This Article is From Oct 09, 2023

China's Rich Entrust Total Strangers To Sneak Cash Out Of The Country

Since international borders reopened post-pandemic, advisers to the rich report a surge in demand for overseas backup options.

China's Rich Entrust Total Strangers To Sneak Cash Out Of The Country

Opportunities to move cash legitimately from China are severely limited (Representational)

Imagine trusting your life savings to a group of strangers you know only via WhatsApp. Some affluent Chinese people are willing to make that gamble to get part of their wealth out of the mainland.

Take 32-year-old Phoebe, who recently moved almost a million yuan ($137,000). To do it, she first had to transfer her money into the account of a local facilitator. Then, Phoebe, who requested to be identified by only her first name because of privacy and legal concerns, had to sit tight.

A few tense hours later, transactions began to pop piecemeal into a separate account she holds in Hong Kong. While the city has been stripped of many of the political freedoms it used to enjoy, it still occupies a unique place in China's financial ecosystem as the only area with unfettered access to global capital markets. Once cash is there, it can go anywhere.

The funds that appeared in Phoebe's account came from 10 people in total-one of whom deposited the equivalent of $1,300 in notes via an ATM. The transaction moved through an informal, unregulated system known around the world as hawala. On one side of the administrative border between the mainland and Hong Kong, Phoebe handed over her money to members of her facilitator's network; on the other side, the transaction was mirrored by others in the network who dropped money into her account.

The entire operation was dependent on faith. But Phoebe's wait wasn't quite as nerve-jangling as you might expect: She'd been referred to the remittance agency-which is illegal in China-by her established, well-regarded wealth manager introduced via mutual connections.

Since international borders reopened post-pandemic, advisers to the rich report a surge in demand for overseas backup options. Crackdowns on ideologically out-of-favor industries, uncertainty over geopolitical tensions and Xi Jinping's push for "common prosperity" have spooked the rich and even the middle class. In addition, the domestic economy looks increasingly dire. Exports are struggling, house prices are falling, and more than 1 in 5 young people are out of work. Many wealthy families feel it's essential to have money outside the country, whether to diversify assets or to pave the way for potential future immigration.

Traditional havens still hold their allure-think a condo in Vancouver or US equity investments-but over the past two years Singapore has increasingly emerged as a favored destination. In the stable, low-tax city-state where Mandarin is one of the official languages, signs of the influx of Chinese cash are everywhere. Nightclub tables fetch as much as $70,000 an evening during the Formula One Singapore Grand Prix, trendy wine bars for Chinese billionaires abound, and there's been an explosion in the number of family offices managing the assets of the rich.

Yet opportunities to move cash legitimately from China are severely limited, with individuals normally allowed to wire only $50,000 a year overseas. They also have a one-time opportunity to move their money when they emigrate. Plugging the gap is where the underground networks come into play. "These agencies have sprouted to meet soaring demand," says Joel Gallo, an adjunct professor of finance at New York University Shanghai. "They act as quasi-banking firms, yet operate without the scrutiny of one and adroitly engage in regulatory arbitrage by standing in a gray zone."

There's no reliable estimate on how big the industry is, but probes disclosed by authorities suggest an enormous scale. One investigation in China's western Gansu province uncovered an operation with 75.6 billion yuan in assets, state media reported in 2021, citing China's State Administration of Foreign Exchange. The money was spread among a network of five organizations that used more than 8,000 bank accounts across more than 20 provinces.

The networks are truly global in scope, operating not only in Hong Kong but wherever there are significant numbers of the Chinese diaspora. It's "highly likely" that underground banks will have pools of funds ready in key locations, so recipients can receive their cash quickly, and in the local currency, according to a 2019 intelligence assessment by the UK's National Crime Agency (NCA).

Linking up with one of these money shops, though, isn't a decision to be taken lightly. People caught using illegal currency exchange services in mainland China usually are fined 30% or more of the amount of money they attempted to transfer. If the sum is significant, those providing the service face significant jail time. Although the maximum penalty of a life sentence is typically handed down only when there are compounding offenses such as bribery, reports of sentences ranging from one to five years are common.

Although China's capital laws don't apply if you're in the likes of Hong Kong, the UK or Singapore, there's a risk of legitimate banks getting suspicious about the source of funds. A spokesperson for the Monetary Authority of Singapore says that while the city-state doesn't implement the capital controls of other jurisdictions, the regulator requires financial institutions, including remittance agents, to detect and report suspicious transactions and behavior. Institutions are also required to mitigate reputational, legal and operational risk from activities affected by other jurisdictions' laws.

Singapore's banks have reason to be on especially high alert: In August authorities arrested and charged 10 people with Chinese origins with a range of crimes including money laundering. More than S$2.8 billion ($2 billion) of cash and other assets were frozen or confiscated. The allegations involve attempts to move proceeds from illicit activities such as scams and illegal gambling, not remittances.

But there is a dark side to remittance operations. To ultimately settle exchanges via hawala, Chinese underground banks regularly use cash generated by criminal groups through activities such as drug trafficking, cigarette smuggling, organized illegal immigration and human trafficking, according to the NCA. For example, a gang with operations in both China and the UK might front the money to pay a hawala recipient in London and then get paid a corresponding amount by the underground bankers in Shanghai.

