Published: January 01, 2000
Much has been written about the benefits offered by the Bank Payment Obligation (BPO) – but how is the BPO used in practice and how can companies build a business case to adopt this new trade instrument?
In 2011, cross-border trade reached the value of around $18.2tr. The majority of this activity was settled on open account terms, which accounts for around 80-90% of world trade.
Open account trading has many benefits for companies buying goods – but for sellers, the open account model is often less than ideal. While many governments around the world, including the US government, have been actively encouraging exports, the open account trading model presents more risk for sellers than a letter of credit transaction. This is particularly the case when a company is trading with a new buyer in an exotic location for the first time. Nevertheless, in order to remain competitive, the seller may be forced to offer extended open account terms to its new potential client.
Companies facing this dilemma now have access to a new instrument: the Bank Payment Obligation (BPO). Intended to support open account trade, the BPO enables data to be sent and matched electronically in ISO 20022 XML format, using a data matching engine such as SWIFT’s Trade Services Utility (TSU). The BPO also mitigates the risks involved in a trade transaction for a seller, as buyer risk is transferred to an obligor bank. Other benefits include the ability for suppliers to finance their receivables.
Around 50 banks have already signed up to support the BPO and early corporate adopters include Ito-Yokado, a department store chain operator and subsidiary of Seven & I Holdings, which uses the BPO to support imports from Chinese suppliers and has improved its working capital management as a result. Another early adopter is BP Chemicals, which has been using BPOs since May 2012.
While the BPO is already in use, it is expected that its adoption will gain additional momentum after the International Chamber of Commerce (ICC) approves the Uniform Rules for Bank Payment Obligations (URBPO), the bank-to-bank rules governing the use of the new instrument.
Once a buyer has asked its bank to create an open account payment instrument with a BPO, the buyer’s bank uploads the purchase order information to the TSU, or other data matching application, which in turn passes the information to the seller’s bank for checking and acceptance. At that point the ‘baseline’ for the BPO is established and the buyer’s bank guarantees that it will pay the seller’s bank as long as the seller ships the merchandise in accordance with the commercial terms established with the buyer. As a result of this guarantee, the seller may be able to obtain pre-shipment financing at this point in the process.
Once the goods have been shipped, the seller’s bank uploads the shipping and logistics data to the TSU to be checked against the baseline. As long as the data matches, the buyer’s bank is required to settle the invoice on the due date. While the SWIFT TSU is currently the only data matching application in use, it is hoped that competing matching engines will be developed over time.
As a new instrument, how does the BPO compare with existing tools and techniques?
Letters of credit are the most comparable instrument in the market to BPOs: in both cases, payment is guaranteed by the buyer’s bank as long as certain documentary conditions are met. However, the industry is keen to position the BPO as a separate instrument, rather than as an electronic letter of credit or an ‘L/C Lite’; in any case, there are some important differences between the two.
For one thing, while both BPOs and letters of credit are conditional payment instruments, in the case of the BPO, the trigger to payment is a presentation of XML data, rather than paper-based documentation such as invoices and bills of lading. The BPO, therefore, provides some of the features of a letter of credit, but behaves quite differently in the way in which data is matched – thereby avoiding some of the disadvantages associated with the more paper-intensive letters of credit.
The BPO may be used as a letter of credit substitute, but is designed to be an alternative to other open account risk mitigation and financing tools such as credit insurance and factoring.[[[PAGE]]]
Whereas credit insurance tends to be portfolio-based, a BPO is transactional – meaning it can be used on a shipment-by-shipment basis. Another important differentiator is that credit insurance is a secondary source of repayment for the company selling the goods. In other words, the seller has to seek payment from the buyer in the first instance. If the buyer doesn’t pay, the seller has to go through the claims process, which can be cumbersome and time-consuming. Using a BPO, the exporter has effectively eliminated the buyer from the picture from a credit risk perspective, and the obligor bank is obligated to make the payment.
Factoring is a popular technique used by exporters, but like credit insurance, it is portfolio-based and does not typically offer exporters the ability to select particular transactions. Meanwhile, factoring companies often want to take over servicing the seller’s accounts receivable ledger, which companies may find intrusive. In contrast, BPO servicing is still done by the exporter.
