Trade & Supply Chain

Connecting digital islands: the future of trade finance?

Published: Jan 2020

With a US$1.5trn trade finance gap globally, there’s a clear need to bring paper-based processes into the 21st century. In the past, efforts to digitalise trade finance have often fallen by the wayside – but could more recent technology-powered initiatives really make a difference?

Digital blockchain created by typography

Trade finance plays a vital role in facilitating global trade, both by providing trade partners with the finance needed to support growth, and by helping them mitigate trading risks. But at a global level, the availability of trade finance continues to fall well short of demand. A report published by Asian Development Bank (ADB) in September 2019, Bridging trade finance gaps through technology, estimated the global trade finance gap to be US$1.4trn-US$1.6trn, “or around 8%-10% of global goods trade.”

The report states that Asia Pacific accounts for about 40% of the rejected trade finance applications worldwide. It also finds that banks are more likely to reject the proposals of SMEs due to the higher costs associated with processing those proposals – not least because of the higher costs of obtaining AML and KYC information. In addition, the high costs associated with trade finance instruments like letters of credit (LCs) can put these beyond the reach of smaller businesses.

“Trade finance is very important to achieving sustainable development goals (SDGs), which include things like economic growth and addressing poverty,” comments Steven Beck, Head of Trade Finance at ADB. “Without sufficient financing to support the growth of trade, we’re not going to realise a lot of the goals that we’ve all signed up for.”

Going digital

So what are the obstacles? The ADB report cites three main challenges when it comes to providing trade finance: costly delays and errors in documentary transactions arising as a result of the continued use of paper; the need for financial institutions to conduct significant due diligence “which raises the cost of supplying trade financing”, and banks’ need for knowledge of their clients, resulting in hurdles for SMEs seeking finance.

The first of these three issues is a particular focus for many in the industry. As the ADB report points out, letters of credit can involve over 20 different parties and as many to ten to 20 documents, all of which need to be examined and validated.

“The primary problem with trade finance is that it is paper intensive, creating inefficiencies across the physical and financial supply chain,” comments Hariramchakraborthy Janakiraman, Head of Trade Product, ANZ Institutional. “This results in increased cost, risk and reduces access to financing especially for SMEs.”

It’s clear that digitising these processes could play an important role in addressing the challenges associated with trade finance, and thereby enabling more businesses to access the funding they need. As Janakiraman explains, a significant portion of global trade is now transacted on open account terms. In this context, the digitisation of trade can unlock faster access to financing and reduce operational costs by enabling access to, and streamlining, the information flow between the trade financier and intermediaries such as shipping companies and the customer.

For corporates, Janakiraman says digitalisation “will eventually provide them a single standard to connect digitally with their financiers, shipping companies, suppliers and buyers.” What’s more, he says it will “bring traditional paper-based instruments such as letter of credit and guarantees into the modern world.”

Peter Jameson, head of Asia Pacific Trade and Supply Chain Finance, Global Transaction Services at Bank of America, adds that digitalisation offers multiple benefits in addressing key challenges in this area.

“From a bank perspective, risk reduction is a major benefit,” he says. “Through capabilities such as digital tracking, rule-based solutions (smart contracts/AI), automated regulatory tracking of documents and automated compliance scanning, banks have quicker access to information.” As a result, he says, banks are able to make decisions faster – and most importantly, more accurately – to support their clients’ trade and financing needs.

In addition, Jameson notes that digitalisation brings numerous other benefits for banks and clients, including operational efficiency, enhanced regulatory reporting and expedited transaction processing – thereby helping to bring down overall expenses and improve profit margins.

Digital islands

When it comes to bridging the gap, efforts to harness technology to streamline trade finance processes date back some time – but historically, such efforts have often fallen short of providing their desired outcome. Last year, for example, it was reported that SWIFT plans to decommission its trade services utility (TSU) in December 2020, calling into question the future of the bank payment obligation (BPO) – an irrevocable undertaking from the buyer’s bank to the seller’s bank to pay under agreed conditions, with data matched electronically via the TSU.

“Digitising trade is not a new phenomenon: members of the trade ecosystem have been trying to convert paper into ones and zeroes for years,” says Ajay Sharma, Regional Head of Global Trade and Receivables Finance, Asia Pacific, HSBC. “The problem is that because much of the work has been done in siloes, we’ve ended up creating digital islands that don’t speak to one another.”

