Fighting Illicit Trade in Tobacco Products

September 2018Visit pmi.com | stopillegal.com

Contents

Overview ................................................................. 3

Understanding illicit tobacco trade ................... 4

Combatting illicit tobacco trade ......................... 7

Conclusion ............................................................16

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Fighting Illicit Tobacco Trade

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Philip Morris International (PMI) is committed to combatting the illicit trade in tobacco products; from the criminal networks that smuggle cigarettes across borders, to illegal operations in poorly monitored free trade zones. These activities have severe consequences for governments, legitimate businesses, and people around the world.

We aim to eradicate the illicit tobacco trade by collaborating on a comprehensive strategy that channels all of our efforts. Meaningful partnerships are required, and bring together the knowledge and experiences of all relevant key stakeholders, including policymakers at the national level, international organizations, law enforcement authorities, and the legitimate tobacco industry.

As a responsible corporate citizen, PMI supports public, private and non-governmental initiatives to combat illegal tobacco operations and other related crimes. We hope to work with as many allies as possible to implement impactful solutions to jointly stamp out these activities.

In this document, we outline several strategies for tackling the illicit tobacco problem. These include tougher enforcement of laws in Free Trade Zones (FTZs),

effective licensing regimes, enhanced tracking and tracing systems, strong know-your-customer guidelines, and strict labelling requirements. We also illustrate the ways stakeholders can unite efforts.

For the campaign against illicit tobacco trade to be effective, the rules cannot be just theoretical. They require enforcement. National governments should sign up to international agreements and treaties, and rigorously and meaningfully implement their requirements.

As a business, we have long led the fight against the illicit tobacco trade. No industry, however, can win this fight on its own; we need to harmonize and enhance efforts. By working together, we can accelerate progress on protecting society from illegal tobacco products, and related crimes.

To find out more about how to fight illicit trade, visit https://www.stopillegal.com/

Overview

Fighting Illicit Tobacco Trade

Understanding Illicit Tobacco Trade

Latin America and CanadaOn average, 15.6% of cigarettes consumed in Latin America and Canada are illicit, representing a volume of almost 40 billion cigarettes. If legally purchased, these cigarettes would mean $4.6 billion in additional tax revenue each year. Most of these illicit cigarettes are Illicit Whites – cigarettes made for smuggling.2

1 in 10 cigarettes is illegal

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1 INTERPOL, Countering Illicit Trade in Tobacco Products, Legal Handbook Series, 2014, p.9. These statistics are derived from 84 countries around the world.

2 KPMG, Project EOS 2016, A study of illicit cigarette consumption in Latin America and Canada, pg. 8.

Illicit tobacco trade is among today’s greatest global challenges, affecting not only our industry but also governments and ordinary people. It misleads consumers, deprives public authorities of tax revenue and funds organized crime and terrorism.

The International Criminal Police Organization (INTERPOL) estimates that illicit cigarette trade accounts for 11.6% of global cigarette consumption. That amounts to 657 billion cigarettes per year.1

A Worldwide ScourgeThe problem is truly global in scope, sparing no region or country.

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Fighting Illicit Tobacco Trade

Asia In Asian markets such as Brunei, Hong Kong, Macao, Malaysia and Pakistan, at least one in every four cigarettes consumed is the product of illegal trade. In Indonesia, Pakistan and the Philippines, more than half of all illegal cigarettes are domestically produced.4

EuropeEurope also suffers from the illegal trade of tobacco products. About 9% of total consumption of cigarettes in Europe is illicit, according to annual research by KPMG. That represents 48 billion cigarettes a year and $12 billion in lost tax revenues.3

Eastern Europe, Middle East and Africa.In North Africa, illicit tobacco trade accounts for 20% of cigarette consumption. That equals 13 billion cigarettes and an annual loss in tax revenues of USD $565 million. More than half of these illegal cigarettes come from Free Trade Zones in the United Arab Emirates.5

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3 KPMG, Project SUN: A study of the illicit cigarette market in the European Union, Norway and Switzerland, 2016, p.7.

4 Oxford Economics, Asia Illicit Tobacco Indicator 2015, p.10.5 KPMG, Illicit cigarette trade in the Maghreb region (excluding Mauritania), 2017, p.3.

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Fighting Illicit Tobacco Trade

The Impact of Illicit Trade

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Evidence suggests that not only criminal organizations, but even terrorist groups exploit the black market for tobacco as a lucrative source of income. In the new global reality, illicit tobacco trade can even finance acts of terror.

