Marius-Cristian Frunza is a chief analyst in environmental markets with Schwarzthal Kapital and a lecturer at Sorbonne and Dauphine universities in France. He worked previously for 2.5 years in a carbon brokerage company in Paris. Recently, he published a highly recommendable book: “Fraud and Carbon Markets”.
By: Tom Heinemann
Compared to other markets, where we previously deal with VAT-fraud, the main asset is the information on where the weaknesses of the system are. So all the infrastructure is a computer and an Internet connection. That is in plain words what is needed for this trade.
“So it is very easy?”
“Yes, very easy to understand for an average skilled person in the financial business. And very easy to replicate – and the time to market is very short because – in order to trade carbon on a spot basis – you only need to open a company, a bank account and a registry account. The time to settle everything is just a couple of days.
“And the trading can be done in minutes?”
“Now, this is a fast trade, where the bank trading can be done in micro- or nano-seconds. Now minutes in financial terms are called a slow trade but for the carbon it maybe took from minutes to a couple of hours – with buying and transfer of the credits. So the people who started the VAT-fraud they obviously needed the funding – substantial funds. Let’s say – when the fraud started the price of a credit was between 12 and 25 €. Generally the deals were around 100.000-200.000 credits at a time. So we talk about millions. Only in small trades. We don’t talk about the big tranches.
So the person who enters the VAT-fraud – idea would generally need millions of seed capital that would allow him to have capital for the trading”, says Marius-Cristian Frunza who has investigated the market for carbon credits and the following fraud intense.”
The dirty money
“Where did the money came from. Well small limited companies – they couldn’t find the capital through bank or other classical financial institutions. So this kind of company obviously need fund sources from mainly organized crime. The person who was able to fund these kind of things – is people from the middle east, far east Asia, ex-soviet union and Israel.”
“Where did the criminal come from?”
“The criminals came from two main sources. One was the ones who had previous experience in the VAT-fraud with gold, mobile phones and clothes, and they found this as a new opportunity to make money as they were familiar with the mechanisms. And the new people was someone who had experience with financial trade, they tried this as a new opportunity.
But they were very new in the VAT it self. In terms of capital source – and where the money came from to seed it – is manly the new wave of organized crime described as middle east organizations – terrorist founders, far east Asia, ex-soviet union – bits and pieces from south and eastern Italy and Israel.
But let’s be honest: You also have people from Germany, people from Denmark and Norway who has no criminal background, but the seed – the people behind the scene….They were also seduced by the idea that they could make a lot of money – without growing up in a criminal environment.”
The French Connection going Nordic
“Based on your research how big was the fraud. Let’s say at the French exchange, Blue Next?”
“In terms of numbers – almost 90 % in the period November 2008 and September 2009 – 90 % of the trading were linked to fraud, which in total implied 1,9 billion € of frauded VAT. Very interesting thing is that the Blue Next is owned by the government by the French state bank – and obviously they paid the VAT up front which made it very easy because they paid it up front and you didn’t have to wait one or up to three months.”
“Tell me about the Danish registry?”
“To have access to a national registry, you pass an initial screening. You have an ID – identity check, but in the Danish registry it was at one time – very easy to open an account only with an e-mail. There was no other background check, so people – a whole lot of people from all over the world opened account at the Danish registry in order to have the ability to trade and have the ability to move carbon without having the link to be able to be traced by any potential investigator.
Generally in the registries in the French and the UK have local people who do business in the country of their origin, but in the Danish registry the number of Danish companies in terms of it’s origin it was probably the fourth. You have U.K. You have Germany or you have Dubai or Hong Kong who are in the top of the list, and people from these countries they opened accounts in the registry. And the Danish people in the registry are in the fourth or fifth place. You will find that almost all the people who has been indicted or convicted they had their name and company in the Danish registry.”
“And when they finally managed to stop it in Denmark the numbers in the registry fell dramatically from around 1300 to only 30. Have you seen that other places as well?
“In the beginning the crime was very genuine. People went to the companies they had interest in and they had intention to hide what they were doing. Once the VAT took out from Blue Next. The Danish registry was present there – but they started to put layers in. They started to use companies to trade and use banks and energy companies and others not to go directly – so the structure of the crime changed gradually with the time.”
“Are you saying that banks and other financial institutions was involved and maybe without even knowing it?”
