Making the Case for BPOs

by Thomas Dusch, Head of Trade Finance International Sales Germany, UniCredit

From its launch in 2007, uptake of the BPO was initially slow. Over the past year or so, adoption has increased dramatically, with several ‘first’ transactions in Europe and Asia, many of which were driven by UniCredit. The BPO offers many advantages, but as yet, there remains a lack of education of the instrument and its value. Voted the most important recent innovation in trade by respondents to a survey at SIBOS 2014, it is a tool with the potential to bring unprecedented levels of risk mitigation and automation in trade transactions, whilst opening the door to a range of financing options and improving balance-sheet fundamentals such as days payable outstanding (DPO) and days sales outstanding (DSO).

Importance of the Bank Payment Obligation

The Bank Payment Obligation (BPO) is an irrevocable undertaking given by a bank to another bank that payment will be made on a specified date after successful electronic matching of data according to an industry-wide set of International Chamber of Commerce (ICC) rules. The digital method uses a Transaction Matching Application (TMA), such as SWIFT’s Trade Services Utility (TSU), to send order details electronically, using the standardised ISO 20022 format.

The BPO represents a major innovation in the settlement of trade transactions. Currently, the two most popular settlement methods are letters of credit (LCs) and open account transactions. While these both have their benefits and uses, they are not ideal for all potential settlement scenarios. Letters of credit use banks to mediate between trade counterparties, making them an essential tool for financing and managing risk. Yet the documentation involved is cumbersome, taking on average 21 days to complete, and longer if there are errors or omissions in the documentation.

Settling via open account is far quicker, as transactions are conducted directly between counterparties without the need for an onerous documentation process. However, it also leaves creditors vulnerable to counterparty default, an uncomfortable compromise given this method currently accounts for more than 80% of the world’s foreign trade.

The BPO is designed to incorporate the strengths of these two methods whilst eliminating the drawbacks, therefore combining fast, automated digital processes with the risk protection offered by bank mediation. Corporations have the opportunity to structure transactions in order to improve DPO and DSO, while bringing risks under control – all at a speed more suited to today’s fast-paced digital economy.

Market evolution

Uptake of the BPO has been slow so far, but we have recently seen a number of promising developments as companies recognise that they can achieve faster transactions without losing the risk management benefits of LCs. October 2014 saw a landmark deal, when Rühr- und Verfahrenstechnik (RVT), a German exporter, and its Japanese partner, Mitsui & Co. Plant Systems, moved away from open account settlement in favour of the BPO – a landmark deal for the Japanese market.

Meanwhile, one of UniCredit’s clients, ZF Friedrichshafen (ZF), chose to move to the BPO in part because it was requested by a counterparty. This is an illustration of how BPO is becoming a critical element in gaining traction in the emerging markets where demand for efficient settlement methods with strong risk mitigation is high. ZF’s case also demonstrates the financing benefits of the BPO and how this can affect client relationships. The company was having some difficulty with its counterparty over payment terms, with the client requiring extra time to cover its six-month production cycle. By using the BPO, however, UniCredit was able to refinance the client for this period, enabling both parties to satisfy their payment requirements. Such was the success of this solution that ZF has since received greater volumes of business from the client.

The BPO is one of the most innovative and value-added solutions for financing and facilitating trade that has emerged for many years

This year also saw the first BPO to take place in Italy, between the Arona-based producer of industrial cooling systems, SPIG S.p.A. and a German supplier.

Barriers to adoption

While these companies are all early adopters, and there is still a way to go before BPOs become mainstream, demand is growing as market awareness increases. Indeed, the key barrier to BPO uptake at the moment is a lack of awareness and understanding. Many treasurers have yet to fully explore the BPO as a settlement option, so they are unaware of how the BPO can be implemented and what benefits it will bring. What’s more, lack of awareness can easily lead to perceived problems that may not exist in reality. For example, a frequent concern expressed by treasurers is that implementing BPO processes will require significant technological upheaval that could disrupt existing workflows. ZF, for example, has a highly standardised workflow, and therefore was particularly keen to minimise any disruption. Rather than creating workflow obstacles, BPO helped the company to streamline and accelerate its processes, and its example stands as testament to the ease with which BPOs can be implemented. UniCredit was closely involved with ZF, with close co-ordination across financing, sales and procurement departments, to ensure that any challenges associated with the BPO implementation were kept to a minimum.[[[PAGE]]]

Future potential

The BPO is one of the most innovative and value-added solutions for financing and facilitating trade that has emerged for many years, and the more information that treasurers have about the instrument, its implementation and benefits, the more quickly that adoption will grow. This eduction process needs to extend not only to treasury, but also into other departments that have a role in trade and trade finance, such as procurement and sales, which often involves teams at both a central and subsidiary level. Banks have a major role to play in this education process: in particular, they must work with clients to show how BPOs could be integrated into their workflow with minimal disruption, and leverage the knowledge they have of clients’ business to demonstrate the value. With proactive efforts amongst banks such as UniCredit, we expect significant growth over the next few years, marking a significant shift in the way that the risk and settlement associated with trade transactions are managed.