We all must do more to combat illicit trade. That includes governments passing the necessary laws, and rigorously enforcing them, legitimate tobacco companies ensuring they do business only with trustworthy partners that will not divert their products, and consumers being aware of direct and indirect consequences of them purchasing illicit products.

7 US State Department, The Global Illicit Trade in Tobacco: A Threat to National Security, p.3

8 Idem.

Various authorities and experts, including the U.S. Department of State, describe illicit tobacco as a low-risk, high-reward criminal activity that fosters a culture of corruption and bad governance.

Fighting Illicit Tobacco Trade

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In this paper, we outline what we believe to be effective strategies for tackling the illicit tobacco trade, in each of the below key pillars.

PMI has fought long and hard to combat illegal tobacco trade. We have helped establish high supply chain compliance standards throughout the world, and have closely collaborated with governments and key stakeholders in the fight against illicit trade.

Combatting Illict Tobacco Trade

Effective control and monitoring

of Free Trade Zones.

Licensing regimes

that focus on tackling illicit trade, not adding

cumbersome regulation

for law-abiding legal operators.

Product tracking and tracing based on open and recognized

international standards,

encouraging broader

application beyond tobacco

products.

Meaningful due diligence and record-

keeping requirements.

Enhanced international cooperation among law

enforcement authorities.

Application of deterrent sanctions to illicit traders.

Fighting Illicit Tobacco Trade

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FREE TRADE ZONES (FTZS)The absence of widely applied tracking and tracing systems makes it easier for criminals to engage in illicit tobacco trade.

Much of the world’s illicit tobacco trade takes place in Free Trade Zones (FTZs). FTZs are areas of economic activity that are not confined within a given customs territory. By their nature, FTZs facilitate trade and remove administrative burden.

These territories can serve as areas where criminals re-package and re-label shipments, free of meaningful oversight.

National customs authorities should be empowered to control and supervise daily activities in FTZs, allowing them to audit books and records, and validate that goods comply with all necessary requirements at local and international levels, including with the requirements of their country of ultimate destination. Authorities should ensure that trafficking in illicit tobacco

products incurs the same sanctions in their respective countries, regardless of whether the offense takes place outside or inside an FTZ, and that these sanctions are consequently applied.

Cooperation between the authorities at the national and international level, as well as collaboration with the private sector, must be prioritized to comprehensively tackle illicit trade. The objective should be to achieve a level playing field, where all legitimate participants in the tobacco supply chain are empowered and expected to operate in line with high compliance standards.

For a more detailed understanding of PMI’s view on Free Trade Zones please click here for link to our position paper ‘Fighting Illicit Trade: Free Trade Zones’

Any company dealing with tobacco products in an FTZ should adhere to the following standards:

• Introduce a meaningful licensing scheme.

• Require tracking and tracing solutions that apply to all tobacco products, even if they are manufactured in, or transit through the FTZ, and involve unique, secure and non-removable identification markings on all unit packets of tobacco products.

• Due diligence and record-keeping practices that attest proper business relationships, accurate inventory controls, and sales practices in line with the requirements in destination markets.

• Product labelling that complies with the regulations in destination markets.

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LICENSINGThe adoption of national licensing schemes for cigarette manufacturers and manufacturing equipment is a critical component of an effective strategy to fight illicit tobacco production and trade.

Licensing requirements should be proportionate and practical, allowing law-abiding entities to readily adopt them. Above all, the requirements should be meaningful and focus on the core issue of illicit tobacco trade. They should ensure that only legitimate actors are involved in the manufacture, import and export of tobacco products and manufacturing equipment.

We believe that licensing systems should expand to cover not only manufacturers, but also machinery directly involved in cigarette manufacturing. Illegal manufacturers can too easily purchase machinery that no legitimate manufacturer would ever consider using.

A sense of proportionality is important. As tobacco manufacturing machines can have up to 20,000 parts; it would be unreasonable to require separate licenses for each part. Licensing for machinery should be restricted to key components that are fundamental to the manufacture of tobacco products.

Authorities should seize and destroy tobacco manufacturing machines without a valid license.

We believe it is unnecessary to require licenses for machines that make labels or are used for packaging. Such machines can be used for any type of goods, with little adjustment. As a result, a licensing requirement for these machines would have to span across hundreds of different types of products, and would likely prove ineffective.

We are ready to share our technical expertise to help formulate a balanced approach that enhances existing controls for stopping the manufacture of illicit tobacco products, and avoids over-regulation and the duplication of efforts.

