Written submission from RUSI, Centre for Financial Crime and Security Studies (FRP0003)

 

Crime in Freeports:
International Experience and Lessons for the UK

 

Written Evidence for the International Trade Committee’s Inquiry on UK Freeports

 

Introduction

 

  1. This written evidence is submitted on behalf of the Centre for Financial Crime and Security Studies (CFCS) at the Royal United Services Institute for Defence and Security Studies (RUSI), an independent research institute and registered UK Charity (no. 210639). CFCS undertakes research on UK and global responses to financial crime, including money laundering and terrorist financing.

 

  1. Since January 2019, CFCS has been conducting a two-year research project of direct relevance to the subject of this inquiry. The project analyses crime prevention policies used to secure free-trade zones (also known as freeports). Specifically, it aims to identify vulnerabilities that make certain free-trade zones more likely than others to be used for illicit trade or financial crime. It also explores best practices in addressing those vulnerabilities.

 

  1. This written evidence focuses on one kind of negative impacts that the introduction of freeports in the UK could have, namely increased risks of illicit trade and financial crime. It is based on CFCS study of other countries’ free-trade zones, including a review of publicly available information and fieldwork in Morocco and Panama, two countries with economically successful free-trade zones.

 

  1. The following sections of this submission discuss:

 

    1. The summary of our observations and recommendations;
    2. International evidence of illicit trade and financial crime in freeports;
    3. International experience of preventing crime in freeports;
    4. Lessons for the UK; and
    5. Recommendations for HM Government.

 

  1. There are various terms used to describe that HM Government calls ‘freeports’, including ‘free-trade zones’ or ‘free zones’. For the purposes of this written evidence, we use the term ‘freeports’.

 

Observations and Recommendations

 

  1. There is no reliable assessment of the scale of illicit activities in freeports. Such an assessment is hampered both by the clandestine nature of those activities[1] and a general lack transparency (including statistics) on the operations of freeports.

 

  1. However, there is evidence of criminal activity taking place in multiple freeports around the world. It often involves trade in counterfeit goods, drug trafficking, smuggling of untaxed goods or trade-based money laundering. Concerns about tax evasion have also been raised, although we believe they are of lesser relevance to the UK for reasons we explain in paragraphs 17-18 of this submission.

 

  1. We recommend a range of measures that HM Government can take to mitigate criminal risks in UK freeports. These recommendations are provided in the end of this submission and are based on a recent CFCS publication entitled ‘Free Ports, Not Safe Havens: Preventing Crime in the UK’s Future Freeports’.[2] The cover the following key areas:

 

    1. Risk assessment in the geographical locations where freeports will be established.
    2. Proportionality of crime prevention measures to the risk profile of activity taking place in freeports (e.g. manufacturing or transhipment) and its volume.
    3. Security-focussed vetting and due diligence on businesses wishing to operate in freeports.
    4. Regular review of freeport operators’ effectiveness in discharging their security-related responsibilities.
    5. Commitment to comply with the OECD Recommendation.

 

International Evidence of Crime in Freeports

 

  1. There is ample evidence that freeports tend to face several common risks of criminal exploitation, including:

 

