Navigating turbulent waters

Introduction

The Red Sea constitutes one of the most significant maritime routes in the world but on 19 October 2023, an air attack with missiles and drones conducted by the “Houthis” sought to make it impassable for Israeli linked vessels. This marked the start of a conflict known as the Red Sea Crisis.

Over the last few months, the situation has continued to escalate, with various vessels, predominantly linked to the US, Europe, and Israel, now diverting around the Cape of Africa to avoid the conflict. Whilst the impact of the crisis is far reaching, this article will focus on the impact of this crisis on financial crime and what Financial Institutions (FIs) can do to prevent financial crime in the region.

Background

According to the World Economic Forum, some trade experts said that approximately 12 to 15 percent of world trade and 30 percent of global container traffic passes through the Suez Canal¹, transporting more than one trillion US Dollars’ worth of goods yearly. Created in 1869, the Suez Canal connects the Mediterranean Sea to the Red Sea through the Isthmus of Suez, serving as the fastest maritime shipping route between Europe and Asia.

The Red Sea route can be accessed via two ‘choke points’, the Suez Canal from the North and Bab-el-Mandeb (Gate of Tears) Strait in the South. Bordering the Gate of Tears Strait is Yemen, a country with a population of 34.5 million, where a civil war that began in 2014 led to the rise of the Houthis.

Who are the Houthis

The Houthis are a political and military group which controls a third of Yemen², though they are not internationally recognised as the country’s government. They portray themselves as a group advocating for economic development and the end of perceived political marginalisation of Zaidi Shias. The Houthis also declare themselves to be part of the Iranian-led resistance against Israel, the US and the West, aligning with groups like Hamas and Hezbollah.

The recent Houthi attacks initially targeted Israeli-bound vessels but soon expanded to all international shipping companies, with an aim to put pressure on Israel into allowing humanitarian aid into Gaza. Their actions escalated the conflict from a regional war into a global crisis.

Impact of the attacks on Financial Crime

Instability in the region has fuelled a rise in terrorism, smuggling, and human rights violations, as well as food shortages, leading to an increase in sanctions. Historically, we have seen that conflict zones become a haven for criminal activity, and this crisis appears no different. Groups such as the Somali pirates have been raiding diverted ships and there are indications that sanctioned ships have been exploiting the chaos to smuggle goods. We consider some of these elements in more detail below:

Smuggling

The Cape of Good Hope has emerged as a smuggling route for Russian oil as it lacks the checkpoints present in the Suez Canal. This makes it easier for diverted ships to use this route to undertake illicit activities, such as unregulated fishing and commodities smuggling.

Since the onset of attacks in the Red Sea area, Windward³ has reported several trends that indicate shifts in illicit behaviour by vessels, making it increasingly difficult to rely on established practices to track such activities.

The recent events in the Red Sea have resulted in law abiding vessels turning off their Automatic Identification System (AIS) transponders to avoid the Houthi threat (“dark activity”). The AIS is a tracking system used for marine navigation that allows vessels to communicate their location. Although the International Maritime Organisation (IMO) legally mandates its use, there are exceptions for ships when they are under fire⁴.

The monthly average of lost AIS transmissions in the Red Sea and Arabian Sea by cargo and tanker vessels from October 2023 to February 2024 increased by 104% when compared to the monthly average of February to September 2023⁵. Turning off the AIS presents an incremental financial crime risk for Financial Institutions (FIs) supporting international commerce transactions, as it is not possible to discern between those vessels switching off the AIS to avoid the Houthis’ attacks from those turning it off to circumvent international sanctions.

Another trend spotted by Windward is an increase in the number of visits by Iranian-flagged cargo vessels and tankers to the Red Sea area from October 2023 to February 2024. There were 152 area visits by high- or moderate-risk Iranian vessels in January to February 2024 alone, compared to a total of 191 in all of 2023 – most marked for smuggling risk⁶.

