The Risk of Fraud in Trade Finance Funds

Greensill Capital and the Fraud Risk in Trade Finance

The collapse of several trade finance funds including IIG Trade Finance, Barak Fund Management, and Greensill Capital highlights many of the risks we have discussed related to trade finance investments. We are skeptical of the low default rates, low volatility, and steady "45-degree angle" reported returns presented by many trade finance funds. We do not think that trade finance is an attractive asset class for institutions that are seeking low-risk investments.

Inadequate Investor Due Diligence

Most investors do not have the resources, or time, to evaluate and monitor the underlying trade finance investments which are often located in emerging or frontier markets. Many trade finance investments are also related to agriculture, natural resources, and infrastructure located in remote jurisdictions which are hard to inspect and verify.

Barak Fund Management, a $1 billion Mauritius-based entity, held investments in Zambia, Botswana, and the Ivory Coast. Few investors would be able to sufficiently vet the underlying collateral for Barak's purported transactions.

Legitimate trade finance funds will typically hire one or more highly reputable collateral managers to monitor inventory levels and product quality for the underlying collateral. One of the most egregious of Greensill's criminal activities was the sale of non-existent receivables backed by fake customers. We believe that if Greensill had been required to maintain a reputable collateral manager for each transaction, the fraud would not have grown so quickly.

Reliance on Documentation Heightens the Risk of Fraud

The high reliance on digital documentation is a serious risk for trade finance investors, and one that is hard to mitigate for most institutional investors. While Greensill chose to create fake invoices to sell to Credit Suisse and other banks, in the case of IIG Trade Finance, more than $60 million of fake loans were sold to investors.

IIG was a $1 billion New York-based trade finance fund that focused on Latin America. The IIG fraud duped investors including the International Finance Corporation, the Inter-American Development Bank, and major Korean Pension Funds. 

The fake loans from IIG Trade Finance used documentation that was created in Adobe photoshop, using materials from prior loans that had already matured. In other cases, the names of real borrowers were modified slightly to create fictitious loans that IIG could sell to investors.

Misconceptions Related to the Role of the Trustee 

We believe that the monthly reports from the trustee are the hidden risk for investors in trade finance funds. Our investigators have confirmed, via employees working inside trade finance funds, that the trustee reports are simply generated by repackaging the information that is provided by the investment manager.

An unethical fund manager can take advantage of this "loophole" and hide actual defaults and non-performing loans. This enables the manager to continue to collect fees regardless of the actual fund performance. Most market participants do not realize that the trustee provides no assessment of the accuracy (or existence) of the fund manager's transactions.

We advise our clients to not invest in CLOs or trade finance vehicles because of the costly underwriting process, the risk of fake loans and invoices, and monthly returns that are often "too good to be true".

Contact us to learn more about the risks in structured finance and trade finance funds.