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When I ran Asia Pacific treasury for a western multinational, BADs and CADs were a real headache – ‘bad’ news indeed.

BAD is the acronym for Bank Acceptance Draft and CAD is the acronym for Commercial Acceptance Draft. They are sometimes called BAN and CAN ie Bank Acceptance Note and Commercial Acceptance Note; and sometimes called BAB and CAB ie Bank Acceptance Bill and Commercial Acceptance Bill.

Bank Acceptance Draft Discount – 星展银 行中国- 个人银行、中小企业

银行 = bank = Yínháng

承兑 = acceptances = Chéngduì

汇票 = draft = Huìpiào

BADs and CADs are basically bills of exchange issued respectively by banks and commercial companies in China. It might sound similar to BAs that banks discount with their respective central banks in the west, but their usage and effects are very different.

BADs and CADs are essentially promises to pay by the issuer. It sounds fair enough. Something akin to the promissory notes that have been helpful in Korea. But this belies the considerable issues these instruments have created in China.

BADs and CADs are legally and regulatory recognised transferrable instruments. Unlike for instance fapiaos – tax invoices – which are not transferrable (thus stymying factoring and receivable sales in China). As such BADs and CADs have oiled the wheels of China domestic commerce for decades.

I can hear readers lighting up with the supply chain finance possibilities of these instruments. And yes, BADs and CADSs can be and are used for supply chain finance and much more besides. But remember these are paper instruments in an often chaotic developing market. BADs and CADs have caused considerable systemic and operational risk in China.

Although the so called shadow banking system in China – mainly wealth management products sold by banks through off balance sheet vehicles to get around the People’s Bank of China (PBOC) mandated deposit and lending rates – has been more in the news recently, longer-term China watchers will be familiar with the term triangular debt. This recycling of corporate obligations, often without final settlement, has thrived on the basis of BADs and CADs.

Since BADs and CADs are transferrable and endorsable, companies would pay their suppliers with BADs and CADs collected from their customers – putting a whole new spin on supply chain financing. Instead of clean bank transfers, you would see accounts receivable converted into a thick wad of BADs and CADs of dubious quality. Naturally, you would want to pass them on as quickly as possible. It became a dangerous national game of pass the parcel.

Because BADs and CADs were paper instruments, they have been hard to track at a national level, driving significant levels of systemic risk in China. In an attempt to control this risk, PBOC has mandated a maximum six month tenor for BADs and CADs.

“When I first learned about ECDS, I enthusiastically signed up as a pilot. I was very excited when I heard that PBOC would soon ban paper drafts and force business to move to EDCS once it had stabilised the platform.”

Their paper form and the Chinese predilection for chops drives massive operational risk in BADs and CADs. Simply put, it is extremely difficult to verify that the BAD/CAD you receive is indeed valid. Even the original issuing chop was hard to verify, especially if it came from a remote location. Even the four state banks had difficulty verifying chops from their own remote branches. And this was compounded by often long chains of transfer endorsements.

I ended up with a policy decision to discount all BADs and CADs received immediately – even for good names whose credit we were comfortable with – simply to address the operational risk of fraud on these instruments. This was expensive and difficult. In some cases impossible. So material collections had to be approved by our banks in advance with confirmation that we could sell the BADs and CADs with which customers proposed to settle. This was extremely painful because – especially in China where collecting accounts receivable can be challenging – you do not want to refuse your customers offer to pay, whatever the format.

In addition to the external operational risks described above, companies find BADs and CADs very hard to manage internally. Sales people may receive them in person from customers. What should they do to them? China is a big country. Do you trust local courier services? Do you trust your own people not to try to cash the drafts and claim they were lost? At best it is a lengthy and administratively costly process which materially delays converting accounts receivable to cash.

The sheer volume of paper involved in this has driven a profitable service from banks called BAD warehousing, which is analogous to the (equally odd) lockbox system for cheques in the USA.

Since negotiable drafts are useful in trade flows, we would not want to eliminate BADs and CADs altogether. The obvious solution is to make them electronic. This is exactly what PBOC concluded a few years ago. They launched Electronic Commercial Drafts System – an online platform to replace the legacy paper BADs and CADs. When I first learned about ECDS, I enthusiastically signed up as a pilot. I was very excited when I heard that PBOC would soon ban paper drafts and force business to move to EDCS once it had stabilised the platform. This is not implausible in China, but it has not happened yet.

Five years on, paper is still the majority sport. Banks still profit from BAD warehousing and discounting to manage the multiplicities of paper risk. But I am heartened by two big developments.

First, instead of the blank (and often incredulous) looks I used to get a few years ago, treasurers mostly know what I am talking about when I ask about ECDS. Better still, large numbers of treasurers are using ECDS, most in conjunction with warehousing for the old paper habit they have not yet been able to kick fully.

Second, although PBOC has not yet banned paper, they are heading in the right direction with incentives. Paper drafts are limited by PBOC regulation to a maximum six month tenor. ECDS drafts can go up to 12 months. This is a significant benefit, especially in China where access to credit can be erratic, and I believe it will speed the move from paper to electronic.

ECDS puts China ahead of most western countries by providing a nationwide platform for safe and reliable negotiable commercial drafts that will drive supply chain finance across the country that is home to the world’s biggest and most extensive commercial supply chains.

I believe the demand is there – it is no coincidence that China is an early and leading adopter of SWIFT’s TSU/BPO solution for cross-border trade. The awareness is building according to my anecdotal inputs. And the regulators are nudging this along consistently.

If ECDS piggy backs the internationalisation of CNY/CNH, then it might become the world’s favourite way of conducting international trade. Why not? UnionPay is showing the way in consumer settlement.