Any such vessels can be smuggling a wide variety of goods, but it has been reported that drug smuggling has been a primary source of revenue for the Houthi militants⁷. The OECD reports that Houthi-controlled areas of Yemen have become open drug markets. The revenue from this activity is used to purchase weapons but also to drive loyalty in the fighters via addiction. This contributes to a complete social breakdown in Yemen. From a financial crime perspective, drug trafficking is a predicate crime so FIs cannot accept the proceeds from such activities, and there is also a sanctions related risk as key individuals and companies involved in smuggling will often be sanctioned.

In summary, the combination of new routes, difficulties tracking ships, and an inability to enforce checkpoints make it harder than ever for FIs to identify potential suspicious activity.

Terrorism

The direct financial cost of terrorism in the Red Sea is significant due to its impact on shipping prices, energy prices, damage to communication cables, and maritime fees⁸. Beyond cost, the attacks by the Houthis pose a threat to global security, endangering lives, funding terrorism and other criminal activities. Countries struggle to combat terrorism effectively, leading to a cycle where crime and violence become part of daily life.

As the level of terrorism increases so does the need for finance mechanisms to support and fund terrorist networks. Due to the stringent sanctions imposed, funnelling funds to finance terrorism has had to find its way by creating complex transactions with the only purpose to obscure the final beneficiary of funds.

On 25 June, the Office of Foreign Assets Control (OFAC) designated nearly 50 entities and individuals believed to be involved in a shadow banking system that facilitated transactions for Iran’s Ministry of Defence and Armed Forces Logistics and the Islamic Revolutionary Guard Corps⁹.

According to OFAC, these sanctions target a network that helps these groups gain illicit access to the international financial system, particularly through the sale of Iranian oil and petrochemicals. Individuals and entities, including various cover companies in Hong Kong, the United Arab Emirates, and the Marshall Islands, have been designated for allegedly assisting in laundering billions of dollars. OFAC also notes that the network supports regional proxy groups such as Yemen’s Houthis.

The U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) separately noted in their advisory published on 8 May 2024 that much of the Houthis’ funding is raised and transferred through an elaborate smuggling network connected to the Iran-based Islamic Revolutionary Guard Corps-Qods Force (IRGC-QF) and facilitated by Houthi financial operator Said Al-Jamal¹⁰.

Both OFAC and FinCEN have been actively highlighting the involvement of shadow banking networks and Iranian financiers to provide funds to terrorist groups, such as the Houthis. It is a challenge for FIs to stay alert to these new networks / typologies to ensure that they do not inadvertently fund terrorism.

Sanctions

In response to the attacks, international bodies have imposed sanctions to prevent financing of the Houthis or any other jurisdiction, regime, entity, or individual supporting them.

In January 2024, the US and the UK imposed new sanctions on four senior Houthi militants and announced the listing of the Houthis as a Special Designated Global Terrorist. This coordinated action marked the first joint sanctions imposed by the US and UK governments since the conflict began in November 2023. In February 2024, the United Nations Security Council adopted Resolution 2140, which imposes a travel ban and asset freeze on individuals or entities designated by the 2140 Committee for engaging in or providing support for acts that threaten the peace, security, or stability of Yemen, including human rights violations.

Besides the direct sanctions on the Houthis, international powers have also been expanding sanctions to other nations or groups that support the Houthis. On March 2024, OFAC identified a company registered in the Marshall Islands with a vessel being used for illicit shipments to the People’s Republic of China in support of Iran’s IRGC-QF and a Houthi financial facilitator, who is also sanctioned under U.S. counterterrorism authorities¹¹.

It was identified that the involved vessel was engaged in ship-to-ship transfers to another sanctioned vessel which obscured its transfer of commodities through “spoofing” – an AIS manipulation that masks the vessel’s true location, which was being incorrectly reported in the South China Sea; the illicit cargo was then offloaded near Singapore.

