Money Makes the Criminal World Go Around - Chinese Underground Banking

The Asian Crime Century briefing eighteen

(People’s Bank of China headquarters, Beijing)

Last week, a student at the University of Stirling in Scotland who laundered thousands of pounds for a major criminal was sentenced to 18 months imprisonment. Ms. Huang Xiaotiong was found guilty of laundering a total of £160,000 through four bank accounts and using the money to buy designer label items and expensive wines as well as paying for her tuition fees at Stirling University. Her purchases included £12,479 on items bought from Gucci, Burberry and Coach, £797 on goods from Harrods, £480n on a Louis Vuitton bag, and £6,900 worth of wine. She would buy the luxury goods with money provided by a Chinese criminal, and send some of those goods back to China to be resold.

Ms. Huang, aged 28, was given the money by a man named as Wai Ma who travelled around Scotland in a Mercedes giving bags of money to associates to clean. Wai Ma was a police target in a major money laundering investigation, but has absconded and so Ms. Huang has faced charges alone. She denied the charge but was found guilty of money laundering linked with serious organised crime after being found guilty of laundering a total of £84,912 at Falkirk Sheriff Court in March.

In Europe last week, police in 10 countries arrested 132 people connected to the Italian ‘Ndrangheta mafia accused of drugs and weapons trafficking with counterparts in Latin America, who used Chinese money brokers in Italy and Colombia to arrange for funds to be moved to pay for drug deals. Europol stated that the investigation involves Italy, Germany, Belgium, Portugal, Spain, Slovenia, Romania, Brazil and Panama.

The operation against the ‘Ndrangheta in Italy illustrates the growing use of money transfer networks, which involve depositing a sum with a money broker in one country while another agent in the network elsewhere in the world pays the equivalent amount to the intended recipient. The Italian authorities have announced at least six investigations involving drug gangs and Chinese payment networks, involving alleged payments to narcotics suppliers in Latin America, Morocco and Spain.

In February, the Australian Federal Police (AFP) charged nine members of an international Chinese money laundering organisation and restrained more than US$100 million in Sydney property, cash and luxury items. The AFP alleges the money laundering organisation was a global operation uniquely-headquartered in Sydney, which facilitated the movement of illicit money through multiple jurisdictions by multiple means, including exploitation of ‘daigou’ (underground banking), casino junkets, and the informal value transfer system, which generally occurs outside conventional banking systems. The AFP explained that the money laundering system typically involved a person in Australia who wanted to buy property, goods or services and had legitimate funds held in an offshore bank account in China but laws in China would prevent them from transferring large amounts of cash out of China.  This person would then use a money broker operating in Australia to obtain the funds for the purchase, achieved as the broker would be part of the money laundering organisation operating in Australia unlawfully.

In the USA, authorities are increasingly concerned about the links between Chinese money laundering syndicates and Latin American drug trafficking cartels. On 26 April, the Subcommittee on Health Care and Financial Services of the Committee on Oversight and Accountability concluded that “Chinese Money Laundering Organizations (MLOs) have attained near total control of the laundering operations for Latin American cartels’ illicit funds raised through their sales of fentanyl, cocaine, heroin, and other narcotics that poison and kill tens of thousands of Americans annually.”

This expansion of Chinese money laundering is partly due to the growth of the ‘Belt and Road Initiative’ (BRI), the infrastructure and investment strategy launched in 2013. The international business connectivity facilitated by the BRI has also fuelled international organised crime connectivity. Dr. Alexander Kupatadze, a Senior Lecturer at London King’s College, has said that “Trade-based money laundering involves disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimize their illicit origins. An increase in trade means consequent growth in TBML activities including opportunities for newer and more innovative black-market exchange schemes to launder proceeds from drug trafficking in the European Union”. The BRI has boosted the long existing trade in counterfeit and illicit products from China and enabled the established Chinese criminal gangs active in those businesses to introduce the additional business line of underground banking and money laundering.

