AI for Banks: Key Ethical and Security Risks
The use of AI to drive efficiency and business improvement has increased significantly in the last five years across multiple sectors.
Times of economic crisis have historically often flushed out frauds and other unscrupulous dealings which may not otherwise have been discovered in normal economic conditions. It appears that the COVID-19 pandemic, together with other economic factors such as depressed oil prices, are no exception.
Since the outbreak of COVID-19, a number of significant alleged frauds have been widely reported in the press in respect of major commodity traders.
News reports have suggested that banks could struggle to recover a significant proportion of the sums involved in the commodity trading scandals emerging this year and could be facing major losses amounting to billions of dollars as a consequence.
If, and how, financiers can recover sums due and payable under trade financing arrangements impacted by these frauds will obviously depend very much on the circumstances in question and the manner in which a particular fraud has been carried out.
Over time there have been allegations made of various techniques used by parties in trade finance to obtain financing fraudulently; one of a number of allegations reported in relation to recent scandals is that, in addition to the issue of an original set of valid bills of lading, some parties also procured that additional sets of fake bills of lading were issued. This apparently enabled them to obtain multiple financings secured by the same cargo.
In these circumstances, a financier holding the valid original set of bills of lading will generally have security over the cargo and so may be able to recover the value of the security to apply against outstanding sums (assuming the cargo still exists).
However, those financiers or other parties holding the forged bills of lading may be left with no security for their losses (unless they have agreed other forms of security with the borrower, such as guarantees). These financiers will undoubtedly have a claim in fraud against the issuer of the forged bill of lading but in circumstances where that party may have limited assets or is insolvent, this line of action is unlikely to be fruitful.
One of the values of a valid bill of lading is that it entitles the valid holder to delivery of the cargo. As such, the carrier will generally be liable to the holder of the valid bill of lading if it delivers the cargo to another party, even where the other party presents convincing forged bills of lading. As such, where a financier holds a valid original set of bills of lading as security for a trade finance transaction, but the cargo to which the set of bills of lading relate has instead been delivered to a third party against a forged bill of lading, the financier may be able to bring a claim against the shipowner for misdelivery of the cargo, which may give banks in this situation an alternative route to recovery. Again, this will very much depend on the financial position of the shipowner and the vessel in question. For example, given that mortgagees would normally rank ahead of a party claiming for misdelivery, any financiers considering the arrest of a vessel would have to establish what other creditors (such as a mortgagee) are likely to rank ahead of them in the event of the sale of the vessel and try to assess whether there is likely to be any residual value remaining in the vessel to cover a misdelivery claim.
Banks already have various procedures in place in order to minimize the risks that they face from problems such as bill of lading fraud in trade finance transactions (and the vast majority of trade finance transactions are successfully carried out without problems). These include (inter alia):
However, the significant potential losses that financiers are facing in light of recent commodity trading frauds highlight that there is scope for improvement of the existing risk mitigation techniques currently in place and new tools creating more transparency and trust in the trade finance system will likely be beneficial to prevent similar losses occurring in future.
The use of new technology to improve the efficiency and security of trade finance transactions has been on the agenda for a number of years. However the drive to develop the use of technology in trade finance appears to have accelerated in response to the recent commodity trading frauds. For example, it has been reported that a group of banks in Singapore have been discussing collaboration on a central collateral database in order to track collateral and improve transparency in the trading process so that there is less ability for unscrupulous borrowers to obtain double finance secured against the same cargoes. More transparency would obviously be beneficial for reducing the scope for bill of lading fraud (and other types of documentary fraud) in trade finance, but in order to be effective such a database will require participation from a sufficient number of market players; who may have some reluctance to share potentially commercially sensitive information with competitors.
Another often cited potential solution to reduce the scope for bill of lading fraud is the adoption of electronic bills of lading. The transparency and traceability of electronic bills of lading platforms makes it much more difficult for certain types of bill of lading fraud (such as by issuing fake duplicates) to be successfully carried out when they are used. As we reported in our 2018 article, electronic bills of lading providers have been reporting growth in the use of their platforms. Since that article was published, new providers have entered the market (often using distributed ledger technology to further underpin the security credentials of such platforms), but uptake remains patchy. There have been a number of hurdles which have slowed the transition in the use of electronic bills of lading. For example, if somewhere in the supply chain a party is not a user of the electronic system, a paper bill will still eventually need to be issued, which to some extent negates the benefits associated with the electronic system – meaning critical mass is key to incentivize market participants to use electronic bills of lading. The legal uncertainty surrounding electronic bills of lading has meant that financiers have generally been reluctant to treat electronic bills of lading as the legal equivalent of paper bills of lading from a security perspective.
The COVID-19 pandemic has forced all sectors to adopt more digitization and technological solutions and has highlighted the practical limitations of paper bills of lading with issues such as delays in the arrival of paper bills of lading and a difficulty in presenting paper bills of lading due to quarantine restrictions. This, combined with the recent commodity trading frauds shining the spotlight on bills of lading fraud in the trade finance market, may well provide the catalyst to hasten the adoption of electronic bills of lading and other collaborative approaches to reduce the scope for large scale frauds in future.
© Norton Rose Fulbright LLP 2021