The digitalisation of global trade is well underway, opening the door to more innovative, accessible trade finance solutions, and supporting trade and business growth around the world. The opportunity to leverage these digital capabilities could not be better timed. The maelstrom of challenges that global trade participants continue to face has resulted in extreme uncertainty and volatility. Heightened banking regulations, the pandemic, and the conflict in Ukraine are just three of the stresses that have forced companies to navigate disruption to trade corridors and the movement of goods, as well as complexities in obtaining all-important trade finance.
Compounding these concerns is the fact that available SCF solutions are far from ideal. They can be siloed, insecure, inefficient, and have limited reach. Corporates looking to provide dynamic discounting to suppliers are limited by their own funds and often have to draw on cash reserves. What’s more, capital requirements and KYC restrictions are causing many banks to focus on large-ticket transactions, leaving smaller businesses overlooked. In fact, some suppliers can struggle to access working capital support at all.
The solution: digital negotiable instruments
This uncertainty, coupled with high levels of inflation, has caused many corporates to evaluate not just their own liquidity but the stability of their suppliers. Indeed, any ‘weak links’ within the chain have the potential to disrupt production for all parties. For corporates, the ability to optimise working capital – an important objective at the best of times – has therefore become paramount across the end-to-end supply chain.
This focus on supply chain performance is an opportune time for the trade ecosystem to embrace digital working capital solutions – specifically digital negotiable instruments (DNIs) – and inject renewed strength and resiliency into their business, and global trade more broadly.
Here, we outline 10 core drivers of DNI adoption.
The use of digital bills of exchange and promissory notes within SCF programmes – which enable sellers to be paid based on the creditworthiness of the buyer – has the potential to transform supply chains and enhance the bottom lines of all parties. Digital promissory notes (DPNs) use the same principle as paper-based notes but, in removing the manual burden, enable a far superior process. In practice, a corporate will invite a supplier onto its SCF programme, where that supplier can elect to receive early payment on the proviso that, in turn, the corporate is offered a discount (say, 3.5%). By way of example, the corporate’s bank would charge the corporate client 1.5% to finance the early DPN payment, with the possibility to extend settlement terms using post-maturity finance. This way, the corporate can increase its bottom-line contribution by 2%.
The DPN – or the signing of a digital bill of exchange – acts as a binding, irrefutable promise by the corporate to pay on a certain date. This creates a trade financing instrument that is unique from a risk perspective. For banks, the DNI acts as a ‘risk transfer mechanism’, with lending able to be based purely on the credit standing of the corporate rather than the supplier. The performance risk of the supplier therefore does not need to be factored in.
And, with a DNI being used as the basis of the lending rather than invoices, the supplier can receive a same-day payment, with 100% of the invoices’ value financed by the bank. This approach opens up far more opportunities for smaller suppliers to access finance and optimise liquidity, thereby ensuring supply chain security for the corporate, as well as a discount and extended payment terms.
Such solutions can be seamlessly integrated into corporate ERP systems and within existing global trade platforms, minimising onboarding disruption, enabling easy interoperability, and making implementation straightforward and efficient. For smaller corporates that do not use ERP systems, invoice data can be uploaded simply using CSV files.
Many of the rigid restrictions that accompany SCF solutions such as invoice finance can be eradicated through the application of DNIs, effectively giving control of supply chain processes and functionality back to the buyers and suppliers. For example, corporates can choose to switch between self and third-party funding as their liquidity needs change with their business cycles, and thereby manage borrowing costs more effectively.
Furthermore, with the costs of onboarding corporates’ suppliers no longer needing to be absorbed by banks, a much broader range of suppliers can be accepted onto the SCF programme, with up to 100% of suppliers now covered rather than the average 20% previously. SCF therefore becomes far more inclusive and available to all, rather than restricted to large transactions and low-ticket volumes. Terms of payments can also be negotiated between a corporate and its full scope of suppliers, with both parties able to realise payment and cash flow benefits.
Bringing these tools to the whole supply chain effectively enables the democratisation of SCF, turning the traditional approach to the process on its head. Instead of supply chains being financed based on the standing of small suppliers (so-called ’weakest links’ in terms of their balance sheets) – which perhaps have had to accept expensive factoring deals with large margins built into the cost of goods – and the financing then trickling back up the chain, digital SCF programmes enable it to work the other way around. By leveraging the strong credit risk of the corporate at the top of the chain and cascading the financing, suppliers across the supply chain are able to secure finance (commonly referred to as deep-tier SCF – DTSCF), manage their cash flow, and begin to scale and grow their businesses.
