Bank Payment Obligation

Feature | 21 September 2017
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TFR features the Global Supply Chain Finance Forum's standard definition of the Bank Payment Obligation

The BPO is included in these definitions because it is a technology and data-driven enabling framework that has significant potential for facilitating SCF solutions based on open account trade flows, in addition to its role as a payment mechanism. As a cooperatively developed instrument, with a common set of rules developed by ICC, the BPO deserves its treatment herein.

It is recognised that there are other proprietary enabling and operational frameworks for the deployment of SCF techniques offered by individual or groups of finance providers. Traditional trade finance instruments, such as documentary credits, also act as enabling frameworks for trade finance and are extensively documented elsewhere.

In describing the parties to a BPO, the definition refers to 'banks' instead of finance providers as used in other SCF technique definitions, due to the fact that the Uniform Rules for Bank Payment Obligations (URBPO) applies only to banks and the required Transaction Matching Application (TMA) is only accessible by banks at this time.

Given the characteristics of the BPO the headings under which the BPO is described below differ slightly from those used earlier in the definition of the other SCF techniques.

Definition

The BPO is an interbank instrument to secure payments against the successful matching of trade data. as per the uniform rules for bank payment obligations, the bank payment obligation (BPO) means 'an irrevocable and independent undertaking of an obligor bank to pay or incur a deferred payment obligation and pay at maturity a specified amount to a recipient bank following submission of all data sets required by an established baseline and resulting in a data match or an acceptance of a data mismatch' (URBPO, ICC Publ. No. 750E).

Synonyms

There are no current synonyms for BPO.

Distinctive features

BPO combines some of the features of a documentary credit but with the intention to meet the needs of open account trade transactions. As a conditional payment mechanism, it may be issued to make immediate (sight) payments or deferred payments, based on the irrevocable undertaking of the obligor bank towards the recipient bank. The matching of trade data on an electronic matching platform triggers this irrevocable undertaking.

The BPO, especially those with deferred payment periods, provides opportunities for the provision of SCF to the buyer and the seller, together with various business opportunities for participating banks in financing trade transactions. The BPO should therefore be seen as an enabler for partner bank-based SCF solutions, in addition to its role as a payment mechanism. The BPO creates SCF opportunities both before and after shipment.

The BPO uses the four-corner model, involving the buyer, buyer's bank (obligor bank), seller and seller's bank (recipient bank). The role of banks in providing the BPO and cooperating with each other as partner or correspondent banks at each end of the transaction, offers a number of benefits. Each bank is fully versed in the circumstances of their respective clients (and will have completed KYC procedures and compliance checks) and typically have a willingness to apply appropriate credit facilities for their customers to support the specific obligations created by the BPO. Their presence in different geographic territories, market knowledge, and mutual agreements provide a framework for the execution of trade transactions and related financings on a global basis in both developed and emerging markets.

Parties

The parties to the BPO are the buyer, obligor bank (buyer's bank), seller (supplier) and recipient bank (seller's bank). The role taken by the parties will vary.

BPO transaction flow

Instead of physical documents being presented to banks as is the case with documentary credits, trade data is electronically submitted by the buyer and the seller to their banks and automatically matched on a special purpose platform called a TMA using the standard format ISO20022 TSMT (trade services management). This is an XML standard designed exclusively for exchanging data between involved banks and the TMA. The matching takes place via the TMA, against an established 'baseline'. Only regulated banks have access to TMA to undertake these transactions.

The establishment of the baseline is the first step and identifies the data elements agreed between the buyer and the seller as the basis for triggering the payment obligation and any subsequent financing. The established baseline forms the basis for the matching of the data set and can only be amended with the agreement of all BPO parties involved. It would be usual for the required data elements to constitute the baseline to be drawn from the purchase order, although a requirement for other data elements may be included.