BPOs offer benefits to both buyers and sellers. From the buyer’s point of view, the BPO offers the opportunity to negotiate extended payment terms because the supplier has better access to financing. It also removes many of the time-consuming activities involved in matching paper invoices and dealing with the payment delays associated with document discrepancies.
For the seller, the BPO effectively separates the risk of non-payment from the company’s ability to finance its receivables. Non-payment risk is mitigated as the seller substitutes bank risk for buyer risk. On the financing side, buyers are frequently larger and have a better credit rating than their suppliers and can use a BPO to leverage their lower cost of capital upstream to strategic suppliers. In return, the buyer may request extended payment terms, or a reduction in the cost of goods. In other words, the BPO facilitates a win-win solution. In addition, BPOs can be used if a seller exceeds its internal credit limit with a particular buyer, as the seller is able to diversify its exposure away from the buyer in favour of the bank.
Mitigating key risks within the trading relationship, BPOs have the capacity to become an important component in a company’s supply chain management strategy. As well as automating financial supply chain processes – and thereby reducing costs – BPOs also improve the company’s end-to-end visibility over its financial supply chain activities. They can also allow trading partners to improve their working capital management and manage their accounts payable and accounts receivable processes more efficiently.
Like any new project within an organisation, the adoption of BPOs needs to be supported by momentum, discipline and executive sponsorship. Building consensus among internal stakeholders is important and not without its challenges.
Inevitably, people in the company’s procurement, treasury, finance and logistics departments will all have a different perspective on what is important when it comes to trade instruments. For example, whereas procurement and logistics usually focus on getting the right goods to the right place at the right time, treasury’s priority may be to avoid the ballooning of the balance sheet by offering very generous terms to a buyer just to close a deal.
In order to overcome these varying and sometimes contradictory priorities, everyone has to recognise the benefit of the new instrument for their particular function. As such, it is important to build a consensus around why this makes sense for the enterprise. Once this has been achieved, the project can then evolve up to an executive sponsor. This is typically the CFO, who may wish to adopt BPOs in order to improve the company’s working capital metrics, or to improve visibility over the invoicing and payments processes.
As companies build a business case for using BPOs, they need to articulate clearly what the overall benefits of the change are intended to be. These may include risk mitigation, the ability to finance, the ability to reduce DSO or the opportunity for greater visibility. The benefits then need to be compared against those tools currently used by the company, such as credit insurance, factoring or forfaiting. Finally, metrics should be developed and defined in order to measure the success of the project once complete.
In addition to overcoming internal resistance, companies looking to use BPOs may also face tactical hurdles such as obtaining support from IT to create and deploy the XML message schemas needed to exchange the data with the bank.
The solution to these challenges for many companies has been to appoint a ‘C-level’ executive capable of making physical and financial supply chain decisions through an enterprise lens, rather than at the line of business or functional level. Quite often this executive reports to the CEO, reflecting the fact that the supply chain optimisation is seen as a major source of competitive advantage.
The BPO is a new instrument — and as such, not all banks currently have the capability and functionality needed to support it. Companies wishing to use the BPO need to look carefully at their banks and ask whether they have the necessary capabilities, and indeed a long-term commitment, to this area.
Features that companies should look out for when choosing a bank include whether the bank has a global network and deep expertise in the areas of trade finance and supply chain. In addition, companies should look for banks with the most suitable technology, such as an integrated suite of treasury, trade and FX solutions.[[[PAGE]]]
The BPO has much to offer counterparties currently trading on open account terms. For companies wishing to use the BPO, it may first be necessary to overcome some internal hurdles – but the same is true of any project of this type, and this task should become easier once the ICC rules have been published and adoption of BPOs gathers pace.
First and foremost, the BPO should be viewed as an exercise in collaboration between trading partners and their banks. Drawing upon global standards and incorporating the benefits offered by letters of credit, the new instrument has the potential to benefit all parties in a trade transaction – and bring trade settlement into the 21st century.
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