Point of View

Due diligence: highlighting the challenges for SMEs

22 February 2024
By Eduardo N. B. Leite, founder of the Trade and Compliance Institute for Trade Facilitation, Electronic Business and Sustainability

Performing due diligence can be challenging for SMEs, and regulators should take this into account when designing trade compliance programmes and initiatives.

Companies and institutions involved in moving goods across borders must apply due diligence to ensure compliance with Customs and trade regulations given their sheer number, complexity and sometimes opacity. However, they are not equal in terms of resources and capacities. This article highlights some of the issues they face and offers some ideas on how to support companies – and especially SMEs – in their compliance efforts.

Knowing your customers and suppliers is intricate and financially burdensome

Let’s take one aspect of exercising due diligence in international trade operations: conducting checks on customers and suppliers. In large companies, customers and suppliers go through a homologation process commonly called KYC (Know Your Customer) and KYS (Know Your Supplier). Investigations are conducted for this purpose, requiring Customs knowledge, trade expertise, legal skills, in some cases the use of laboratories, and the participation of experts (economists, engineers, etc.). Once a customer or supplier has been validated, continuous monitoring must take place.

To get a better idea of what this exercise covers, let’s have a look at what HM Revenue & Customs in the United Kingdom expects from Customs agents (the list is not exhaustive[1]):

  • checking where the business is established;
  • demonstrating that the business has its own bank account(s);
  • providing a set of annual financial accounts, including trading accounts and balance sheets;
  • demonstrating financial solvency or creditworthiness, including whether a company is subject to liquidation or administration proceedings;
  • demonstrating that the company is not subject to bankruptcy proceedings or county court judgement (CCJ) orders for outstanding debts;
  • checking that the customer has the appropriate certifications and licences in place before the goods are imported, depending on the types of goods involved;
  • checking that the trader has taken the necessary steps to make sure its supply chain is not involved in fraudulent activity.

In addition to these requirements, other aspects need to be investigated such as corruption: proof of the existence, in fact and in law, of the foreign operator, and identification of its controllers and administrators; proof of status as the real purchaser, orderer or seller of the goods; specification of trademarks and legitimacy of reproduction rights used in goods; etc.

Today, the process of verifying a customer or supplier is intricate and financially burdensome, because of the existence of diverse business registration systems and standards for goods. Here, the introduction of standards and unified systems for identifying companies and goods in trade supply chains would be a game changer for all the entities involved in international trade, including Customs authorities. The existence of digital ID systems and regulatory frameworks allowing an entity to prove its identity online could change the ways cross-border transactions happen. But there is not yet a global, unique and widely-recognized identifier scheme for subjects (people and legal entities) and objects (material/goods and immaterial/intangibles).

Existing tools for companies and governments do not focus on Customs issues and can be expensive

There are tools to facilitate compliance management, used by companies to obtain reports which will enable them to decide whether they can work with a party, and to know whether that party is what it says it is, whether it is compliant with environmental, social and governance standards, whether it can do the job, whether it shares the same values and code of conduct, whether it might cause financial harm or misuse data disclosed to it, etc.

Although the price of a standardized/basic report can be quite low for cases which are relatively simple, the price of a report for a complex case will be expensive, as the intervention of experts will be required. Large companies usually turn to service providers to perform this task, as indeed do governments, but many MSMEs do not have the resources to do so.

According to a survey of three multinationals which analyse global databases to identify compliance risks, a monthly subscription including a limited number of reports costs on average USD 1,000 per month. On a pay-per-use basis, prices start at around USD 100 per report, and increase depending on the depth of the research required.

Compliance reports of this kind do not specifically address Customs issues, but the development of data mining tools facilitates the inclusion in the analysis of information from Customs and regulatory agencies’ platforms. In addition, the reports often provide anonymized information, data and trade statistics, similar to what can be done using the Global Trade Helpdesk[2], and they attest or certify information without sharing commercially sensitive information, such as Digital Preferential Certificates of Origin.

Any information can be integrated by the service providers in order to enrich their reports, either for private companies or for Customs – and for their risk management departments especially.

By way of example, analysing the financial data of a potential manufacturer can provide strong evidence as to whether it has the required producing capacity in the country declared as being the origin of the goods, or whether this might be a case of triangular operations with tax havens or privileged tax regimes. A compliance report can also indicate whether or not a company is subject to sanctions.

That being said, the quantity of data/statistics about companies provided in these reports can make them complicated to interpret. Another challenge is the number of companies to be monitored.

Authorized Economic Operator (AEO) and Customs regimes are not adapted to all resources

Governments not only punish infringers, but also incentivize compliance by providing facilitations to operators who identify and act upon any risks related to their operations, customers and suppliers, implement specific measures, and show a history of compliance with such measures and with the law in general. In line with WCO instruments, many Customs administrations have established compliance certification programmes, such as AEO programmes, with the aim of building an ecosystem of trust. Some AEO programmes go beyond WCO security-oriented requirements and cover the prevention of corruption and forced labour, for example.

Some Customs regimes, especially those that provide exemption from or suspension of taxes, also impose obligations on beneficiaries that force them to be more diligent with their operations. Such obligations include the correct and timely payment of taxes and may, in certain cases, include a requirement that commercial relationships are only established with qualified partners.

Unfortunately, such schemes do not benefit all companies in the same way. The International Trade Centre, in its publication “Supporting SMEs through trade facilitation reforms”, explains that “SMEs are often excluded from trusted party schemes, such as authorized economic operator (AEO) arrangements, because they do not satisfy the security and guarantee requirements. Likewise, SMEs rarely benefit from the release-before-clearance facility at the same ratio as large firms, as they must provide costlier forms of securities.”[3]

More inclusive standards and guidelines are needed

International standards and guidelines play a critical role when it comes to foreign trade, benefiting both regulation makers and implementers. However, the limitations and constraints of MSMEs and Least Developed Countries should be considered in guidelines, frameworks, recommendations, technical specifications, orientations, whitepapers, compendiums, research papers and reports.

Data on risk management practices would be welcome

Many governments outsource activities that can be performed better by the private sector. Such activities include the custody and control of goods in bonded warehouses, and many inspection-related processes such as weighing, scanning and checking for drug contamination.

With the emergence of machine learning tools and Big Data, risk management is also being outsourced, especially in Developing and Least Developed Countries. Private companies can fill an information gap by building databases on the value of goods, the ownership of companies and business relationships, while also using open and official data that is not processed by Customs authorities’ risk management software.

Here also, transparency regarding the control methodology would help to drive compliance. Some Customs administrations are quite transparent in their annual reports about the controls they have undertaken and lessons learned, enabling companies to better understand what is required to achieve compliance.

More information

[1] https://www.gov.uk/guidance/due-diligence-when-making-customs-declarations

[2] The Global Trade Helpdesk (GTH) is a multi-agency initiative jointly led by ITC, UNCTAD and the WTO, that aims to simplify market research for companies, and especially Micro, Small and Medium Enterprises (MSMEs), by integrating trade and business information into a single online portal.

[3] https://intracen.org/resources/publications/supporting-smes-through-trade-facilitation-reforms-toolkit-for-policymakers