Paper processes are manually intensive, time consuming, frequently error prone and inefficient. They involve post, couriers, cross-border processing and tracking. Digital transactions are the antithesis of this; fast, efficient, automated, and streamlined. With transaction turnaround time and efforts significantly reduced thanks to STP, approval and payments can be made more rapidly, enabling suppliers to receive funds efficiently and cash flow and working capital to be optimised.
6. Lower costs
DNIs can cut end-to-end transaction costs by up to 80%. For banks, they not only remove any supplier onboarding costs (typically US$60k per business) but they also reduce operational and administrative burdens. Third-party software costs associated with operating large SCF programmes, such as reverse factoring, which require significant investment from FIs, can also be minimised. In turn, these lower costs allow local and regional banks to enter the market and engage in SCF programmes, generating wider investment and liquidity opportunities for all stakeholders.
Suppliers are able to access dependable and attractively priced funding through the corporate’s SCF solution, serving to strengthen the corporate-supplier relationship. For smaller suppliers in particular, many of which are forced to employ expensive factoring services as the only means of supporting their working capital needs, this can be a considerable business boon.
More generally, digitalising SCF processes minimises administrative costs, which can hit SMEs particularly hard, even reducing the incentive to undertake export and import activity and therefore restricting their growth potential.
Documenting a single shipment can require up to 50 sheets of paper, resulting in non-digital processes being far from ESG friendly. As the importance of sustainability strategies continues to take centre stage across the world, switching to digital trade instruments is an effective way of contributing to a business’s ESG efforts.
As global trade transitions from being based on paper documents to digital, regulatory developments are being explored and introduced across the world to facilitate the new landscape. The UN’s Model Law on Electronic Transferable Records (MLETR), for instance, is being adopted by G20 countries and beyond, seeking to enable the legal use of electronic transferable records both domestically and across borders. Trade hubs such as Singapore have already implemented MLETR-based legislation.
Arqit’s TradeSecure™ platform has been developed to meet the needs of and be fully compliant with MLETR, enabling users to benefit from new legislation that permits and facilitates the use of digital versions of trade finance documents, including bills of exchange, promissory notes and bills of lading. In this respect, TradeSecure is currently uniquely positioned to meet the system reliability requirements of the UK’s new Electronic Trade Documents Act.
The global, multifaceted nature of trade means it can be particularly susceptible to financial crime. Paper-based transactions are far more prone to fraud than digital transactions, so the move to digital can act as a form of risk mitigation in itself. DNIs are digitally sealed and this security, coupled with a record of the instrument being kept on a distributed ledger, provides the holder of an instrument with complete assurance that it is genuine. Any attempts to tamper with the DNI will cause the seal to break, alerting the holder to fraudulent activity, and with sensitive data securely encrypted and inaccessible to interceptors.
This ability to ‘fire and forget’ – i.e. where data can be sent via networks in the knowledge that only the intended recipient can access and utilise it – is hugely valuable, and a core component of DNIs.
Alongside digital innovation inevitably comes evolving cyber-security risks to which the industry must be alert. It is therefore not sufficient for digital security tools to protect only data today; they must be capable of protecting against future risks.
One innovation on the horizon is inadvertently set to trigger an entirely new level of threat: quantum computers. Through the application of quantum mechanics, these supercomputers are able to solve complex problems at a fraction of the speed of today’s most advanced devices.
This transformational technology is designed to deliver enhancements to businesses across the world. But in parallel, their exceptional intelligence will expose significant vulnerabilities in today’s lines of defence. In fact, when quantum computing becomes a market reality – projected to be this decade – the encryption algorithms the industry currently relies upon to protect data will no longer be fit for purpose. It has been calculated that, were one of the US’s five largest FIs subject to a quantum attack targeted at the Fedwire Funds Service payment system, it would result in a financial failure costing up to US$1.95tr. .
Threats of such intimidating scale cannot be taken lightly. To remain ahead, robust, cutting-edge encryption solutions equipped to thwart such data breaches have been developed and are already at hand. TradeSecure leverages encryption technology that has been developed to a military standard, thereby enabling companies engaged in global trade to transact and conduct business safely and securely, while standing up to the most extreme current and future cyber threats.
Corporates are increasingly leveraging the full scope of the benefits of DNI-based SCF platforms; aggregating, packaging, and funding invoices efficiently and securely – all while maintaining stability across their supply chains. Although digitalising entire trade ecosystems can seem a daunting and far off prospect, digitalisation can be undertaken on a step-by-step basis, with DNIs being immediately accessible to corporates both large and small.
Certainly, as well as future-proofing entire supply chains, there are extensive reasons to adopt DNIs, and benefits that corporates can reap here and now. With impending security developments to be mindful of that may not have been factored into businesses’ existing digital trade strategies, it could be time for DNI adoption to rapidly climb the priority ladder.