  1. Trade in counterfeit goods. An OECD study published in 2018 found that establishing an additional freeport within an economy was associated with an average 5.9% increase in the value of counterfeit exports from the host economy in the time period 2011-2013.[3] The OECD and EU Intellectual Property Office (EUIPO) list freeports among five key factors that make countries attractive to organised crime groups involved in counterfeiting.[4]
  2. Drug trafficking. According to the World Customs Organization’s (WCO) report published in 2019, the largest number of seizures within freeports reported by member states related to drugs (148 of 626 seizures in 2011-2018, followed by 143 seizures of counterfeit goods).[5]
  3. Smuggling of untaxed goods, such as cigarettes. Seizures of tobacco products were likewise recorded in the data collected by the WCO.[6] Several studies of illicit cigarette trade point to transit and manufacturing in freeports.[7]
  4. Trade-based money laundering (TBML). International trade can be exploited to (a) create a pretext for transferring criminally obtained money, such as through misrepresenting the price of goods, or (b) move value in the form of goods being transferred, which can be used or resold by the recipient. The Financial Action Task Force, which sets global anti-money laundering/counter-terrorist financing (AML/CTF) standards, cites examples of TBML schemes involving freeports.[8]
  5. Tax evasion. Some freeports specialise in the storage of high-value goods, especially art objects.[9] The European Commission and European Parliament have expressed concerns that ownership of these goods can be transferred without paying tax.[10] This is possible because (a) transactions taking place in a freeport are not taxed by the state where the freeport is located; and (b) the freeport operator is not obliged to notify a customer’s state of residence about the objects owned by that customer and stored in the freeport.
     

International Experience of Preventing Crime in Freeports

 

  1. To advance efforts against crime in freeports, the OECD adopted a Recommendation of the Council on Countering Illicit Trade: Enhancing Transparency in Free Trade Zones in October 2019.[11]

 

  1. Broadly speaking, the Recommendation addresses the following areas:

 

  1. The access of competent authorities to goods and related documentation in freeports;
  2. The vetting of businesses operating in freeports; and
  3. The availability of detailed digital records of freeport operations.

 

  1. HM Government’s consultation on freeports refers to the OECD’s Recommendation but does not explicitly commit to implementing it.[12]

 

  1. Some countries’ experience suggests that robust regulation can mitigate criminal risks in freeports. For instance, the OECD found that ‘foreign trade zones’ established across the US, which are subject to a well-developed compliance regime, were not associated with significant flows of counterfeit goods.[13]

 

  1. The UK government may wish to take note of the following aspects of the US regime:

 

  1. Reviews of foreign trade zone operators. Foreign trade zone operators are reviewed on the basis of the Compliance Review Handbook for Foreign Trade Zones. The Handbook includes ‘a standard checklist of questions meant to identify and assess risks such as the physical security of the FTZ merchandise and the appropriateness of systems and procedures for inventory management’.[14]
  2. Analysis of high-risk shipment patterns. In 2007, the Customs and Border Protection accepted the recommendation from the Government Accountability Office to conduct analysis on patterns of shipment involving foreign trade zones for risk-management purposes.[15]
     

Lessons for the UK

 

  1. There are various factors that can render freeports vulnerable to criminal exploitation. Some of these are country-level factors, such as widespread corruption, which are of limited relevance to the UK (as distinct from risks that organised crime groups will seek to corrupt some members of freeport staff, which is at least possible).

 

  1. There are, however, freeport-specific factors that the UK should consider. In the CFCS publication cited in paragraph 8 above, we identify a number of such factors, listed here in brief:

 

  1. Pre-existing risk profile. If a freeport is established in a locale with active organised crime groups or known smuggling routes, increased volume of trade and reduced customs controls can exacerbate already existing risks.
  2. Reduced customs controls compared to the rest of the country. In principle, customs controls in a freeport need not be less effective than elsewhere in the UK. However, the experience of other countries suggests that:

 

      1. The exemption of goods from customs duties can reduce the incentive to police in- and outflows of goods in a freeport; and
      2. Difficulties may arise in delineating and coordinating the responsibilities of various agencies involved, including freeport operators and customs authorities.

 

  1. Inadequate physical security. Physical security measures must secure the freeport’s perimeter to guarantee oversight of goods moved in and out of freeports.
  2. Inadequate oversight of commercial activities within a freeport and/or inadequate record keeping. Oversight and recording of the goods that are being manufactured or reprocessed within a freeport is necessary to safeguard against:

 

  1. The freeport’s use for counterfeiting purposes, which is a realistic possibility based on the Intellectual Property Office’s conclusion that ‘[some] counterfeit products are being manufactured, assembled and re-packaged in the UK’;[16]
  2. The leakage’ of untaxed goods into the UK’s customs territory.

