Waking the Sleeping Giant? The Potential for Trade Finance Transformation

  

By Helen Sanders, Editor

 
There are few areas of modern life which have not seen radical change over the past two decades. The way we shop and communicate, the way we do our jobs, what we eat, and where and how we travel continue to change inexorably. The way that both individuals and businesses consume banking services is no different. Across areas such as cash management, FX and lending, there has been significant innovation in recent years, with opportunities such as mobile payments and wallets and FX trading platforms facilitating new business models and prompting changes in user expectations. However, trade finance remains a key area where developments have been modest in comparison, despite its importance in facilitating international trade. Recently, the sleeping giant seems to have stirred, however, albeit slightly, with a notable number of press releases about proof of concept projects to digitise trade finance, frequently based on distributed ledger technology (DLT), often known as blockchain. Could we now be starting to see the start of a transformation in trade finance? 

Innovation imperative in trade finance

Trade finance is often described as an area ripe for change, and Daniel Schmand, Managing Director and Head of Trade Finance and Cash Management, Corporates, EMEA, Deutsche Bank, and Chair of the ICC Banking Commission emphasises, 

“The level of unmet demand for trade finance has been estimated at more than US$1.6tr annually at a time when banks continue to face capacity constraints in responding to this demand and fintech firms are actively looking to apply innovative solutions to trade financing.”

As he continues, digitisation of trade finance brings immediate and quantifiable benefits to all participants,

“The 2017 ICC Banking Commission report, Rethinking Trade and Finance[1] notes that the elimination of paper from trade finance transaction processing could reduce processing time by two hours per transaction and reduce compliance costs by 30%.”

While there are operational advantages to digitisation and increased efficiency are universal across all participants, the imperative for SMEs is more profound. According to the 2016 edition of the above report, 58% of trade finance applications by SMEs were turned down, compared with 53% in 2014, severely hampering international trade and damaging growth, particularly given that two of every three jobs globally are created by SMEs. There are multiple reasons for this, but the slower, more opaque and more expensive a transaction, the greater the risk and therefore the less attractive it is for banks to offer financing. By reducing costs and accelerating transactions, however, and making it easier to comply with relevant regulations, digitising trade finance could help to unlock additional financing and therefore fuel growth.
 

Motivation and momentum

There is undoubtedly motivation for change across the banking and wider community, as Schmand comments,

“The dependence of trade finance on a paper environment, while logistics such as container shipping have electronic architectures, is holding back trade. Given that more than 80% of trade is financed by some form of credit, the industry has a responsibility to resolve the issue.”

This motivation is illustrated in the 2017 ICC Banking Commission report cited above which highlights that nearly 44% of respondents identify priorities linked to digitisation and technology as strategic priorities; however, while 50% anticipate high levels of digitisation within a decade, a similar number expect this evolution to take 10 – 25 years. Given the progress that has been made in other areas of banking, even the most optimistic of predictions still seem relatively conservative. Angela Koll, Specialist Trade & Supply Chain Finance, Commerzbank AG explains some of the reasons why innovation in this space is likely to take time, 

“Trade finance is based on a complex ecosystem with multiple stakeholders, a large number of data flows, country specific jurisdictions and regulatory requirements. Added to this is the challenge of meeting the increasing demands of compliance, sanctions, embargos and KYC. As a result, trade remains very much based on paper-driven processes, as the document contains key data about the transaction, often being signed and stamped to provide evidence. These documents are subject to certain standards and are globally accepted, such as the invoice, bill of lading or insurance document.”

 

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This is not to say that no progress has been made. Bolero brought the first electronic bill of lading solution to market in the late 1990s, and now facilitates six million trade documents and $80bn worth of trade transactions per annum. However, as Ian Kerr, CEO, Bolero International says, 

“Although there has been significant progress made in the digitisation of trade finance transactions through the efforts of Bolero and our partners, it remains an under-digitised industry, with a large number of manual processes and paper documents at both ends of a transaction. However, the vision that Bolero first set out in 1998 is now becoming a reality, with technology availability, awareness and demand now coalescing.”

