Underground banking

On the 4 August the National Crime Agency (NCA) announced that they had arrested a 33-year-old Chinese national in Teesside “as part of a National Crime Agency investigation into a suspected Chinese underground banking network”. They went on to say that the investigation related 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”.

As compliance professionals we are all well aware of the requirements for any firm in scope the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, and that those obligations are growing. Those firms which fail to meet the exacting standards risk significant regulatory penalties. In January 2022, high-profile London firm Mishcon de Reya paid an agreed penalty of £232,500 for failure to conduct effective due diligence on four related clients and failing to provide adequate training to relevant staff.

Whilst the regulations themselves are familiar to law firms, their application in practice is not always straightforward. Decisions about anti-money laundering (AML) risk frequently hinge on judgement calls about what is or is not normal business practice, what might or might not be suspicious, and what does or does not constitute adequate and sufficient due diligence. These decisions are particularly challenging when you are dealing with an individual or a company from a distant country with an unfamiliar language, culture and set of business practices.

What is underground banking?

Chinese underground banking is not a new phenomenon. China’s “underground money shops” have their roots in ancient Chinese vassal states that issued their own individual currencies, which required visiting traders to change their currency money on arrival and departure at “exchange shops”. Silk Road trade between China and Arabia created a demand for brokers at both ends of the major trade routes who were prepared to settle each other’s debts, negating the need for physical currency to travel at all. The settling of debts by trusted intermediaries is known as “hawala” in many Arabic and South Asian countries and is mentioned in the Islamic hadith. Whilst superficially unfamiliar to Western eyes, the exchange and settlement of debts in facilitation of trade was in many ways the blueprint for modern banking.

Modern Chinese underground banks are therefore a new iteration of an age-old institution, rediscovering and re-purposing traditional informal value transfer techniques for the modern world.

The focus on China as a money laundering threat is comparatively new. In October 2019, the National Crime Agency (NCA) published a report – Chinese Underground Banking and ‘Daigou’ – that highlighted the threat and in particular the role played by daigou shopping in transferring money across jurisdictions. As recently as July this year, MI5 and the FBI issued a joint statement highlighting the threat posed by the Chinese Communist Party through espionage, technology theft, and the exploitation of academic and business contacts. Therefore, the undeniable benefits of encouraging Chinese business and investment raise complex issues about the movement of funds across international borders and the underlying derivation – or final destination – of those funds.

How does it work?

Despite the impressive economic growth of China, its formal banking system remains largely unfit for purpose with glacial bureaucracy and excessive delays creating barriers to international trade and commerce. Part of the reason for this is the imposition of tough foreign exchange controls to try to stem capital flight from China by those who wish to move their newly acquired wealth abroad. Many smaller businesses keen to trade with Western countries are therefore driven to alternative methods of moving funds. Underground money shops provide a fast, efficient and reliable international transfer service, albeit an unlawful one, using a variety of techniques to shift value from one jurisdiction to another and attracting a wide range of clientele, whether they be small traders, individuals buying foreign properties, parents paying overseas university fees, or members of organised crime groups and corrupt politicians moving their money offshore and out of the reach of the Chinese government and its law enforcement agencies.

It is useful to think of the Chinese underground bank not as a bricks-and-mortar premises, but as a loose collection of disparate services aimed at moving value from point A (in China) to point B (perhaps a London property sale). Underground bankers use a variety of techniques to move funds. Organised smuggling gangs transport cash and commodities across borders such as that between Guangzhou and Hong Kong. More sophisticated networks use Chinese bank accounts to transfer funds below the reportable limit to numerous “money mules”, often Chinese university students with a UK bank account who are prepared to receive and send on funds for small commissions.

More sophisticated still are those with higher-level business connections who can arrange the movement of money through larger, ostensibly legitimate commercial businesses by over- or under-invoicing, creating false paper trails, or shipping commodities for the sole purpose of transferring value between jurisdictions (a process known as trade-based money laundering (TBML)).