For a more detailed understanding on PMI’s position on Licensing please click here for a link to our position paper ‘Fighting Illicit Trade: Licensing’

Licensing systems should expand to cover not only manufacturers, but also machinery directly involved in cigarette manufacturing

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Fighting Illicit Tobacco Trade

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TRACKING AND TRACINGThe absence of widely applied tracking and tracing systems makes it easier for criminals to engage in illicit tobacco trade.

Tracking and tracing is the ability to record the forward movement of products and trace backwards their history along the supply chain. We mark all our products with unique identification markings that we use to track and trace them. This way we retain superior oversight of our supply chain to help prevent diversion.

We have extensive experience in implementing national and regional tracking and tracing solutions. This includes in the European Union, where we have been tracking and tracing our products for well over a decade. These efforts began as part of the Cooperation Agreement with the European Union and all EU Member States, and now continue voluntarily to ensure strict supply chain controls.

Globally, we track more than 600 billion cigarettes every year, in every market we operate in.

Strict oversight of any tracking and tracing solution is important. Authorities are responsible for establishing, controlling, and supervising the system, while the private sector performs daily operations to implement solutions in factories and across the supply chain. We believe in tracking and tracing solutions that ensure interoperability, are independently controlled, and do not impact the manufacturing and distributing environment.

For example, we support the generation of a unique identifier—the product identity—by

an independent third party that fulfills all requirements as defined by relevant national or regional authorities. This is already the case with the EU Tobacco Products Directive (2014/40/EU), which requires unique codes for tracking and tracing each pack of cigarettes.

For a more detailed understanding of PMI’s view on tracking and tracing, please click here for a link to our white paper “Fighting Illicit Trade: Tracking and Tracing”

Open StandardsAny successful tracking and tracing system must start with open standards that allow for competing technologies and solution providers to constantly innovate and develop ways to tackle illicit trade. Criminals work continually to defeat current solutions, putting pressure on authorities and law-abiding industry participants to adapt likewise. That means requirements that are standardized and interoperable across geographies and products.

We look forward to a free market for solution providers governed by technical guidelines and standards, not a one-size-fits-all solution. We accept that such flexibility will help drive permanent innovation and keep costs proportionate to the benefits of any tracking and tracing system.

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DUE DILIGENCEAs a responsible corporate citizen, we conduct robust due diligence on every potential business partner.

Our comprehensive know-your-customer policy helps us meet our goal of only doing business with entities that share our high standards of integrity and ethical business practices. We also work with our customers to seek that they are equally thorough when they transact with their business partners.

Authorities should demand no less. They should require adequate information from tobacco companies about their customers. Authorities should document and periodically repeat their controls, and always be on the lookout for potential fraud. This includes when customers change.

One common criminal scheme involves routing payments to non-existent third parties to mask the identity of criminal actors. We propose a set of principles designed to stop such schemes, centered on controlling the acceptable forms of payment in tobacco transactions.

Such payments should be limited to:

• Wire transfer or cheque, in both cases from a bank account in the customer’s name; and

• Cashier’s cheque or bank draft issued by a bank in the country in which the customer is located.

Other important principles of effective due diligence include:

• Ensuring the payment currency matches the invoice;

• Allowing cash payments only in exceptional and justified cases; and

• Prohibiting third-party payment transactions.

PMI has long fulfilled these requirements. They are undoubtedly effective in helping prevent fraud.

we also work with our customers to ensure that they are equally thorough when they transact with their business partners

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INTERNATIONAL COOPERATIONCooperation is key to designing effective anti-illicit trade strategies. The private and public sectors need to come together to pool experience and expertise.

SANCTIONSAny meaningful regulatory framework should focus on enforcement of the law. After all, illicit traders abuse volatile systems; the ones that are prone to corruption, have ineffective enforcement, or low sanctions.

Manufacturers, supply chain partners, governments, police and customs authorities need to share information on seizures of tobacco products, discoveries of tax evasion, production quantities and values, and other evidence about illicit trade that can lead to successful enforcement of existing laws.

Such information could include licensing records, investigative and prosecution records, payment receipts for import, export or duty-free sales, and details of seizures.

Over the years, we have worked with many governments and international organizations. These partnerships have been invaluable in promoting an effective framework to dismantle organized criminal groups.

We propose that sanctions for non- compliance with anti-illicit tobacco laws should be severe, and include both financial and non-financial elements. These sanctions should vary, depending on the type of offense, from, for example, license withdrawal, fines, to sanctions as severe as imprisonment.

