF Recommendations are recognised as the global anti‐money laundering (AML) and counter‐terrorist financing (CFT) standard.
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© 2010 FATF/OECD. All rights reserved No reproduction or translation of this publication may be made without prior written permission.
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Money laundering vulnerabilities of Free Trade Zones– March 2010 J
TABLE OF CONTENTS
 EXECUTIVE SUMMARY ................................................................................................................4  CHAPTER 1: INTRODUCTION.......................................................................................................6
1.1 Need for the Typology...........................................................................................................6 1.2 Scope .....................................................................................................................................6 1.3 Methodology..........................................................................................................................6
 CHAPTER 2: THE ROLE AND SCOPE OF FREE TRADE ZONES..............................................8
2.1 Definition...............................................................................................................................8 2.2 Evolution................................................................................................................................9 2.3 Privatization.........................................................................................................................13
 CHAPTER 3: VULNERABILITIES OF FREE TRADE ZONES...................................................15
3.1 Application of AML/CFT measures in Free Trade Zones...................................................15 3.2 Relaxed Oversight and Lack of Transparency.....................................................................16 3.3 Lack of Systems Coordination.............................................................................................17 3.4 Vulnerable Types of Goods .................................................................................................17
 CHAPTER 4: FREE TRADE ZONES AS A METHOD USED BY ILLICT ACTORS.................19
4.1 Predicates.............................................................................................................................19 4.2 Trade Based Money Laundering..........................................................................................19 4.3 Case Studies.........................................................................................................................20
 CHAPTER 5: CONCLUSION AND POLICY CONSIDERATIONS.............................................27
REFERENCES .................................................................................................................................. 30 ANNEX A: ML/TF RISK INDICATORS........................................................................................31 ANNEX B: COMPLIATION OF BEST PRACTICES AND RECOMMENDATIONS .................34
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EXECUTIVE SUMMARY

1.

Free Trade Zones (FTZs) have proliferated in recent years, such that today there are

approximately 3 000 FTZs1 in 135 countries around the world with a total turnover in the billions of

U.S. dollars.2 FTZs are designated areas within jurisdictions in which incentives are offered to support the

development of exports, foreign direct investment (FDI), and local employment. These incentives include

exemptions from duty and taxes, simplified administrative procedures, and the duty free importation of raw

materials, machinery, parts and equipment. In addition to boosting economic opportunity, these incentives

can result in a reduction in finance and trade controls and enforcement, creating opportunities for money

laundering and the financing of terrorism. Because the same characteristics that make FTZs attractive to

legitimate business also attract abuse by illicit actors, FTZs are a concern that the Financial Action Task

Force (FATF) should address.

2.

The case studies included in this report illustrate ways in which FTZs are misused for money

laundering and terrorist financing. In particular, the cases highlight the following systemic weaknesses that

make FTZs vulnerable to abuse:

• Inadequate anti-money laundering (AML) and combating the financing of terrorism (CFT) safeguards;

• Relaxed oversight by competent domestic authorities;

• Weak procedures to inspect goods and register legal entities, including inadequate record-keeping and information technology systems; and

• Lack of adequate coordination and cooperation between zone and Customs authorities.

3.

Further examination of the vulnerabilities highlighted in the case studies allowed for the

development of ML/TF risk indicators related to financial transactions, unusual business activity, and

trade-based money laundering (TBML) which takes place within FTZs.

4.

Although this is the first global report to address FTZs, this is not the first time that the money

laundering and terrorist financing vulnerabilities of FTZs have been identified. Through the work of the

Caribbean Financial Action Task Force (CFATF) and Aruba a number of best practice elements have been

1

The geographic area in which special regulatory and tax treatment is applied to certain trade-related

products and services, which in this paper is referred to as a free trade zone, is also known by various other

names throughout the world, including: free zones, freeport zones, port free trade zones, foreign trade

zones, e-zones, duty free trade zones, commercial free trade zones, export processing zones, logistic zones,

trade development zones, industrial zones/parks/areas, hi-tech industry parks, hi-tech and neo-tech

industrial development zones, investment zones, bonded zones, special economic zones, economic

development zones, economic and technological development zones, resource economic development

zones and border economic cooperation zones.