 

Box 1 - Exploring innovation horizons “Following McKinsey’s ‘Three Horizons of Growth’, Commerzbank approaches trade digitisation at three levels: improving, adopting and innovating. Horizon one is to improve and extend the current core and traditional trade business; two is to build momentum of emerging new business by adopting new digital products which have already entered the market, and three is to explore new disruptive technology and identify innovative solutions for the future. “For example, on horizon 1, we are increasing and supporting digital communication with customers and optimising existing processes with new technology and standards, e.g., MT798. On horizon 2, we are strongly supportive of the Bank Payment Obligation (BPO) – that allows automatic matching of digitised trade data via SWIFT TSU, a matching platform offered by SWIFT, becoming more active in the handling of electronic documents, and offering a supply chain financing platform for automatic financing of payables. The third horizon is where much of the current media interest is focused, namely on the opportunities in disruptive technology such as blockchain, Distributed Ledger Technology (DLT), smart contracts and internet of things (IoT). We are an active member of the R3 Blockchain consortium, a collaboration across banks to discuss and identify possible use cases. We have entered a co-operation with the Fraunhofer Institute to develop scenarios for ‘supply chains of the future’ that incorporate digitisation, blockchain, IoT and smart contracts for more efficient supply chains and working capital management. “It is important to focus on all three horizons simultaneously and to decide, how much time and investment you prioritise for which horizon. It will take time for transformative new solutions based on distributed ledger technology (DLT), blockchain and other transformative technologies to develop, and for the spectrum of stakeholders to adopt them, so in the meantime, it is advisable to adopt already existing digital products and solutions and to improve the current core and traditional trade business.” Angela Koll, Specialist Trade & Supply Chain Finance, Commerzbank AG

 

A key difference today compared with a decade ago, however, is the change in user expectations for greater efficiency, speed and transparency, as Angela Koll, Commerzbank comments, 

“Driven by developments in technology and user expectations, there is an increasing demand both within the trade industry and amongst corporate customers to conduct trade transactions digitally, to improve transparency, speed and allow easier access to financing. This is particularly complex given the challenges given above, but new technology could enable the creation of new models and solutions for mitigating trade risk, offering finance, providing liquidity and optimising working capital, and enhancing processes for faster handling and cost savings. There is progress under way, but this requires time, expertise and progress in different steps.” (See Box 1)

The focus on using existing technology, as well as emerging technologies on which to base innovation initially is a crucial one in gaining rapid adoption, as the rapid growth of SWIFT’s global payments innovation (gpi) initiative in cross-border payments illustrates. Daniel Schmand, Deutsche Bank comments,

 “The letter of credit underpins most trade with the Uniform Customs and Price (UCP) for documentary credits in its current iteration of UCP600 in force today. The electronic version of this (eUCP) has been in force in its updated version since 2007 and is technology-agnostic to ensure as wide a reach as possible. But more needs to be done to connect the different stages of digital trade finance. This means working with other parts of the supply chain such as customs authorities and ports so that all information is accessible via a cloud that has a critical mass of users and is trusted. Some good work has already got under way with the electronic bill of lading (eBL) but that is just one part of the transaction journey.”

Ian Kerr

Ian Kerr, Bolero, also urges the potential value of a network-based approach,

“Increasingly, we see the opportunity for a ‘network of networks’ to facilitate international trade. The trade finance process differs depending on the type of participant you are, and how the transaction is settled, so interoperability is essential between applications and networks to connect participants and processes in a coherent way. There are parallel benefits in the physical movement of goods where the internet of things [IoT] means that each pallet or container can have its own IP address and cash flows. In particular, risk and the pricing of risk, transparency, costs and speed can all be improved substantially, so the core processes underpinning trade finance transactions need to be fit for purpose.”

Leveraging current opportunities

As well as digitising and creating networks to facilitate trade, which will take time, a potentially valuable trade finance initiative of recent years is the Bank Payment Obligation (BPO) introduced as an alternative to traditional trade finance instruments by SWIFT in collaboration with the ICC, banks and corporations. The BPO is an irrevocable commitment made by one bank to another that trade settlement will occur on an agreed date once certain conditions have been met, such as the shipment or delivery of goods. Payment is then made once key transaction data has been matched electronically. By exchanging and matching data, and settling transactions automatically, the trade process can be faster, cheaper and more accurate. Unlike trade done on open account, it enables banks to confirm payment obligations, therefore providing some payment assurance, and enables the seller to obtain financing based on the terms of payment outlined in the BPO. Angela Koll, Commerzbank expresses support for the use of BPO,

“Numerous banks, like Commerzbank, have identified corporate demand for the BPO, and as a result, the volume of BPO transactions is increasing steadily on both the buyer’s as well as the supplier’s side. Consequently, the number of banks committing to BPO is also increasing. There is also demand amongst corporates for digital issuance and handling of trade documents and a  sense that platform solutions for issuing and handling electronic documents e.g., the eB/L will become more important over the coming years.”