Money, Money, Money

This growing international underground banking system is part of informal payment systems amongst Chinese communities often referred to by the Chinese term ‘fei qian’ or ‘fei chien’, meaning flying money, which relies on a trusted network of transfer agents. The network of Chinese money agents has grown in the past several decades as restrictions on the movement of money out of China has led to a demand from wealthy Chinese for informal methods.

Capital flight has been a growing problem for the government of China since the economy started to expand following the start of the period of opening up in the late 1970s. This is partly a result of greater wealth seeking new investment opportunities, but also driven by endemic corruption in both the private and public sectors.

The legal restriction of the flow of funds out of China was formalised in 2006 when the State Administration of Foreign Exchange (SAFE) promulgated the ‘Measures for the Administration of Individual Foreign Exchange’.  SAFE regulations stipulated USD50,000 as the maximum for the domestic individual purchase of foreign exchange per person per year, and bans using foreign exchange for investing in properties, securities, and dividend-paying insurance products. This was highly restrictive to Chinese nationals, who largely did not have the same access to stable investments in China as have been available in the West.

Despite the huge increase in wealth in China since the 1980s, there are indications that a large number of people in the richest segment of society continue to seek to move their wealth out of the country. Professor Frank Gunter of the Foreign Policy Research Institute estimated in 2017 that in the prior decade US$3.8 Trillion in capital had left China.

The Huron Research Institute in Shanghai has reported that large numbers of High Net Worth Individuals (HNWIs) are seeking to emigrate. In 2014, 64% (393 millionaires and billionaires) were either emigrating or planning to do so; in 2017 it was 50%; and in 2018 it was 37% (a drop but 12% of those polled had already emigrated or were applying to do so). This has resulted in tens of thousands of Chinese HNWIs leaving the country: Estimates are of 10,000 in 2017, and 15,000 in 2018, with the most popular destinations being Australia, the United States, and Canada.

The key problem with all of the unexplained or unauthorised capital outflow is that there is a high risk of funds being related to corruption, and hence being the proceeds of crime. In 2011, the PRC central bank estimated that in the prior two decades about 18,000 government officials had fled the country with an estimated US$120 billion.

Going Underground

The restrictive laws and regulations for money movement out of China have led to huge national and international underground banking money laundering networks to facilitate the exit of funds. These networks are multi-faceted and based on the legal banking system, illegal underground banking networks, and misuse of the credit card system. This is a diverse and huge scale money laundering system that has developed in parallel with the huge growth of the economy in China as well as the expansion of the banking system and online payments.

The ‘underground’ nature of underground banking often refers to the complex network and layers of transactions that disguise the illegitimate origin of funds flowing through this system. Underground banking is not any single channel or platform, but involves multifaceted activities across multiple business sectors.

The National Crime Agency (NCA) in the UK has stated that Chinese underground banking often utilises the ‘Daigou’ system to move funds. This involves cash from criminal activity being paid into the accounts of persons buying retail goods in the UK (or anywhere outside China) that are in demand in China, and then exported to China for sale there, often in contravention of Chinese customs controls. This activity requires a large number of bank accounts in the target country, often provided by Chinese overseas students (who may be told that they are providing money transmission services for other students, but are likely to know that the activity contravenes customs controls in China).

In August 2022, the NCA arrested a Chinese national on suspicion of money laundering in relation to a suspected Chinese underground banking network. The NCA stated that the investigation relates 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.

The demand for Western goods purchased outside China has developed for several reasons in addition to currency controls. Counterfeiting has been rampant in China for decades, and hence there is a strong demand for access to genuine luxury goods. Some products, such as baby formula milk, have been subject to widespread counterfeiting in the past several decades and this has created demand for imports of genuine items. These factors have led to the growth of a global network of Chinese nationals buying various goods that are in high demand in China and exporting them back to their home country. The illegality of this activity comes from the evasion of import duties as well as income tax in China.

A recent case in the USA illustrates the methodology outside China. In January 2022, the FBI detailed the activity of two Chinese nationals accused of operating an illegal money transfer business in Southern California. The men allegedly ran an “informal value transfer system” to move money from China to the U.S. Their customers deposited money into Chinese bank accounts controlled by the men, who transferred the equivalent in US dollars minus commission in the USA.