But perhaps the most effective techniques are the oldest. Like the ancient Silk Road traders, the best underground bankers aim not to move funds, but to transfer debts, using the funds located in China to pay Chinese bills and funds in London to pay UK bills. Much as the money paid into your bank account is unlikely to be the same notes that you draw out of the ATM at the weekend, the existence of cash pools in different jurisdictions and regular trade in both directions means that the money itself never has to move across borders at all.

Daigou is another process which grew out of China’s economic miracle. There is a growing demand for expensive Western commodities in China and entrepreneurial overseas Chinese students and workers now service a lucrative market advertising Western branded clothes, perfume, jewellery and other commodities, taking payments online and posting the goods back to customers in China. Marketing and sales are often managed through Chinese social media sites such as WeChat and the more successful daigouers attain a status not dissimilar to Western social media influencers. There is nothing intrinsically illegal about daigou – the word itself simply means “to buy on behalf of someone” – however, the process of transferring large sums of money and commodities informally provides opportunities to underground bankers who have either co-opted established daigou networks, or simply borrowed the techniques, as a modern spin on TBML. 

Red flags

Like other forms of informal value transfer, Chinese underground banking presents complex challenges for both law enforcement and businesses struggling with money laundering compliance. 

The inefficiency of China’s mainstream banks means that legitimate clients are pushed into sharing financial services with criminals, and those funds that started life as legitimate earnings emerge from the underground bank mixed with funds derived from serious crime and corruption. Clients asked questions about how funds were transferred may be reluctant to discuss their financial arrangements, particularly if they implicate family and friends of using illegal networks in China in order to evade financial controls.

The following should be regarded as potential red flags for Chinese underground banking:

• transfers of money from multiple origin accounts in China
• transfers of money in sums just below the reportable limit (currently US$50,000)
• money received via multiple UK accounts
• payments from third parties
• use of an intermediary, agent or corporate structure not directly connected to the client
• 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).

What to report

Where you suspect that money may have been paid through an underground bank, you should give serious consideration to submitting a suspicious activity report (SAR) through your firm’s MLRO. In addition to the reasons for your suspicion, you can add context to your report by making it clear:

that you suspect the use of underground banking services for the purposes of money laundering

• why you have that suspicion
• the nature of the client
• the nature of the transaction
• what due diligence you have conducted, and
• 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.

Adding detail and context to a SAR report both improves the intelligence picture of how money is moved from China and will ensure the appropriate identification of money laundering.

Due diligence on people and businesses

Chinese names are of limited use in identifying individuals, with well over half of mainland Chinese people sharing only 100 family names. Furthermore, names are recorded officially in Chinese characters, with a number of different characters often being written identically in English script. Even with a date of birth added, you are likely to find that there are dozens, if not hundreds, of Chinese people called Wang Jianguo who were born on the 1 August 1955.

However, identifying and verifying the identity of a Chinese client is not an insurmountable task. Passports are individually issued and generally reliable forms of identification. They also show the individual’s name in Chinese characters as well as Western script. More useful still is the Chinese identity card containing the individual’s official ID number. This number is central to numerous official Chinese processes and is generally memorised by individuals at an early age. The number itself conveys personal and easily extracted information about the client, including their date and place of birth and their gender.

In relation to Chinese corporations, any legitimate company with an international footprint should be registered online and should be able to produce copies of their formal business registration documents showing company information such as their name and principal place of business and the name of the individual authorised to act on their behalf. Basic company information is available from the Chinese National Enterprise Credit Information Publicity System website, although at this time it is only available in Chinese.

Firms working with a Chinese client should consider instructing a specialist compliance service with appropriate language skills, the cost of which is likely to be substantially less than the cost of a regulatory penalty for conducting inadequate due diligence. These services can be used to carry out effective ID verification, access key online data, search for adverse media in Chinese, and add cultural context to your engagement with an important client base.

Managing risk

Underground banking and daigou has accrued a (not entirely deserved) reputation as a criminal process. Law firms, together with the rest of UK business, law enforcement and government need to strike a careful balance between identifying, managing and mitigating risk, while continuing to engage positively with emerging markets. Proper risk management comes not from a reluctance to engage with higher risk customers, nor from reckless abandonment of due diligence principles, but rather from building understanding, engagement, and ultimately informed knowledge and capacity to work effectively with your clients.