 

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The growth of BPO is only one in a series of current initiatives that is under way, however. Daniel Schmand, Deutsche Bank, emphasises that innovation is taking place on different fronts,

“As a bank, we continue to invest in digitisation. In April 2017, we announced the acquisition of a 12.5% share interest in the receivables auction platform TrustBills, an electronic true sale market place for national and international trade receivables which can be accessed by investors and asset managers without prior securitisation.

“We also have joined a blockchain consortium where, together with HSBC, KBC, Natixis, Rabobank, Societe Generale and UniCredit, we collaborate on the development and commercialisation of a new product called Digital Trade Chain (DTC) based on a prototype solution originated by KBC and tested to ‘proof of concept’ stage. DTC aims to simplify domestic as well cross-border commerce for SMEs by leveraging blockchain. It will enable authorised SME clients to initiate transactions on a paperless and secure basis, and track the transaction at each stage of the transaction lifecycle, through to the point of settlement/ payment, both online and via mobile devices.”

However, every new initiative in such a complex industry takes time to reach fruition (Box 2), as Angela Koll, Commerzbank notes,

“BPO is a good example of how long it can take to bring a new product to market – products do not launch themselves, and awareness, adoption and motivation are essential. Commerzbank first started to implement the BPO in 2013 and went live in 2014. Since then, we have put a great deal of effort into raising awareness and commercialising this new instrument. In recent months, we have seen an increase in BPO business as awareness, interest and readiness increases amongst customers. However, adoption by banks has been very slow, not least due to the effort, vision and customer communication required.”

 

Box 2 - Challenges to commercialisation “The leap from proof of concept and pilot projects to going ‘live’ is always tough in a climate where there is increased scrutiny on risk. Some of the key challenges we have identified include: Standardisation and interoperability Standardised data and file formats, data exchange and security protocols etc. Integration with legacy systems, including digitalisation to ensure effective (backward) integration of local systems and processes Scaling Real time processing of high volumes across multiple systems in different locations – the distributed ledger - including real time clearing and settlement Financial viability for a critical mass of stakeholders Regulation Acceptance and approval from local and regional regulators and central banks Compliance with multiple KYC, anti-money laundering, sanctions, embargoes and tax reporting requirements Security Secure, controlled access to data, including tailored data access privileges Even if the technology is viable, significant collaboration is required across multiple stakeholders before solutions can be deployed in scale. This will take time.” Daniel Schmand, Deutsche Bank & Chair, ICC Banking Commission

 

A game-changer for trade finance

Many of the digital initiatives publicised over the past year have involved DLT or blockchain technology (Box 3) such as smart contracts. Ian Kerr, Bolero outlines some of the reasons for the focus on DLT,

“Given that it was originally designed to support the cryptocurrency bitcoin, DLT has a number of features that map well to the trade finance process, namely the secure, encrypted, automated and real-time process for the transfer of ownership of an asset that is validated by multiple entities. This does not make DLT a panacea, but with the right use cases, there are significant opportunities to digitise trade finance.”

Angela Koll, Commerzbank concurs,

“The value of DLT will be that trade data can be provided by different parties and seen by all participating trade stakeholders at the same time. If this data is handled in a secured data environment and data is provided by authorised parties, there will be new opportunities for both buyers and suppliers and their supply chains, new ways of avoiding and mitigating risks (e.g., payment risks), financing options at different points of the supply chain and optimised processes. It will also help to reduce fraud as data records are permanent and changes cannot be made without the knowledge or consent of all other parties.”

However, as Daniel Schmand, Deutsche Bank warns,

“DLT is one of a number of technologies that we believe have the potential to reduce the cost of trade finance provision and for this reason, the banking industry is supporting its development in pilots and proofs of concept. DLT can provide auditable data, digital synchronisation by design, and is considered secure and tamperproof. It offers the opportunity to connect participants in real time to monitor and manage transaction flows using ‘smart’ contracts that give oversight and control over trade guarantees. 

 

Box 3 - Introducing DLT/blockchain  Blockchain creates a new way of exchanging data in which data is not copied but distributed. When a party requests a transaction, it is broadcast to a network of computers, referred to as nodes, which verifies the transaction and the identity of parties to it. Each action is added as new block to an existing blockchain, rather than amending the transaction, so the blockchain forms a permanent, real-time and unalterable record.  Unlike a document that is transmitted from one party to another – which therefore produces a copy –  blockchain relies on one single source which is held on a shared (distributed) network and continuously reconciled. As data is not stored in a single location, it is public and verifiable, and there is no centralised version, or copies of it, that can be hacked or corrupted.