Small operators of foreign exchange have also been associated with the growing Chinese underground banking network. In Hong Kong there is a long established cross border money remittance system, centred on over 2,700 licensed remittance agents and money changers who move money out of Mainland China. The Hong Kong remittance agency will typically have a partner on the mainland with a bank account, which is credited with RMB when the agent in Hong Kong pays out HK dollars. This is illegal in Mainland China, but not in Hong Kong (although AML laws and regulations may be breached in certain circumstances). The scale of cash movement through remittance agents is impossible to measure, but the SAFE reported that they had taken enforcement action against 210 underground remittance agencies on the mainland involving more than 100 billion yuan (HKD122 billion) from 2007 to 2011.

Cash movement out of Mainland China, largely to Hong Kong and Macau, remains a major part of underground banking. There are huge amounts of goods moved daily across the border with Hong Kong, much of it for onward shipping to other parts of the world. The high volumes mean that there are limited Customs inspections of vehicles and containers, and cash can be smuggled through physical movement on vehicles. The scale and volume of movement of Chinese nationals to and from Hong Kong, Macau, as well as international destinations has enabled ‘micro-transfers’ using Chinese travellers as ‘mules’ to carry cash, which is impossible to detect consistently.

Chinese nationals have established a large number of shell companies in Hong Kong and Macau, but also increasingly in other international jurisdictions. The benefit of a shell company is that it can facilitate a bank account, even if no real business is conducted. To maintain the shell company and move money through the related bank accounts the money launderers need to create a fictional business as a cover for the cash movements. Hong Kong and Macau remain major centres of the organisation of money laundering relating to Chinese services to organised crime groups.

The broad term ‘Underground banking’ has involved large parts of the legitimate banking sector in China.  Significant amounts of illicit cash flow out of China through the banking system, with Hong Kong and Macau being the major conduits for such funds to then be moved to other jurisdictions. Banks dominate financial activity in China, and the total assets of financial institutions reached RMB 381.95 trillion yuan by the end of 2021, an increase of 8% on the prior year. Money laundering through the banking system has increased substantially as it has diversified, especially with a rapid increase in online lending entities primarily via mobile phone platforms which do not have strong AML controls. The non-bank payment sector has experienced huge growth in China, with estimated volumes of RMB 17.6 trillion in 2013 increasing to RMB 100 trillion in 2016.

The growing scale and complexity of the financial system in China has led to great difficulty in enforcing foreign exchange restrictions. Chinese nationals have been seeking ways within the banking system to evade the SAFE since the enactment of foreign exchange controls in 2006. The SAFE has tried to stem some of the creative means that people had devised to evade currency movement restrictions, such as what in Chinese has been called “ants moving” (蚂蚁搬家) which involves “borrowing” quotas from friends and relatives to circumvent the annual quota. In 2009, the SAFE banned “split settlements” and in 2017 made “ants moving” a suspicious activity under its watch list.  In April 2019, the SAFE issued a guideline for banks intended to prevent people from splitting up foreign exchange movement quotas.

The requirements issued by the SAFE seem to have limited effect, and there are continued examples of cases of cross border money laundering using the legitimate banking system. For instance, in November 2015 the authorities in China announced that they had taken enforcement action in a major underground banking case involving USD 64 billion, with 100 suspects from 8 gangs arrested. The ringleader of the network operated dozens of shell companies in Hong Kong that were involved in foreign exchange transactions. The case involved over 3,000 bank accounts being frozen by the authorities, indicating how the legitimate banking system is a key part of underground banking.

It is becoming clearer that the use of Chinese underground banking is facilitating major international organised crime groups. What may have started as a system for wealthy Chinese people to move their funds out of China to circumvent government restrictions has developed through the BRI to become a global business for criminals. How to take concerted action against this problem is challenging given the difficulty of dealing with Chinese law enforcement agencies, which are inherently politicised and serve the interests of the Chinese Communist Party. The most important first step is for international law enforcement agencies to recognise that there is a growing problem with Chinese money laundering networks, work with the financial sector to develop typologies of this activity, and then institutionalise a response. Chinese underground banking is going to grow and we need to learn to deal with these networks.