 

  1. There are several vulnerabilities that have been observed in other countries’ but that we believe, based on the HM Government’s current plans, to be of limited relevance to the UK. These include:

 

  1. Prevalence of cash transactions. The ability to purchase goods for cash from companies operating in freeports creates opportunities for investing the proceeds of cash-generating crimes and shipping goods purchased in that manner to overseas destinations.
  2. Reduced AML/CTF oversight. In some countries, AML/CTF oversight of regulated businesses (such as banks) operating within freeports is relaxed compared to the rest of the country, leading to a corresponding increase in their vulnerability to financial crime.
  3. Lack of reliable beneficial ownership records. In case of freeports used for high-value storage, the lack of reliable beneficial ownership records impedes the detection of potential tax evasion on the part of the goods’ owner.

 

  1. In relation to beneficial ownership records in particular, we note that HM Government is not intending for freeports to be used for high-value luxury storage,[17] which is the focal point of the EU institutions’ criticism of their own freeports. In any case, the EU’s 5th Money Laundering Directive now extends AML/CTF obligations to ‘persons storing, trading or acting as intermediaries in the trade of works of art when this is carried out by free ports, where the value of the transaction or a series of linked transactions amounts to EUR 10 000 or more.’[18] This provision has been implemented in the UK’s Money Laundering Regulations 2017,[19] which should alleviate some of the risk related to art storage in freeports.

 

  1. Finally, in some countries, freeports with known patterns of criminal exploitation have become international reputational risks. This is demonstrated, for instance, by the fact that the US State Department’s annual International Narcotics Control Strategy Report consistently assesses the regulation of freeports as part of its analysis of a country’s financial crime risks, and in some cases observes that ‘[freeports] present a significant gap in regulatory oversight’.[20]

 

Recommendations for Crime Prevention in UK Freeports

 

  1. The establishment of a freeport should involve an assessment of illicit trade and security risks specific to that location. This assessment should be undertaken with participation of Border Force, HMRC and other law enforcement agencies as appropriate. It should take into account the existing organised crime landscape in the location in question and propose measures to mitigate these threats if a freeport is established.

 

  1. Once freeports are established, the government should: (a) publish annual statistics on their overall activity; and (b) publish law enforcement and customs seizures statistics related to freeports. This would be consistent with the government’s commitment to ‘facilitate greater sharing and analysis of data’ on the operation of freeports.

 

  1. Border Force and HMRC should conduct regular analysis of the patterns of trade involving freeports to identify anomalies and support risk-management efforts.

 

  1. The efforts taken by Border Force and HMRC to prevent and detect illicit trade in freeports, including the frequency of physical inspections of goods, should be proportionate to: (a) the risk profile of businesses and activities; and (b) the volume of trade. Random physical inspections should be conducted to ensure compliance. Effective information sharing between Border Force, HMRC and other law enforcement agencies will be key to ensuring the effectiveness of these efforts.

 

  1. Due diligence conducted on businesses operating in freeports should enable robust assessment of the risks they pose. In particular, if a business operating in a freeport trades on someone else’s behalf, it should be required to disclose that person’s identity. Further thought should be given to which agency can conduct checks most effectively and which should be responsible for doing so.

 

  1. The effectiveness of Freeport Operators in discharging their security-related responsibilities should be subject to periodic review.

 

  1. The government should require Freeport Operators to comply with the OECD Code of Conduct for Clean Free Trade Zones, including: appointing a dedicated point of contact for law enforcement liaison activities; incentivising electronic payments and ensuring the traceability of cash transactions; and participating in peer learning with other UK and international freeport administrators.

 

  1. As part of its commitment to challenge-based initiatives aimed at developing technology that facilitates the operation of freeports, the government should consider trialling such initiatives for the purposes of better illicit trade detection.

