December 8, 2023

According to Artemis sources, the audit of the compromised insurtech Vesttoo is still ongoing, but in an effort to find out what happened in connection with a fake or fraudulent letter of credit (LOC) claim, multiple LOCs were said to be involved, all issued by the same bank.

Attribution Collateral FraudAs we have reported, the insurance and reinsurance industry faces a potential crisis of confidence in certain forms of collateral as the fallout from Vesttoo’s fraudulent or bogus letter of credit (LOC) claims spreads.

While the incident of the cedent’s attempt to honor the Letters of Credit had initiated this investigation, we can now report that an ongoing audit reportedly found that multiple Letters of Credit (LOCs) were involved, all issued by the same bank.

This points to broader problems, more serious fraud, more dollars or premiums, and important transactions being affected.

It also suggests that the implications and consequences will affect the insurance and reinsurance industry more broadly, possibly involving more than one cedent, through the leading specialists and risk translators and the brokerage groups that look after clients and arrange these deals.

We are told that the source of the fraud remains unknown, but it is clear that the issue indicates a failure in the process of verifying and ensuring the integrity or security of the collateral. If it turns out that investors knew of or participated in any fraudulent LOC issues, perhaps in the KYC process itself.

The bank mentioned throughout the story, China Construction Bank, is said to be behind all the LOCs that are believed to be fraudulent or fake, the sources said.

We’re told that the issue could be related to virtually every LOC issued by the bank for transactions facilitated by Vesttoo.

At this stage, while information remains scarce and details vague, it increasingly looks like a coordinated, focused fraud.

But questions remain about who was directly involved and who knows, where ultimate responsibility for any proven fraud lies, and where any criminal investigation might focus.

There is another aspect to the question of who should know, identify collateral issues and ensure that the collateral is of sufficient quality or value and that the collateral has the integrity required to support the reinsurance arrangement.

In the case of Letters of Credit (LOCs), collateral control and security have historically been an issue for some financial markets and asset classes.

LOCs are widely used in the insurance and reinsurance markets.

This is not the case for insurance-linked securities (ILS), where cash collateral is the primary mechanism and the collateral is then invested in liquid, safe assets such as US Treasuries. This remains the dominant form and process for collateral instruments such as cat bonds and most private ILS arrangements.

For example, Letters of Credit (LOC) are also a form of Tier 2 capital for Lloyd’s and are therefore widely used in this market to place funds. Some reinsurers and other insurance companies also use them in their business processes.

From what we understand, LOC is also a commonly used tool in China, mainly for international trade financing.

While LOC fraud has been reported in other markets and asset classes in the past, we have not heard of any specific examples in the re/insurance space.

From what we can tell, the focus of Kroll’s ongoing Vesttoo audit appears to be to determine how these fraudulent or bogus LOCs (which we still don’t know exactly what that means) were used in transactions, and to try to identify their origin, and which parties in the transaction and security chain may have occurred, were known, or were involved in planning and perpetrating the fraud.

Beyond that, other questions need to be asked about who should detect such incidents of fraud. Because, if it does involve multiple LOCs from one bank, as sources tell us, then it seems like someone might have discovered that while checking for collateral quality and integrity.

It also seems likely that the entire KYC process will be subject to some scrutiny if any investors are involved.

Of course, when it comes to fraud, bad actors will find ways to bypass checks and balances. This means that no matter where the problem lies, the lessons learned from this incident must update the processes used to try and close any holes or weaknesses that are discovered.

Motives also remain in question. It’s hard to believe that the bank, or the employees there, would have been motivated to issue a false letter of credit, unless they were motivated by someone on one side or the other of the chain of security that rolled out from them during the transaction.

Should the allegations and information that emerge prove to be even partially true, criminal charges and/or regulatory involvement seem all but certain before this episode is over.

Also read:

20 July – MS Transverse: Any Vesttoo LOC collateral exposure is “immaterial”.

July 20th – Vesttoo: Collateral damage.

July 19th – Vesttoo: New report claims a large number of fake LOCs. The question is how?

July 18 – Vesttoo faces fraudulent collateral claims. Confirmation of the investigation, some leaders withdrew.

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