“Yes, indirectly. They traded indirectly or sometimes directly with links to the VAT-fraud, and you cannot clear the volume of it, so we are talking about 8 billion € of VAT-fraud on the whole of EU on the carbon market. You cannot trade this kind of numbers if you only are a small limited company, you need big institutions behind this. You need bigger to clear to this kind of volumes. You cannot do it by yourself.”
“You estimate that the EU lost some 8 billions in this?”
“Yes, 8 billion €. This is my central investigation, From 7 to 9 billion.”
“And this huge amount of money cannot be done by individuals, there has to be some big companies involved. Is that right?”
“It has to be. You need markets that has liquidities. And here you see very intense things like 2 billion being traded during 6 months on the Blue Next Exchange. We also have trades in other markets and also in big financial institutions that could “clear” this kind of volumes and pay the VAT. So you have the allegations against Deutsche Bank and other institutions.”
No European CIA or FBI
“Why did it take so long for the EU and the member states to find out that they were being frauded immensely?”
“I don’t think it took long to know. I think they knew very early that there were signs from the very beginning. You cannot ignore it was too big and direct. It wasn’t something you discovered that the person was a trader during the day and a bandit during the night. People knew from the beginning that there are fraudulent elements on the market.”
“Why didn’t they stop them then?”
“I think that one thing was that carbon was the big thing in the European Union. Something that the EU was very proud of to have the EU ETS – the European Carbon permits – and second you had a lot of financial institutions involved and it was generally financing crimes today probably more related than we think, but still it was seen in the modern world as a high level clean business sector.”
“How many have so far been arrested and convicted for doing this?”
“I took various cases from Eastern Europe, Romania, Bulgaria and to the U.K. and with very small exposure – like a couple of thousands of € of VAT fraud – and up to millions and the number of people who were in some kind of a trial were around 200.”
“How many do you think they represent. Are there more behind this?”
“I think the total head count involved in the VAT is around 1.000 – meaning people with significant business above half a million €. You have a lot of businesses who traded a couple of thousands – and they made 30, 40, 50.000 € in Eastern Europe – a lot of money for the country, but definitely in terms of big players we have 1.000 persons involved. And I said significant people. By that I mean the criminal. I do not take the accountant, or the secretary of this firm – or the analyst or what ever. This is not the 1.000 with the real criminal intentions. Like if you make a deal with the New York Mafia you have 1.000 criminals in the five families, but you have a lot of associates. People who is not related directly involved – or as a member.”
The price of fraud
In his research for the book, Marius-Christian Frunza found that the price of a carbon credit was directly linked due to the massive fraud.
“The VAT traded generated a very high pressure on the prices and the prices dropped because of the VAT-fraud to 4 € less than their economic value. So without the VAT fraud on the market we would have had a credit that was 4 € higher than it is today. Here it was a market were it was 90 % of the trades involved in the VAT fraud – the market will give a price for an underlying which gave you the opportunity to do fraud. So you did not have a price for the carbon or not a price for the environment. You had a price for fraud. And this is why the prices went down, because the VAT was not depending on the price. If we take the VAT fraud it is definitely the speed and the volumes – if we compare to clothes or food VAT – the carbon credits do not take any stock volume and they can be traded between two countries in Europe in only a couple of minutes.”
“So obviously if you want to do crimes and if you want to be fast and untraceable, carbon is one of the preferable.”
No news on hacking the net. Still?
According to Marius-Cristian Frunza, the hacking scandals in the carbon market, was due to the lack of security. So no news there. Or?
“In a higher perspective, hacking was very current in the financial infrastructure since the early 90’s were we had the first on-line hackers from the ex-Soviet countries entering various account moving money – because security was very low. But on the carbon market it is probably the most easy fraud – probably the easiest to imagine and to do – even easier than the VAT fraud. So we might think – that also in terms of volumes – we have much less volumes in theft than we had in the VAT-fraud.
“But why was it so easy to hack into these accounts?”
“Because nobody thought that someone – and also the people who in the beginning designed the whole EU ETS – never thought that it could be object to a fraud.”
“But the system was invented by the EU-Commission?
“Yes, it was the EU Commission – but people obviously ignored the fact that theft, fraud and other things could occur. So they left it with low security, no traceability of the people and the permits. It was really not very clear, and the laws that impacted the EU ETS – system are not also very clear.”