Likewise, the limited scope of individual initiatives may have hindered their effectiveness, as Janakiraman explains: “Prior to the past couple of years, industry participants have been attempting to digitise on their own with a focus on specific documents (eg bill of lading) or processes rather than the end-to-end supply chain. The biggest change over the last few years has been the concerted effort by various involved parties such as banks, corporates, shipping companies, government departments to digitise the entire supply chain.”

Strength in numbers

This step change includes a growing focus on technologies that could finally help to bring the different parts of the puzzle together. In particular, there continues to be much discussion about the potential of blockchain/distributed ledger technology (DLT) to address challenges in trade finance.

As Sharma points out, “Blockchain can be the superconnector, or a network of networks, that links these digital islands, bringing all parties together. This will greatly reduce trade friction and vastly improve working capital for companies.” He notes that a report co-authored by HSBC and Bain estimates that blockchain could increase global trade volumes by US$1.1trn by 2026, up from the current base of US$16trn.

Janakiraman observes that blockchain “brings a real opportunity to digitise trust in the trade finance industry.” In particular, he says that private blockchain technology offers the unique capability of being able to bring non-trusting parties into a common platform to transact, “while maintaining confidentiality.”

This isn’t just talk – there are already numerous examples of blockchain-based solutions that address the pain points in trade finance. One area of focus is letters of credit: according to Sharma, issuing LCs can take five to ten days using a paper-based process – but with blockchain, an LC can be issued in as little as a few hours. “Put simply, when we remove paper, more trade can be done in the same amount of time,” he says.

Sharma adds that HSBC has already completed 14 blockchain letter of credit transactions, and is working with clients “to either continue or begin their blockchain journeys.” He adds that once clients are familiar with how easy it is to integrate blockchain into their systems, “we’ll be able to move onto full commercialisation.”

Ones to watch

There are plenty of initiatives to watch – and many of these are characterised by high levels of collaboration across different players within the industry. While not an exhaustive list, the following initiatives are making waves in this space:

  • Marco Polo: facilitating interactions. Jointly run by TradeIX and R3, the Marco Polo Network aims to “facilitate interactions and create value for all its participants including financial institutions, their corporate clients, and the broader trade ecosystem.” In December, the network successfully completed a blockchain open account trade finance trial which incorporated more than 70 organisations.
  • ICC TradeFlow: streamlining paper-based processes. DBS and Swiss commodities trader Trafigura announced in November that they have plans to launch a blockchain trade platform in Singapore, the ICC TradeFlow platform. The platform is expected to halve document transit time.
  • Lygon: speeding up bank guarantees. An Australian platform spearheaded by ANZ, Westpac and the Commonwealth Bank with IBM, Lygon allows for the digitisation of bank guarantees – speeding up the issuance of bank guarantees from up to a month to on or around the same day. The platform has recently concluded a successful pilot and is preparing for commercialisation in mid-2020.
  • The Trade Information Network: sharing information securely. Janakiraman says the Trade Information Network “is a global innovative platform that enables corporates to securely share trade information with banks of their choice and therefore get access to more financing opportunities. The platform aims to be the inclusive industry standard network for multi-bank trade finance and is about to start its pilot, with commercialisation expected in 2020 as well.”
  • Networked Trade Platform (NTP) and eTradeConnect: digitising trade data. Led by the Singapore and Hong Kong regulators respectively, NTP and eTradeConnect aim to “digitise trade data and become one-stop trade information ecosystems,” Janakiraman explains. NTP already has over 2,000 customers after going live in December 2017; eTradeConnect went live in October 2018 and is set for commercial transactions this year.
  • Voltron: providing an end-to-end solution. An open platform for documentary trade built on by R3’s Corda blockchain platform, Voltron aims to “improve the trade finance process by simplifying letters of credit, delivering shorter settlement times, instant discrepancy resolution and simplified sanctions screening.” In May 2019, more than 50 banks and corporates took part in a simulation of digital LC transactions.
  • supporting collaboration. Built by IBM, supports collaboration between businesses and banks in Europe. In 2018, announced it was collaborating with eTradeConnect to facilitate cross-border trade and pave the way for a “digitised corridor between Asia and Europe for trade finance business.”