After shipment, as a second step, the seller submits the trade data (data set) for automatic matching against the established baseline on the TMA. Upon successful matching (with zero mismatches), the BPO becomes due and the obligor bank is automatically obliged to pay the BPO amount at maturity to the recipient bank. In the event of mismatches, the buyer is contacted for acceptance of the mismatch and the BPO becomes due if and when the approval is received. The payment of the BPO at maturity is effected outside the TMA through normal payment channels.

BPO as an enabling framework for SCF

Depending on the existence of relevant partner bank relationships, the four-corner model provides the opportunity to offer SCF in various countries and markets.

Most obviously, there are opportunities for the discounting of receivables due under a BPO based on the risk of the obligor bank. Further finance opportunities are also available, such as pre-shipment finance, the early settlement of the undertaking of an obligor bank to a recipient bank, or an extension of the timeframe for payment by the obligor bank in favour of the buyer.

For example, upon the successful matching of data sets (extracted from invoice and perhaps transport and other documents) against the established baseline (usually based on the purchase order), the BPO becomes due and the irrevocable undertaking of the obligor bank can offer the basis of a financing within the 'four-corner model'.

Figure 2 illustrates a number of spaces: pre-shipment, post-shipment and extended post-shipment, which offer SCF opportunities.

Figure 1: Establishing the baseline

Source: Global SCF forum

Variations of SCF under the BPO

Post-shipment finance BPO - discounting of the deferred payments after successful matching of trade data

  • Financing requested by the seller and effected by the recipient bank - the seller instructs its bank (recipient bank) to discount the deferred payment outstanding for the period of the BPO after the matching of trade data. The financing is provided without using the seller's credit line, but is earmarked under the obligor bank's credit line at the recipient bank. The seller receives early payment of the BPO amount less discount charges. A finance agreement between the seller and recipient bank is the contractual basis for this financing (including the components of recourse).

  • Financing requested by the obligor bank and effected by the recipient bank - the obligor bank (on behalf of the buyer) instructs the recipient bank to advance the BPO amount to the seller after the matching of trade data. The financing is booked under the obligor bank's credit line at the recipient bank. The seller receives early payment of the full BPO amount, the obligor bank is charged with the BPO amount plus financing costs. A financing agreement between the recipient bank and obligor bank is the contractual basis for this financing.

  • Advance of payment requested by the buyer and effected by the obligor bank - the buyer instructs its bank (obligor bank) to advance deferred payment obligation created after the matching of trade data due under the BPO to the seller. The obligor bank finances the deferred payment period and pays the BPO amount to the recipient bank in advance. The seller receives early payment and the buyer is charged in addition to the BPO amount with the financing costs. A financing agreement between the buyer and the obligor bank is the contractual basis for this financing.

  • Financing requested by the buyer after maturity date of the BPO (refinancing of the obligation of the buyer to meet a maturing BPO which can be characterised as extended post-shipment finance).

At maturity date of the BPO, the buyer requests its bank (obligor bank) to extend credit to it for an additional period, so as to meet the maturing BPO. This financing does not affect the handling of the BPO as between obligor and recipient bank, ie the BPO amount is fully paid by the obligor bank at maturity. But based on a financing agreement between the buyer and the obligor bank, the obligor bank recovers the funds due under the BPO together with the financing charges from the buyer's account at a later date agreed between them.

Pre-shipment finance based on a BPO transaction

An established baseline containing reference to the issuance of the BPO (and often data present in a purchase order) offers a first level of security for the transaction, as it provides the basis of the source of repayment, provided that the seller performs its contractual obligations. The established baseline enables the seller to prepare and ship goods and therefore provide the trade data for a successful data set matching and payment by the obligor bank at maturity date. In this way the BPO is facilitating pre-shipment finance based on the purchase order. A financing agreement between the seller and the recipient bank would be the contractual basis for this financing.

Contractual relationships and documentation

For the BPO transaction flow

Obligor and recipient banks rely on the ICC Uniform Rules for Bank Payment Obligations (URBPO), which came into force on 1st July 2013, and the contractual agreement of the TMA, such as SWIFT's Trade Services Utility.