Partnerships have been invaluable in promoting an effective framework to dismantle organized criminal groups

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Any meaningful regulatory framework should focus on enforcement of the law

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Fighting Illicit Tobacco Trade

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A MILESTONE IN THE FIGHT AGAINST ILLICIT TOBACCO TRADE:

WHO FCTC PROTOCOL

Parties to the FCTC created the Protocol with the objective of eliminating all forms of illicit trade in tobacco products, expanding on the existing Article 15 of the FCTC. WHO refers to the Protocol as a ‘global solution to a global problem’. 9

The Protocol will enter into force on September 25th, 2018, i.e., 90 days after the 40th ratification which took place on June 27th, 2018. A link to the current list of countries that are Parties to the Protocol can be found here.

The FCTC will then convene the first Meeting of the Parties—the Protocol’s governing body—In Geneva from October 8th to 10th. The meeting will bring together Parties to the Protocol to discuss the practical applications of the treaty. The expected outcome of this meeting is that the Parties to the Protocol become well-equipped for the Protocol’s

practical transposition into their local laws.

Consisting of 47 Articles overall, the Protocol is divided into three substantive sections relating to (i) Supply Chain Controls; (ii) Offences; and (iii) International Cooperation.

The first (Supply Chain Controls), requires the implementation of measures to preserve the integrity of the tobacco supply chain. These measures seek to prevent the diversion of tobacco products, key components of tobacco products, and manufacturing equipment used to produce tobacco products, into illicit trade channels. The measures addressed in this section include among others the implementation of licensing systems, due diligence processes, record-keeping obligations, provisions for a global tracking and tracing regime, and controls within free trade zones.

The FCTC Protocol to Eliminate Illicit Trade in Tobacco Products (The Protocol) was drafted as an international treaty aligned with the 2003 WHO Framework Convention on Tobacco Control (FCTC).

9 See: http://www.who.int/fctc/Protocol_summary_3Jul18-en.pdf

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Section two of the Protocol, covering Offences (Articles 14-19) must be properly implemented at the national levels to enable the Protocol to meet its objectives. These Articles of the Protocol provide guidelines for Parties on how to address unlawful conduct. There are also provisions regarding search and seizure and confiscation of assets. Standards are set for what actions should ideally be considered as unlawful conduct under the Protocol. Importantly, the destruction of illicit products is also highlighted, addressing this very relevant and recurring topic, and related threat of the seized illicit products reappearing on the market.

The final substantive section of the Protocol outlines ways in which parties can cooperate among themselves and with competent international organizations to, among others, share best practices, provide trainings and technical assistance. This

section encourages Parties to share general information regarding seizures of tobacco products and information on whether taxes have been evaded, the quantity or value of the production of tobacco products, and methods used in illicit trade.

Illicit trade damages society, resulting in lost tax revenues, increased criminality, and enhanced access to cigarettes by youth. PMI is very encouraged by the prospect of joining forces with relevant stakeholders and other legitimate tobacco manufacturers to fight the illicit tobacco trade. Successful public-private partnership is the most effective way to fight the issue.

This is why we support and welcome the entry into force of the Protocol. With international scope and a broad remit to address the multiple drivers of illicit trade, we believe that the Protocol has a key role to play in helping to defeat the black market in tobacco.

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Illicit tobacco trade has a broad impact beyond our business. The damage it causes is not often immediately apparent to the general public, even if the societal consequences can prove enduring.

We know that illicit tobacco trade is a significant revenue stream for organized criminal actors. It is a global and dynamic problem, requiring a global and dynamic response. We are ready to work with all committed partners, in the public and private sectors across the globe, to help eradicate illicit tobacco trade.

The World Health Organization’s FCTC Protocol to Eliminate Illicit Trade in Tobacco Products brings together countries against the scourge of illicit tobacco trade. This treaty will become an effective regulatory framework once it is globally adopted. Its success, however, will rely upon collaboration: national governments, international organizations

and civil society working together to fight illicit tobacco trade together.

In addition to this collaboration, the role of information and research is critical. We invest significantly in research to determine the factors driving illicit trade. We also want to identify the forms of illicit cigarettes on the black market in different countries around the world. We support education campaigns to raise awareness of the problem. As a business, we have championed such efforts, including through our digital campaigns on our dedicated website stopillegal.com.

We believe in encouraging an effective and uniform approach for fighting illicit tobacco trade.

Conclusion

Fighting Illicit Tobacco Trade

Fighting Illicit Trade in Tobacco Products

September 2018

Fighting Illicit Tobacco Trade