Blockchain and beyond

While there are numerous blockchain-based initiatives under way, it’s also worth noting that there’s more to digitalisation than blockchain/DLT. ADB’s Beck says that the bank is currently engaging with a blockchain pilot on Voltron, adding that it’s important to be in tune with blockchain and the possibilities it brings – but he also points out that the hype around this topic has led to some “unrealistic expectations” about the current state of play with this technology and what it can deliver.

In addition, Beck comments that in the last year, the focus on blockchain has been somewhat overtaken by enthusiasm for artificial intelligence (AI). “I think if you ask most people in the market today, they would agree that AI has really taken the number one spot in terms of people’s imagination around what it can deliver to make us more efficient,” he says. “I think certainly in the AML, KYC, CFT space, the ability of AI to pick up patterns on a huge volume of transactions, in a way that human beings just can’t, is very exciting.”

In April 2019, for example, Citi announced it was working with EY and SAS to develop an AI-based risk analytics scoring engine. According to a press release, the platform will provide in-depth analysis of global trade transactions and will harness advanced analytics and natural language processing “to better understand networks of related parties, unstructured data and customer activity over time”.

Overcoming the barriers to technology

From blockchain to AI, it’s clear that there are plenty of promising initiatives that could play a role in overcoming the challenges that have long been associated with trade finance. But before the full benefits of digitalisation can be achieved, there are also a number of obstacles that will need to be overcome.

Beck says that the “raison d’etre” of ADB’s trade finance business is to close the trade finance gap – and that the development bank recognises the essential role that technology plays in addressing challenges around AML and CFT. However, he says that three things will be needed before we can achieve these goals through technology:

  1. Regulation. The first challenge that Beck highlights is the regulatory environment around digital trade. “Some countries, for example, don’t have any legislative grounding for something as basic as digital bills of lading,” he says. “We’re never going to be able to seriously move the needle until we’ve got the proper regulatory frameworks in place that can enable this stuff to take off.” As such, he says it’s important that governments adopt the Model Law on Electronic Transferable Records created in 2017 by the United Nations Commission on International Trade Law (UNCITRAL).
  2. Legal Entity Identifiers. The second issue that Beck highlights is the role that the Legal Entity Identifier (LEI) could play in addressing challenges around AML and KYC. “In 2010, G20 mandated the Financial Stability Board to create a globally harmonised LEI – an eight-digit number linked to verification of who’s who, who owns whom, and (coming soon) who owns what,” he explains. “I think until we have a harmonised identifier system that’s fully adopted globally, it’s going to be really tough to address a lot of the problems in AML, KYC and CFT.”In addition, Beck says that the LEI can play an important role in helping financial institutions make the best use of metadata and thereby boost lending to SMEs. “If you’ve got a lot of companies trading on systems and platforms, and able to collect an ocean of information, you need a unique identifier so that you can find the equivalent of a grain of sand – in this case, an SME.”
  3. Digital standards. With many proofs of concept and blockchain pilots already under way, Beck argues that these are “totally disjointed – there’s no interoperability between these different platforms.” To bring these together, he says, digital standard protocols are needed that can drive interoperability and interconnectedness. “We’re therefore working with the government of Singapore to start an entity called the Digital Standards Initiative,” he explains. “We expect it to be up and running in 2020, and we’re asking the International Chamber of Commerce to run it because they can bring together all the different components of the trade ecosystem.”Beck says that this will enable seamless digital trade between these different parties. “In other words, you’ll have the exporter being able to communicate with the shipping company, ports, customers, banks, insurance, warehousing and logistics, as well as with the buyer, so that each of the data elements for each of those component parts are captured. That would drive incredible efficiencies in trade, while lowering barriers for SMEs.”

Beck hopes that these initiatives will facilitate the use of technology to overcome long-standing challenges in trade finance and thereby address the trade finance gap. However, he also acknowledges that achieving all these goals is a major undertaking. “One of our biggest challenges is to break this down into manageable bite sizes, so we can establish reasonable measurable milestones,” he says.

At the same time, Beck notes that geopolitical factors are driving economies toward decoupling. “We’ve got a lot of forces moving in that direction, both intentionally and unintentionally,” he concludes. “Our Digital Standards Initiative works to keep the world connected into the future. Let’s hope it works. There’s a lot at stake.”

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