 

21 May 2020

May 2020

 


[1] Challenges of assessing the scale of organised crime activities are cogently explained in Finckenauer, J. (2009).  Organized Crime.  in M. Tonry (Ed.).  The Oxford Handbook of Crime and Public Policy (pp. 304-324). Oxford: Oxford University Press, p. 307; Jojarth, C (2009). Crime, War, and Global Trafficking. Designing international cooperation.  Cambridge.  Cambridge University Press, p. 7.

[2] Available at https://rusi.org/publication/briefing-papers/free-ports-not-safe-havens-preventing-crime-uk%E2%80%99s-future-freeports.

[3] OECD, ‘Trade in Counterfeit Goods and Free Trade Zones: Evidence from Recent Trends’, 2018, p. 13.

[4] OECD/EUIPO, ‘Trends in Trade in Counterfeit and Pirated Goods’, 2019, pp. 15-16.

[5] Kenji Omi, ‘“Extraterritoriality” of Free Zones: The Necessity for Enhanced Customs Involvement’, World Customs Organisation (WCO) Research Paper No. 47, September 2019, p. 13.

[6] Ibid.

[7] KPMG, ‘Project SUN: A study of the illicit cigarette market in the European Union, Norway and Switzerland’, 2017, p. 84; transcrime, ‘European Outlook on the Illicit Trade in Tobacco Products’, 2015, p. 51.

[8] FATF, ‘Money Laundering Vulnerabilities of Free Trade Zones’, 2010, p. 23.

[9] The Economist, ‘über-warehouses for the ultra-rich’, 23 November 2013, <https://www.economist.com/briefing/2013/11/23/uber-warehouses-for-the-ultra-rich>; Graham Bowley and Doreen Carvajal, ‘One of the World’s Greatest Art Collections Hides Behind This Fence’, New York Times, 28 May 2016 <https://www.nytimes.com/2016/05/29/arts/design/one-of-the-worlds-greatest-art-collections-hides-behind-this-fence.html>.

[10] European Commission, ‘Commission Staff Working Document Accompanying the Document Report from the Commission to the European Parliament and the Council on the Assessment of the Risk of Money Laundering and Terrorist Financing Affecting the Internal Market and Relating to Cross-Border Activities’, 24 July 2019, SWD/2019/650, p. 244; Ron Korver, ‘Money Laundering and Tax Evasion Risks in Free Ports’, European

Parliamentary Research Service, October 2018.

[11] Available at https://legalinstruments.oecd.org/en/instruments/OECD-LEGAL-0454.

[12] HM Government, ‘Freeports Consultation: Boosting Trade, Jobs and Investment Across the UK’, 10 February 2020, p. 30.

[13] OECD, ‘Trade in Counterfeit Goods and Free Trade Zones: Evidence from Recent Trends’, 2018, p. 46.

[14] US Government Accountability Office, ‘Foreign Trade Zones: CBP Should Strengthen its Ability to Assess and Respond to Compliance Risks Across the Program’, GAO-17-649, August 2017, p. 22.

[15] US Government Accountability Office, ‘Persistent Weaknesses in the In-Bond Cargo System Impede Customs and Border Protection’s Ability to Address Revenue, Trade, and Security Concerns’, GAO-07-561, April 2007, pp. 40–41.

[16] Intellectual Property Office, ‘IP Crime and Enforcement report 2018-2019’, p. 19.

[17] HM Government, ‘Freeports Consultation: Boosting Trade, Jobs and Investment Across the UK’, 10 February 2020, p. 10.

[18] Article 1(1)(c)(j) of Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 Amending Directive (EU) 2015/849 on the Prevention of the Use of the Financial System for the Purposes of Money Laundering or Terrorist Financing, and Amending Directives 2009/138/EC and 2013/36/EU, Official Journal of the European Union, L156/43, 19 June 2018.

[19] Regulation 14(1)(d)(ii).

[20] US Department of State, ‘International Narcotics Control Strategy Report 2020, Volume II: Money Laundering’, p. 196.