2

Akinci, G. and Crittle, J. (2008).

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developed. The World Customs Organization, the only global standard setter of free trade zones, has also
developed reference tools for the development of FTZs. Finally, the FATF TBML Typologies and Best Practices Papers3 published in 2006 and 2008 respectively presented red flag indicators and best practices
relevant to FTZs.

5.

The misuse of free trade zones impacts all jurisdictions including those without FTZs of their

own, because goods can originate from or be transhipped through FTZs not subject to adequate export

controls. Proliferators of weapons of mass destruction (WMD) abuse FTZs to tranship dual use goods and

to disguise the final destination of sensitive items. FTZs can also be used to create legal entities and access

the international financial system, providing opportunities to launder illicit proceeds. Many major zones

are also located in regional financial centres linking international trade hubs with access to global centres

of finance.

6.

Free trade zones are central to the integrated global economy. They stimulate economic growth

and play a central role in business for many countries and leading manufacturers. The relevance of FTZs

continues to grow as globalization defines economic progress. However the standards, oversight, and

regulations governing FTZs have not kept pace with these developments. As a result, illicit actors have

been able to take advantage of relaxed oversight and the lack of transparency in zones to launder the

proceeds of crime, finance terrorism, and facilitate WMD proliferation.

3

See www.fatf-gafi.org.

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CHAPTER 1: INTRODUCTION

1.1

Need for the Typology

7.

Free trade zones (FTZs) present a unique money laundering and terrorist financing threat because

of their special status within jurisdictions as areas where certain administrative and oversight procedures

are reduced or eliminated in order to boost economic growth through trade. Jurisdictions throughout the

world create these designated areas, which go by many names. For the purposes of this paper, these areas

are referred to as FTZs. The special tax and administrative arrangements available to exporters and export

service providers in FTZs, although intended to boost legitimate trade, can create money laundering and

terrorist financing vulnerabilities.

8.

Other typologies reports have addressed related vulnerabilities, notably the Trade Based Money

Laundering (TBML) typology report and TBML Best Practices Paper published in June 2006 and

June 2008 respectively. While these reports were instructive, they did not fully address the vulnerabilities

nor the scope of techniques utilized by illicit actors in part because they did not take into account the

estimated 3 000 FTZs that play a significant role in global trade and which attract substantial funds that are

associated with cross-border transactions.

1.2

Scope

9.

This report presents the first completed attempt at the international level to identify and address

the money laundering and terrorist financing vulnerabilities of FTZs. The report also addresses potential

shortcomings in the FATF’s current AML/CFT framework.

10.

The objectives of this typology report are to:

• Understand the size, scope, definition, and role of FTZs worldwide and their role in the global economy;

• Identify the money laundering and terrorist financing threats and vulnerabilities associated with FTZs;

• Identify the methods used to move and launder the proceeds of crime and/or finance terrorism using FTZs; and

• Suggest areas for further consideration to improve the AML/CFT framework concerning FTZs.

1.3

Methodology

11.

In preparing this report, the project team utilized a number of resources. First, the project team

conducted a thorough literature review, referencing work conducted by international organizations, trade

associations, and academia. The project team also developed a comprehensive questionnaire that was

distributed to FATF members and observers in January 2009, which produced valuable information.

Finally, the project team engaged the private sector and international organizations. Using these research

tools the project team was able to identify: (i) the characteristics that define FTZs; (ii) the number and

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scope of FTZs around the world; (iii) the types of activities serviced by the FTZs; and (iv) the AML/CFT vulnerabilities associated with FTZs. In addition to identifying the AML/CTF vulnerabilities, the project team reviewed the scope of measures that exist to reduce the threat of ML/FT in FTZs. This stage incorporated work conducted to date on TBML and interviews with free trade zone authorities and merchants. This background and research have provided a means for the team to evaluate the extent to which ML/TF vulnerabilities are mitigated and assess whether safeguards need to be strengthened, and if so how that might be done.