The above indicates that for FIs, the scope and focus of sanctions is changing. No longer is the focus directly on the Houthis but also on those who finance them.

Looking to the future, what can FIs do to reduce Financial Crime in the Red Sea region?

The above sections highlight how the Red Sea crisis has resulted in an increase in criminal activity, and the heightened risks that FIs may face as a result. FIs can take the following steps to detect and prevent the resulting financial crime:

1. FIs providing international trade finance services / payments, should be aware of the incremental risks that the Red Sea crisis represents to the different involved parties; besides the impact on both the time and cost of international trade transactions diverting from this corridor, there is an increase in the risk exposure to entities and / or individuals supporting financing of associated terrorist activities. Awareness may imply reinforcement of the KYC controls to understand the nature of their customers’ business and ensure this is aligned to its licit commercial activity.
2. Regarding controls related to correspondent banking, FIs should consider and assess the risk exposure and mitigants of respondent banks located in high-risk jurisdictions related to the Houthis’ activities.
3. As part of their Financial Crime Risk Assessments, FIs should incorporate the typologies and guidance notes issued by international organisations, such as FinCEN, to identify and assess their risk exposure and the mitigants in place.
4. FIs should ensure that the controls in place for processing transactions on behalf of money service businesses, virtual asset service providers, non-government organisations and charities operating in non-equivalent markets are robust and frequently tested. Any links to known terrorist affiliated locations or individuals must be flagged and reviewed.
5. FIs should ensure that customer due diligence practices facilitate the identification of shell or front companies. Where such entities are identified, questions should be asked to understand their purpose, ownership, nature of business and countries of operation, to establish any links to sanctioned or terrorist parties.
6. FIs should continue to test the capabilities and effectiveness of their screening systems to ensure that new and evolving sanctions are incorporated.
7. FIs should revisit their sanctions policy to ensure that the policy incorporates the shadow banking related sanctions. The thresholds for sanctions exposure could also be reconsidered, factoring in information published on countries known to be neutral or allied to the Houthis.
8. FIs should update their terrorist financing and sanctions related training to incorporate the latest typologies and methods pertaining to Houthi financing. Given the escalation of terrorist activity in the region a refresher for staff on the methods of terrorist financing may also be useful.
   

As the consequences of this crisis continue to be felt across the world, it is important that FIs play their part in ensuring that terrorists cannot finance their activities. FIs should ensure that their control framework has been enhanced to bolster effective detection and prevention of criminal activities pertaining to the Red Sea crisis.

This article was authored by Claire Franklin and Isabel Baldock and was first released on https://www.doccredit.world/ on 25 September 2024.

Sources:

¹ Red Sea attacks: What trade experts have to say about the shipping disruptions | World Economic Forum (weforum.org)
² Houthis Red Sea: Five maps that show why the Red Sea is so important (afr.com)
³ Knowledge Base - Windward’s Maritime AI™ Insights & Resources
⁴ Vessels 'go dark' to avoid Houthi attacks, but may still be vulnerable - The Loadstar
⁵ Knowledge Base - Windward’s Maritime AI™ Insights & Resources
⁶ Knowledge Base - Windward’s Maritime AI™ Insights & Resources
⁷ Houthi drug trade fuels instability in Yemen, Middle East - ShareAmerica
⁸ Recent threats in the Red Sea (europa.eu)
⁹ OFAC Targets Shadow Banking Network
¹⁰ FinCEN Advisory Iran Backed TF
¹¹ Treasury Targets Vessel Shipping Iranian Commodities for Houthis and Qods Force | U.S. Department of the Treasury

Contact us

Claire Franklin Forensic & Financial Crime Director, Strategy, Risk & Transactions Deloitte Southeast Asia cfranklin@deloitte.com	Isabel Baldock Forensic & Financial Crime Senior Manager, Strategy, Risk & Transactions Deloitte Southeast Asia imendezalvarez@deloitte.com