Navigating complex, overlapping sanctions is placing renewed pressure on banks’ compliance operations and putting the trade finance industry to the test – again. Marc Smith, founder and CTO at Conpend, shares frontline insights on the current sanctions environment, the impact on trade finance, and the innovative digital solutions that are taking on the strain

The war in Ukraine has had an unprecedented impact on global trade flows, with the barrage of sanctions intensifying pressures on supply chains, at a time when frictions had only improved scarcely from the Covid-19 pandemic. This has also taken a toll on financial institutions (FIs), who are responsible for the flow of money and documentation that facilitate trade. Indeed, between 80 and 90 per cent of cross-border trade relies on trade finance and the sector forms a key part of many banks’ corporate banking business.

In order to meet their financing requirements, banks perform rigorous checks on trade documentation. Yet, owing to the pervasiveness of paper documentation throughout the supply chain, compliance checks are frequently manual, even today. Banks' compliance responsibilities are crucial to maintaining a secure and trusted global trade ecosystem. In the current environment, however, banks are scrambling to implement the new rules throughout their trade portfolio. The sheer volume of resources being dedicated to compliance efforts is serving to emphasise the impracticality of manual checks and driving innovation to streamline the review processes.

Banks under pressure as sanctions intensify

For context, the restrictions first introduced by the EU within 48 hours of Russia's invasion have expanded globally - evolving into the largest sanctions program ever established. A complex international network of financial penalties and trade sanctions severed both Russia and Belarus from global markets. The restrictions target Russian businesses, financial institutions and wealthy individuals, limiting goods, services and finance. Given the size of Russia's economy, and its significant integration in global trade prior to the war, sanctions have had a deep impact on trade finance.

In the decade leading up to last year's sanctions deluge, regulatory and compliance checks have been on the rise. Banks now take greater responsibility for anti-money laundering checks, and of course, sanctions monitoring – a complex and time-consuming task even at the best of times. While sanction procedures are certainly nothing new, the current environment has created an operational nightmare for banks. This is partly due to the speed and frequency of developments, including a sanctions list that grew daily at the start of the conflict, but also because the rules and regulations don’t necessarily correspond across different countries and regulators, and there can be various deviations per region, country and even per company.

Perhaps more alarming, another complication is that a new array of sophisticated tactics is being used by fraudsters to try to undermine the sanctions imposed, making detection all the more challenging. These tactics include falsified bills of lading and certificates of origin; front companies concealing a beneficiary; ship-to-ship (STS) transfers; laundering of international maritime organisation (IMO) numbers, and the manipulation of automatic identification system (AIS) transponders, which are used to show a ship’s location.

Amid a scramble to interpret and implement the new rules, the multijurisdictional complexity of supply chains and the use of intermediaries for trade represent further significant challenges to identifying infringements and other illegal activity.

As the conflict evolves, new sanctions packages have been announced, with the EU adopting its ninth package of sanctions against Russia as recently as December. Yet frustratingly, these are frequently enacted with little implementation guidance. Certainly, banks cannot afford to rest on their laurels – illegal activity is also on the rise as sanctioned entities attempt to undermine restrictions through fraud and money laundering.

The result has been increasing workloads, pressure and complexities for financial institutions. Regulators hold banks liable for compliance breaches, including accidental misses. In the heightened, high-stakes environment, banks and their executives face large fines, reputational damage and even prison sentences for compliance failures. Unsurprisingly, many banks have reacted with caution, reducing their exposure to sanctions by de-risking or overcompliance. However, by taking a stronger stance than legally required, the impact on permissible trade and trade finance is far more than governments intended. In the face of harsh reputational and financial consequences, the need for a reliable solution is growing.

Emerging threats and the way ahead

In response to sanctions, illegal activity is on the rise as individuals and businesses seek to evade the restrictions. Some practices are already well known to authorities, such as concealing a beneficiary with a front company or falsifying documents like bills of lading or origin certificates. Other tactics involve manipulating a ship's automatic identification system (AIS) transponders to obscure its location, not to mention further deceptive shipping practices that seek to conceal a ship’s identity.

In this context, "knowing your vessel" (KYV) checks are a crucial tool in combating increasingly sophisticated forms of maritime fraud. In turn, technology can detect strange sailing patterns, and based on historic data, artificial intelligence (AI) can flag suspicious changes in a vessel's appearance or the flag it sails under – indicators of its involvement in illegal activity. These checks are performed on a huge amount of data, some of it several months, or even years old. As such, automation is enabling banks to complete processes that are nearly impossible to do manually – empowering them to increase their productivity and efficiency.

Are digital solutions the answer: Shifting the burden onto AI

There are better alternatives to de-risking that help FIs to tackle these challenges – alternatives that help manage the cost of maintaining a robust compliance program. Digital solutions are an opportunity to optimise compliance checks by shifting the burden of document checking onto technology – using AI and analytics to detect criminal activity. Automation generally does not make decisions or take action based on findings. Rather it performs extensive checks quickly and without user input or intervention and raises alerts when risks or breaches are detected, using AI to minimise false positives. The bank’s operatives then interpret and choose how to act based on the alerts. When this is applied using a risk-based approach, the manual effort required from the operator can be drastically reduced and enable the approval of a large percentage of transactions without manual intervention.

Banks can also benefit from a high degree of customisation and flexibility. New regulations can be applied to an entire trade portfolio automatically. For example, within 48 hours of Russia's invasion, Conpend released a preconfigured filter that allowed clients to search their entire TRADE AI portfolio for suspicious transactions, including those that had previously been approved. Conpend's datahub – a function of our TRADE AI solution – can provide updated watchlists to clients in real time. This enables a screening process that is thorough, flexible, and centred upon quality up-to-date data – offering a degree of oversight that is essentially impossible to accomplish without AI.

Of course, data is central in the approach and can be used to further enhance compliance processes. For example, by using data from previous transactions, an automation tool can build a risk profile for a bank's individual customers. AI uses this profile to assess patterns and anomalies, flagging transactions that appear suspicious while supressing false positives.

Certainly, AI is an invaluable tool in carrying out the most demanding, yet monotonous, of compliance tasks thoroughly and reliably. Those FIs already invested in these capabilities were far better positioned to process the avalanche of sanctions, reduce costs, and manage their risks with scenario and contingency planning abilities. Digitalisation and automation offer the flexibility to handle fast-moving developments, freeing FIs to allocate resources to more meaningful, value-added tasks.