The decision to finance trade is based on the banks' ability to reduce risk to an acceptable level in order to extend a loan. More often than not, this is done using one of the tried-and-true risk mitigation tools, such as a letter of credit (LC), a guarantee, or open account services. This intermediation has proven highly lucrative for financial institutions with up to 80% of merchandise exports across the world requiring some form of financing.
However, these same mitigation tools that reduce risk also can create friction between all parties involved, especially for smaller transactions. This has made the sector inaccessible to many and created shortfalls in supply – especially in frontier markets and among small and medium-sized enterprises (SMEs). Indeed, the Asian Development Bank estimated a global trade finance gap of $1.5tr. in 2017 with 40% of global unmet demand pooled in the Asia Pacific region and Africa. As a result, technology to upgrade the tools will play a vital role in making the sector more efficient without compromising risk mitigation.
Doing more without increasing risk
In its current state, there is immense untapped financing potential that many banks cannot access due to lack of verifiable data to manage the risk within their parameters. While multinational banks can employ more sophisticated models and sometimes link financing risk to the buyer, this does not help the smaller buyers in emerging economies, nor the smaller banks which do not have the expertise and resources to use these models.
The trade finance industry needs to have a wider, more disruptive solution. Blockchain provides a unique opportunity to solve many of the challenges faced within the sector in terms of efficiency and data management. Â
Making a valuable change
However, as with any technological innovation, the benefits have to be significant enough to justify change. Digitisation of trade finance is by no means new. Since the 1990s, there has been some progress, using Electronic Data Interchange (EDI) as an interoperative technology. In doing so, transactions were brought together more efficiently but are still ultimately duplicating the existing trade finance process on paper – and its inherent flaws – that have been present for centuries.
For instance, banks are still following the same risk models that they have instituted and used for decades based on paper documentation. The same can be said for corporates, which are also using traditional processes to facilitate their trade transactions and have just upgraded to using email and PDF. As such, even if some of the information is digital, the lack of structured data means that information cannot interact with other data points. Instead it is simply an electronic version of the paper document.
The ‘so what?' factor
Where blockchain differs from previous technology is in its ability to present reliable data to relevant participants without the risk of a central database. Those on a blockchain network have access to real-time visibility on trade data, improving trust between participants, reducing risk concerns, and making it far cheaper to meet modern regulatory demands.
Beyond reducing fraud risk and compliance cost, blockchain also enables the convergence of data from physical, financial, and compliance supply chains. This provides trading parties and their banks secure and easy access to a wealth of verified trade data that was not available previously. This data can then be leveraged to develop and provide new forms of services and products, and potentially even reduce the trade finance gap by building data-based trust models.
Collaboration is key
Nevertheless, blockchain's effectiveness needs to be supported by participants that fully engage with this technology. This will enable increased access for banks and corporates and unlock the full potential of blockchain for trade finance. Contour's recent partnership with TradeCloud looks to achieve this goal. TradeCloud's web-based platform, and existing user base, allows for greater efficiency when automating the process of LC applications.
Agreed orders from users on TradeCloud's platform are sent securely, and in real time, to Contour. This removes Â the need for manual processing or reconciliation between systems as all data resides on a single shared ledger that is processed only to the relevant participants. This makes it far easier for corporates to see benefit in this process, not only because of the efficiency gains found in the transparency of the transaction, but also in the consolidated view of information that provides increased trust for participants.
Although a relatively new technology, the features found within a successful blockchain ecosystem can revolutionise a centuries-old industry. International trade, by its very nature, relies upon synchronisation and trust, and those are the key functionalities that blockchain provides. Market participants will have increased access to funds and goods, improving global trade and enhancing the already profitable industry. Collaboration between trade parties needs to be a key part of the process, allowing for greater efficiencies and transactions with reduced risk.