 

“This means many of the issues and challenges associated with the physical storage, update, transportation and submission of key documents could be eliminated as DLT makes possible new levels of efficiency, transparency, simplicity and security compared with the often cumbersome and paper-heavy manual processes companies have to undertake after a buyer and seller have agreed a transaction. 

“However, our view is that the full power of DLT is in the convergence of technologies, e.g., when DLT is combined with the internet of things or artificial intelligence. Imagine a container that could self-monitor its routing. When realising a potential late arrival or conflict, it could link up to the internet, research alternative routing to arrive on time and avoid production delays, whilst fully automating the transfer of related payments and transaction flows.”

 

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Realising the potential

Another obstacle to the development and adoption of DLT-based solutions – and indeed, those based on any other technology – is that the legal framework and standards need to be agreed. Ian Kerr, Bolero outlines,

“There are still issues to consider that currently pose obstacles to trade finance digitisation, which we are working on proactively with our partners. For example, there need to be commonly-defined processes and standards for interoperability, all counterparties to a transaction need to be engaged, and the transaction needs to have legal certainty. There are also some challenges to overcome relating to DLT. For example, while many banks have conducted proof of concept projects, these typically involve a single transaction, so there remains a question of scalability.”

He continues,

“These issues are surmountable if there is consensus and collaboration across the trade finance communities, and Bolero is engaged in a number of conversations with key players. We are seeing several consortia taking shape that are well-backed and committed to interacting with existing networks to achieve the degree of digitisation and interoperability that is required. In reality, the biggest barrier is not technology, but rather legal certainty, co-operation and consensus.”

Daniel Schmand, Deutsche Bank, and in his role as Chair of the ICC Banking Commission, concurs, and suggests some of the steps to achieving this,

“Overcoming the obstacles to digitalising trade finance will require different approaches run in parallel. These include active and regular engagements with central banks and regulators, and leveraging ICC Banking Commission and other trade organisations to create standards that allow for easier adoption. ICC Banking Commission rules will evolve under the aegis of the Digitalisation Working Group to ensure there is a framework in place that everyone has confidence in. There is a momentum and a will to digitise trade and supply chains and the work that has been done by banks in collaboration with SWIFT in the form of global payments innovation (gpi) initiative is an example of how an end-to-end transaction could look. 

“But while gpi simply involves counterparty banks and possibly an API, the moving parts in trade are more complex. It is our responsibility at the ICC Banking Commission to bring these together. In addition, trade finance participants need to engage in consortia not only cross-industry but also across other industries in order to create solutions that are fit for purpose. Finally, it is essential that stringent testing takes place to create trust in new technologies and also ensure that there is an interoperability not only between DLTs but also with legacy systems.”

So what could the future hold? As we saw earlier, there is little expectation of a silver bullet in trade finance in the short to medium term; more likely is that progress will be steady, with some missteps and dead ends along the way. Angela Koll, Commerzbank predicts,

“Trade finance is unlikely to look fundamentally different in three years’ time. A number of the horizon 3 (blockchain/DLT) initiatives will still be ongoing, but these will be further advanced, and we are likely to see more pilot projects and steps towards establishing the necessary legal and regulatory framework. To reach this stage will take a great deal of effort and commitment, both by banks and corporates. At the same time, adoption of horizon 2 initiatives, such as BPO, eDocs (eB/L) and the use of MT798 is likely to have increased.”

Daniel Schmand, Deutsche Bank concludes, 

“While three years is a relatively short time frame, we may see some things ‘live’ that foreshadow further changes to come. Change in the banking landscape is driven by different factors, not least: shifting revenue pools and margin erosion; new standards and regulation’ digitisation and new technologies, as well as competition from new entrants. The factor I would focus on, however, is changing client demand. It is not only the banking landscape that is changing, but also our clients. Their business models are equally impacted by new digital trends such as 3D printing, robotics and others. Therefore, we are expecting a shift in the type of products and services our clients require. Currently we are seeing first examples of new technologies and business models being deployed, e.g., corporates have built 3D printing factories, rolled out IoT and cloud based platforms as a service, or started to extend their value chains.”

This year’s Sibos and EuroFinance conferences are likely to see a plethora of new releases in the area of trade finance. Some will gain greater traction than others, but the most likely successes are those that recognise the complexity of trade finance, encourage adoption, and work with commercial, market and regulatory stakeholders to create a common expectation of standards, legal certainty and security.