“So it falls back on the EU-Commission?”
“Yes, both on the EU-Commission and the European Union.”
“But let’s make this very clear. Each and every credit – and they have handed out more than 10 billion in the EU ETS – system. Each and every credit has a unique serial-number. How on earth is it possible to steal them?”
“It has a unique serial number, and also the persons – who log in and log out – and his various movements are designed to be not traced. Now – How it’s possible to steal them it’s that the system didn’t have a very high security level, but how and why we cannot track a person is a question, because if you know the serial number, you know the serial number I you for instance are in Denmark, the Danish registry knows everybody who owns the permits who is in the registry, but they do not what is happening in Italy, in Romania or in the U.K. So somebody should know what is happening in the whole of Europe, and that is supposed to be known by the European Commission.”
The missing carbon sheriff
According to Marius-Christian Frunza the lack of a “carbon-sherif” is needed in the EU.
“If you trace the carbon credit one year after, the deal is already done – so it should be in real time. I don’t think that they in Brussels have a person or a risk manager of all the registries. You don’t have someone in that position, who have the power to seize an account or to block an account in every country. There is no such thing. Each country has it’s own power and registry – what ever level that is – and they could trace it – maybe theoretically. But having the real power and to be real govern there I think it wasn’t.
One of the conditions of the EU ETS-system was at all levels that each country keep a degree of independence into develop itself on his own, and not to be verified by Brussels – that was one of the early conditions in early 2000 that was brought forward by all the members in order to make the ETS going. It was a kind of a metastatic system were everybody did whatever they wanted. So there wasn’t any kind of unified system and work. Everybody did more or less what they wanted.
“Daniel Butler – the former broker from Prague – tells us that it was easier to hack into a registry, than it was to hack into a webmail?”
“Yes, I agree on that. The webmail and the big providers today they have real issues on keeping track of all the updates on hacking and viruses. Nobody thought that there could be a theft. Nobody thought that it was real security issue, so the level of securities in the registries was at the very beginning of the e-mails.”
“So it was very easy for a hacker?”
“Yes, very easy. And this is why I say that the theft and hacking occurred after the VAT.”
“How many credits is still missing?”
“We have numbers in order of millions. Between 3 and 5 millions are still missing. The thing is that if you look at history – the very early announcement from Holcim in Romania and after the theft in Czech Republic and Austria – a lot of people declared the theft after it happened, and it was the idea that they didn’t so it because it was a kind of an image-effect.”
“So if you add all this together and take the VAT-scam, the hacking and the theft and all the trading, how much in total have we been frauded here in Europe?”
“The criminal amount developed around the carbon markets – including the VAT-fraud, the money laundering and the electronic theft it’s around 15 billion €.(…)
15 billion € of criminal damages and more than half – almost 60 % is due to VAT-fraud.”
The blind folded politicians
“With all the registries gathered in the Commission, it should be able to trace the 4 maybe 5 million credits still gone missing?”
“Yes. For sure they are able today to trace them.”
“So why don’t they do it?”
“They do it. They trace. I think that the IT has the means. The technology has the means to trace each, and also to trace the trades done previously for sure. This information exists. No doubt about it.
“But why don’t they do it then?”
“Because, and again – this is a legal aspect – you have the information and someone should come and say: This is a crime. There is a system or legal entity that should be alerted and that somebody who has the means to put a person to jail or indict him – which doesn’t exists at the moment.”
“So – and because the lack of legal issues – will you say that the EU Commission is actually covering up as to where the criminals and the stolen credits are located?”
“I don’t see this as they cover things, because covering is already part of a criminal enterprise, but obviously they have the information and there is no momentum to do something with it with this information. (…)
People should make a distinction between the crime itself and the criminals that are underlying the crime. For instance: If I hack into your account and your money – and with this money I’m going to buy something else to somebody else and with a legal transaction, then this person is innocent. Your problem is that you lost the money. I’m the person, so people should find me to claim the money. Now, maybe your bank – because they had a lack of security – you will get your money back and they will put them back into your account – like with all the hacking and all the other problems – the bank will always cover this, because of reputation etc.
Now the EU-Commission is not a bank (…) and their reputation is not a business.
So there are no consequences.”