12.

The project invited a wide range of participation from the international community in the spirit of

sharing experiences and knowledge. It encouraged international cooperation with a view toward the

development of a uniform framework for regulating international trade systems in FTZs. The project team

was co-chaired by Belgium and the United States and was composed of Aruba, Australia, the CFATF,

Singapore, and the World Customs Organization (WCO).

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CHAPTER 2: THE ROLE AND SCOPE OF FREE TRADE ZONES

2.1

Definition

13.

FTZs are created within jurisdictions to promote trade, support new business formation, and

encourage foreign direct investment. They provide a preferential environment for goods and services

primarily associated with exports, whereby a minimum level of regulation is imposed on those companies

approved to operate within the zone. Additional benefits include exemptions from duty and taxes,

simplified administrative procedures and duty free imports of raw materials, machinery, parts and

equipment.

14.

There are as many names for these specially designated trade-promotion areas as there are

countries that conduct international trade. In addition to free trade zone, some of the other common terms

for these areas include special economic zones, foreign trade zones, and export processing zones. The

International Convention on the Simplification and Harmonization of Customs Procedures (Revised Kyoto

Convention) uses the term “free zones,” which the revised convention describes as “a part of the territory

of a Contracting Party where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory"4.

15.

Respondents to the project team’s FTZ questionnaire noted there is more than one kind of zone

and although all may exist “outside the customs territory” each area exists to facilitate a certain activity,

such as manufacturing, processing, warehousing, storage, and transhipment. Some respondents indicated

their FTZs were more than work zones, as they can include on-site housing, retail establishments, financial

services, even tourism and gambling.

16.

Generally an FTZ is an area or regime within a country with a special status concerning customs

and/or tax controls, in which enterprises are licensed to conduct business or provide services for export

and/or import purposes though the granting of special incentives to stimulate their development. There is a

separate customs area providing duty free benefits and streamlined procedures to promote international

trade. Generally there is single management and/or administration, although a number of different

organizations, private and public, may be involved in the management and operation of a zone.

17.

Logistically, zones are most often located near ports of entry; air, land or sea, but operate apart

from traditional ports of entry and often under different rules. This location facilitates entry to the zone as

well as the exit and entry to the customs territory. It also provides Customs officials with easier access to

the port and FTZ. Prohibited merchandise, items that are forbidden by law to enter a jurisdiction, cannot

generally be admitted to an FTZ but certain types of restricted merchandise such as items which may

require a special license or permit may be allowed. In most cases merchandise entering and exiting an FTZ

must be accompanied by commercial documents, for example a bill of lading and a commercial invoice.

4

World Customs Organisation (1999).

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Tracking is conducted through a mix of paper and IT systems, depending on the zone, however many use both. Most FTZs inspect some percentage of cargo entering the zone, but this varies widely.5

2.2

Evolution

18.

FTZs have played a role in global trade since ancient times. Beginning in the 18th century these

zones became central locations on international trade routes serving as hubs for trade and transhipment.

Examples of these centres included Gibraltar (1704), Singapore (1819) and Copenhagen (1891). The first

modern zone was established in 1959 as the Shannon Free Zone in Ireland, the world’s first duty free

industrial location targeting industries that would use the airport to move both people and freight. The zone

was very successful at turning the local economy around and subsequently serving as a model for future free zones around the world.6

19.

Zone development has moved away from one rigid definition of a FTZ and today has evolved as

zones and their roles in different economies is reflected through a wide range of different types of zones

with features tailored to the purpose of the zone including foreign direct investment (FDI), economic

development, and employment generation, among others.

20.