The contractual relationships of the buyer and seller for the handling of the BPO transaction with their respective banks (obligor and recipient bank) need to be agreed bilaterally. To support the issuance of these agreements, ICC has published 'Guidelines for the Creation of BPO Customer Agreements' in August 2015, with reference to clauses which should be part of such contracts in the corporate-to-bank space. The use of a bank payment obligation needs to be agreed as a defined payment term between buyer and seller in their underlying commercial contract.

For financings under a BPO

Due to the fact, that such financings are not included in the BPO transaction itself, financing agreements (quite separate to the BPO itself) involving the relevant parties (ie seller and recipient bank, buyer and obligor bank or between the recipient and obligor bank, need to be established). The terms of such financing agreements will depend on the type of finance (see above 'Variations of SCF to be contemplated under the BPO as an enabling framework').

Figure 2: Matching of trade data

Source: Global SCF Forum

Security

The irrevocable payment undertaking of the obligor bank to effect payment at maturity is based on the buyer's credit worthiness. It does not only secure the payment itself, but also provides security for financing by the recipient bank or the obligor bank, depending on the type of finance. In the four-corner model, the reliability of the bank-to-bank relationship provides additional security for the financing.

The existence and authenticity of the trade transaction is secured by two matching processes of the BPO transaction: 1) matching of baseline data between buyer and seller and 2) matching of trade data against the established baseline. According to their contractual agreements, the buyer and seller are obliged to provide correct data for the matching, and the banks concerned are not expected to verify the authenticity of data; therefore, a trusted trading relationship between the trade partners is essential.

Risks and risk mitigation

Post- shipment finance under a BPO

The risk for the obligor bank is that the buyer does not make payment of the BPO amount at maturity. This risk is mitigated by buyer's credit worthiness and the establishment of an appropriate credit facility.

The risk for the recipient bank engaged in any financing under the BPO is the failure of the obligor bank to meet its obligations for whatever reason. The recipient bank needs to establish the necessary credit line for the obligor bank.

Pre-shipment finance under a BPO

The primary risk of re-shipment finance on the basis of the established BPO baseline is the performance and credit risk of the seller, as repayment is dependent on the seller's performance ability and its provision of trade data for a successful matching against the baseline. Mitigation of risk is provided by proven performance of the seller in a repeatable and predictable fashion. Other risks and their mitigation are analogous to those under post-shipment finance above.

Benefits of the BPO and financing

For the buyer:

  • Reassurance that the goods will be delivered in accordance with expectations

  • Controlled payment under the BPO

  • Harnessing the ability of the partner banks to carry out the transaction in all its aspects

  • Improved operating processes through automation

  • Fast and flexible digital matching processes based on the TMA

  • Opportunities to raised finance flexibly at various points during the transaction cycle.

  • Working capital optimisation by extension of payment terms combined with financing possibilities for the seller

  • Improvement of supply chain stability

For the seller:

  • Reassurance that payment for the goods will be made on the assumption that a successful matching of trade data against the established baseline takes place.

  • The ability to raise finance against a deferred BPO, subject to the recipient bank having the required credit line for the obligor bank

  • Further possibilities to raise pre-shipment finance

  • Finance is raised against the payment undertaking of the obligor bank and the buyer's strong credit rating with the possibility of a lower implied cost of funding than would have been obtained under other financing structures

  • Harnessing the ability of the partner banks to carry out the transaction in all its aspects

  • Improved operating processes through automation

  • Fast and flexible digital matching processes based on the TMA

  • Improvement of supply chain stability

The BPO handling and financing offers benefits not only to large corporates, but also to small and medium-sized enterprises (SMEs), subject to status and credit availability.

Asset distribution

Financings of the BPO are typically offered by the recipient or obligor bank. In the case of very large amounts distribution techniques might be used.

This is an extract from the 'Standard Definitions for Techniques of Supply Chain Finance'. TFR will feature extracts from the standard definitions on an ongoing basis to support consistency across the industry. The complete document can be found here: http://bit.ly/2nPlDXt

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