Insight & Analysis

Built better by blockchain: rethinking trade finance contracts

Published: May 2020

Trade finance contracts can be a paper-based nightmare. Blockchain is here to fix all that with smart contracts. We talk to one business analysis expert to find out if this is true.

Pen and crumped paper on red background

Trade finance today is a core business for global banks, insurance companies and other players. Yet, despite this business line’s prominence, the logistics of trade finance is still behind modern technology. The industry remains manual and document intensive, inhibiting visibility and amplifying challenges such as financial crime. It is high time trade finance receives a digital upgrade – to make business faster, safer and – ultimately – smarter.

Smart solutions

“If we go back just 50 years, every element of a trade finance agreement was paper-based,” says Vaibhav Verma, Manager, Business Analysis at a New York-based information technology and consulting company, Synechron. Indeed, one agreement could generate huge amounts of paperwork, fast becoming unmanageable when programmes expanded to more members of the supply chain. “These manual processes are no longer sustainable in a world where, thanks to the power of technology, businesses of all sizes can participate in global trade.”

What’s more, the restrictions of manual processing have long meant that trade finance providers tend to offer these programmes only to multinational corporations that make up the short tail of the supply chain. This makes sense, notes Verma, but has meant that many small and medium sized enterprises – “for whom a trade finance agreement could be the difference between regular and reliable cash flow and insolvency at the hands of a buyer being late on a payment” – have been unable to access this support.

He believes that this is just one reason why so many corporates, banks and fintechs are exploring blockchain technology, with efforts concentrated on the use of smart contracts in digitising trade documents, recording and registering new documents on the blockchain.

Blockchain role

Verma explains that distributed-ledger technology (DLT), which is the keystone of blockchain, allows each counterparty within an agreement its own copy of the same ledger. Crucially, these individual copies of the same document, distributed across the closed network – consisting only of those involved in a given agreement – are immutable. This makes holding and distributing documents via DLT inherently secure.

DLT is equipped to play a significant role in addressing trade-based money laundering, he believes. More than simply digitising a trade finance agreement, smart contracts have the functionality to automatically execute an event – such as payment – if certain preconditions are met. This function addresses the issue of counterparties claiming to have sent a payment they had not, as smart contracts can trigger payments and provide receipt of this action to the relevant authorised parties. “As well as removing the manual burden of chasing the missing accounts receivable, this could improve trust across the supply chain,” he adds.

Another considerable advantage of smart contracts is their scalability – with the technology able to support inclusion of multiple parties in the same linear contract. “In practice, this could mean that if a shipment of goods becomes damaged before it reaches the buyer, then the incumbent insurance provider could be notified of their responsibilities automatically,” notes Verma.

Trade finance needs smart contracts

The value that smart contracts can bring to trade finance can be distilled into five reasons, notes Verma. These are:

  1. Mitigating manual risk: human intervention is the first cause of errors. Smart contracts require fewer intermediaries and only call for manual intervention when necessary.
  2. Speed: by being based entirely online, smart contracts significantly reduce the time needed for approval, meaning trade finance programmes could get up and running faster.
  3. In-built trust: smart contracts essentially codify trust between counterparties of a trade finance agreement, since all relevant parties have access to the underlying agreement, and the smart contract is able to trigger payments upon receipt of goods. This should support the reduction of supplier fraud.
  4. Ease of management: smart contract technology allows incumbent banks to access and audit all underlying collateral, eliminating the risk of banks making multiple payments to fraudulently submitted duplicate invoices.
  5. Scalability: trade finance agreements are complex. It is vital that the technology used to digitise trade finance has the flexibility and scalability to accommodate growing supply chains and financing programmes – lest it generates as much administrative burden as its paper predecessor. Smart contracts have the functionality to expand with the growth of a given entities’ supply chain.

What’s next?

For many sandboxing the application of blockchain, exploration of this technology has graduated from ‘thinking and learning more’ to ‘experimentation’. Most of the trade finance blockchain initiatives being piloted today are being steered by banks – for example, the Marco Polo network – and with little external input. “While banks certainly have the capacity to invest in and develop an effective trade finance blockchain solution, this approach may be limiting and is not enough to influence and motivate all the participants in a trade,” suggests Verma. He argues that efforts are required in building public-private partnerships for a “consultative, multilateral dialogue with a laser focus” not only on building a value-adding blockchain solution, but on what the users of these agreements need now and in the future.

Various regulatory bodies across the globe are aware of the challenges in trade finance. The financial industry can currently monitor the movement of funds which is only one aspect of trade and is currently not capable of monitoring the movement of goods along with movement of funds.

“This lifecycle can be enriched by bringing together entities like customs and shipping along with the financial industry,” says Verma. He feels that “noteworthy improvements” can be achieved by getting regulatory bodies together to form a heterogeneous group and exposing the need to identify the stakeholders, grouping together those who play key roles.

“By designing a blockchain solution for trade finance programmes and forming partnerships, we may see significant time savings and new efficiencies,” he comments. “And in the longer term, this could mean that providers are able to offer trade finance programmes further along the supply chain’s long tail.”

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