Today the range of zones generally falls into one of the following categories.7

Free trade zones (FTZs); these are typically general purpose fenced in, duty-free areas offering warehousing, storage and distribution facilities for trade, transhipment, and re-export of products. These are located in most ports around the world.
Examples: Colon Free Zone, Panama, and Singapore

Export Processing Zones (EPZs) are industrial areas focusing on assembly and manufacturing of intermediate imports aimed primarily but not exclusively at foreign markets. Particular sectors include labor-intensive, light manufacturing such as garment production and the assembly of electronics. EPZs also promote linkages with the domestic economy by encouraging technology transfer and innovative industrial strategies. Certain types of EPZs are sometimes called Hybrid Export Processing Zones because they combine the traditional export focus of an EPZ with a sub-divided area in which non-export oriented activities can take place.
Example: Karachi, Pakistan

Enterprise zones are economic development areas intended to revitalize specific urban or rural areas where they are located through tax incentives and financial grants. These are most often found in the developed world.
Example: Docklands, London

Freeports typically the largest of the zones, accommodate all types of activities including tourism, retail sales, and on-site residence, and accompany a broader set of incentives and benefits. Freeports are different from traditional FTZs as they are not seen as export drivers but areas promoting overall economic growth linking the zones with the overall economy of the nation. This has also resulted in greater expansion and liberalization of the core set of policies

5

FATF FTZ Questionnaire Analysis.

6

Akinci et al, p. 9.

7

Akinci et al, p. 10.

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present in most free zone programs. The European Union allows inward processing relief and other customs schemes that produce some of the benefits of free zones without requiring formal zone definition. In the UK, for example, free ports do not offer significant benefits beyond inbound processing relief schemes. As a consequence ports like Rotterdam have marketed themselves as “freer than a Freeport”.
Example: Hong Kong, China
Single factory EPZ schemes provide incentives similar to export processing zones but are not a zone at all, rather a single factory located anywhere in a country which receives the special duty free privileges of zones. In the United States they are also called sub-zones.
Example: Mauritius and Madagascar are examples of where Single Factory EPZs exist.
Foreign Trade Zones is the name of the specially designated zones in the United States. They are established in or adjacent to a port of entry in which all types of merchandise may be held without being subject to U.S. Customs duties and other taxes.
Special Economic Zones (SEZs): SEZs extend the relaxed tax and administration characteristics of FTZs to investment arrangements, labour laws, management practices, and wage rate policies in specific areas of the country. Originally this structure applied only to China but versions now exist in India and elsewhere. China has proposed applying special treatment within SEZs to promotion of real estate, tourism, infrastructure development and banking.
Snapshot: Shenzhen, China
The Shenzhen Special Economic Zone (SEZ) was founded in 1980 as the first in China. It is nearly 2 000 square kilometres, has over 12 million inhabitants and a GDP in 2006 of USD 71.3 billion. The SEZ has significantly contributed to the transformation of Shenzhen from a fishing village to a major industrial and financial centre which has benefited tremendously from the liberal economic policies granted to the SEZ. As the first Chinese SEZ, Shenzhen has served as a pilot for market oriented reforms. Shenzhen enjoys the most liberal economic policies in China both in terms of FDI and engaging in international trade. Examples of the pilot reforms include differential corporate tax rates for foreign and domestic firms. Migrants from across China account for 83% of the population of Shenzhen and less than 6% are over the age of 60. This combination has lead to an innovative economic environment. Shenzhen has also built its success on the availability of capital. In 2005, one third of the total number of venture capital firms in the whole country was located in Shenzhen. Foreign direct investment (FDI) has played a major role in the development of Shenzhen. Toshiba, Epson, Wal-Mart, Sony and IBM are major investors. 141 of the world’s top 500 multinational companies have invested in Shenzhen.
The story of the Shenzhen zone is multi-faceted as the SEZ hosts hundreds of other national level zones with special incentive regimes. Within Shenzhen there are 15 free trade zones, 17 export processing zones, 5 economic and technological developments zones, 53 high technology developments zones and 15 border economic cooperative areas.8
Bonded Warehouses: Specially designated storage warehouses that have the authorization of Customs authorities.

8

Zhang Yansheng (2007).

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