The British law enforcers found that Chinese student accounts were sometimes used as a back door to get money into the legitimate banking system. The NCA identified more than 100 people who'd made cash deposits into over 14,000 personal bank accounts held or set up predominantly by Chinese students. The amount of cash put into these accounts in a 12-month period totaled in excess of $163;100 million ($121 million), with some of the people parking more than $163;2.5 million each.

The high stakes of navigating this murky world are one reason why trusted financial professionals have emerged as go-betweens. While it could cost them their careers if caught by company compliance, private bankers under pressure from clients can step into a gray zone. Bloomberg News spoke to four financiers who discussed how the lines can be blurred. All requested anonymity to speak freely. One former private banker, who currently works at a multifamily office, describes how he's personally been involved in moving money for wealthy clients. Another financier says he's helped introduce clients to such services, while his firm helps rich Chinese set up variable capital companies-a structure used by some investment funds in Singapore that can shield the ultimate beneficiaries' identity from the public, though regulators can see.

Two other private bankers at different European banks say that while on the books they can't help clients avoid capital controls, they do pass on contact information for underground remittance agencies for close and trusted customers. Typically none of these referrers take a cut: Passing on the links is about keeping important clients happy-and potentially winning future lucrative, legitimate business. The explosion in wealth in China over the past decades means there's plenty of potential demand. UBS Group AG, for example, estimated in its annual wealth report that there were 6.2 million Chinese with assets of more than $1 million at the end of 2022.

Right now there are increasing signs that more money is looking to leave. Real estate consultant Juwai IQI said in August that it expects more than 700,000 Chinese to exit the country in the next two years. Top destinations for buying property-based on searches on its site-include Australia, Canada and the UK. Singapore introduced a 60% property tax for foreign purchasers in April, which has crimped midmarket demand.

If more cash flows out of China than into it, that means not all remittance requests can be satisfied by mirrored transactions, and agencies need to find ways to actually get money across the border. Clamping down on these routes has been a long-running game of cat and mouse. Chinese authorities have swatted simple options such as cash being moved in suitcases or car trunks or sailed to Hong Kong in junks. Increased scrutiny of overseas acquisitions has reduced the opportunities to get money out by paying an inflated price for companies outside China. And the crackdown on crypto has made it much harder to use digital currency as a workaround.

Yet there are still ways. One popular technique is known as "smurfing." It involves recruiting people on the mainland who haven't used their legitimate remittance quotas of $50,000. By using many people, the agencies can then use their bank accounts and small individual allowances to funnel large amounts of money outside the country. Case investigations disclosed by the government show that sometimes this can reach epic scale. One man, surname Li, recruited 102 individuals to help send C$6.8 million ($5 million) in 2020, state media reported.

And when the sums of money are even bigger, things get more sophisticated still. One common ruse is to doctor import contracts where bills have to be settled offshore. This can be done by inflating the value of the goods imported, with the seller then agreeing to siphon the difference into a separate offshore account. Or it can involve outright falsification. In one case in the eastern city of Wenzhou, a company created fraudulent commercial trades claiming it paid $9 million for imports. Another investment company, in Shenzhen, fabricated trades and wired almost $18 million overseas, according to the State Administration of Foreign Exchange disclosures.

Uncovering these sorts of illicit trades has become something of a forensic detective game for companies such as XTransfer Ltd., which helps small and medium-size businesses with trade and clears compliance with banks. In the company's Hong Kong office, a member of XTransfer's staff points to lines of data used to check whether a trade is authentic. In total the company uses more than 1,000 stats to automate verification. There are usually telltale signs when something's off. High-value goods including diamonds, emeralds or big-ticket electronic items are a common ruse for fabricated trades, says Gong Weisong, an anti-fraud expert at XTransfer. "If the number of transactions to a specific seller is abnormally high, and also from various unrelated accounts, that's another red flag," Gong says. "Another thing we've noticed is that people who make up trades will often have meticulous documentation, which is also abnormal."

Even if moving money out of China becomes more difficult, experts don't foresee any letup in overall attempts. Based on unexplained discrepancies in tourist data-which suggest Chinese tourists are leaving cash abroad when they travel-as much as $150 billion is expected to exit this year, according to an estimate from Gary Ng, a senior economist at French investment bank Natixis.

"After the Covid era, Chinese have an increased demand for sending money overseas both for work or personal reasons," says Liu Xinyu, a partner at law firm King & Wood Mallesons. "More people could resort to illegal channels, and we could see a rise in cases investigated by authorities."

As well as being lucrative, the underground networks are sophisticated, clipping transactions in a way familiar to anyone who's done foreign exchange. One way they make money is by asking for a more expensive exchange rate, according to people who've used them. For example, if one typically needs 716 yuan for $100 at a bank, they'd ask for 733 yuan instead. The rates change daily.

For individuals, even as Covid lockdowns are lifted, the memories of the extreme curbs remain. "The pandemic definitely sped things up," says Dominic Volek, group head of private clients at investment migration consultant Henley & Partners. People with wealth in China are "looking for a Plan B."