From barter to trading bytes

Feature | 30 May 2017
Standard_Chartered

Banks and fintechs have made a lot of progress in developing trade digitisation solutions. The next step is to focus on global technology and legal standards
as well as interoperability, says Samuel John Mathew

Much has changed since the days when people could trade grain in exchange for spices, precious stones or cattle. The probability of an actual trade depended solely on the coincidence of wants - someone with surplus cattle needed to be willing to exchange them for grains, and vice versa.

Then came the advent of coins, and eventually paper and digital money, as a common store of value and a medium of exchange. This fuelled global trade, which grew at an exponential rate. According to WTO, global cross-border trade stood at US$18.4trn in 2014, having grown at an average compound annual growth rate (CAGR) of 6.8% since 19801.

However, as trade supply chains have become more global, complex and paper-based, the operational and regulatory costs of on-boarding clients and putting up trade facilities has begun to impact the ability of banks to offer trade finance to smaller clients. Indeed, International Chamber of Commerce (ICC) has estimated a trade finance shortfall of US$1.6trn for emerging market small and medium sized enterprises (SMEs)2.

Evolving digital trade landscape

This web of inefficient, paper-based flows has prompted ideation around new ways of fulfilling and settling trade. The prize is large - the global revenue pool for trade in banks is estimated at US$45bn - and fintech firms are looking to benefit, with a particular focus on SMEs3.

The banking system has always lacked interfaces into the physical supply chain and industry bodies such as customs. Where technology solutions are concerned, SWIFT for Corporates offers corporates direct SWIFT access instead of routing via their banking partners. The Bank Payment Obligation (BPO) meanwhile, is intended to inherit data from the physical supply chain and auto-match transactions to create payment obligations/bank payment guarantees. Uptake however, has been limited, due in part to the need of the physical supply chain needing to be digitised before trade finance can be digitised. At the same time, corporates have increasingly become multi-banked, making it important to move away from proprietary bank platforms.

These dynamics have led to the development of various platforms, which had some success in linking the physical and financial supply chains. Platforms such as essDOCS and Bolero focus on the digitisation of document flow under letters of credit and electronic bills of lading, while Taulia, Ariba and PrimeRevenue are some examples of digital supply chain management and dynamic discounting. Most of the platforms gaining traction are closed loop in nature, and while this is critical from a security standpoint, it is also the biggest handicap where greater adoption is concerned.

Distributed trade ledgers and blockchain

The blockchain and the immutable distributed ledger is the conceptual panacea that promises to resolve the existing issues in global trade finance. Several use cases and proof of concept transactions have been announced and conducted, leveraging immutable blockchain-based distributed ledgers. Some
examples include:

  • TradeSafe Singapore - Standard Chartered, DBS and Ripple participated in the proof of concept, which was structured to address the problem of multiple financing and determining the authenticity of invoices in the invoice financing space. Through the use of distributed ledgers, banks can check if a particular invoice has been financed by any other bank. Customs or port authorities can also use the distributed ledgers to add their verification to authentic invoices that they handle4.

  • Singapore National Trade Platform (NTP) - Developed by Singapore Customs, this will be a trade and logistics ecosystem connecting various parties in a trade. It aims to be a one-stop trade information management platform for the trade and logistics industry, as well as for adjacent sectors such as the trade finance industry5.

  • R3 - A distributed database technology company, R3 leads a consortium of more than 70 of the world's biggest financial institutions in research and development of blockchain database usage in the financial system. R3 has successfully concluded a trial with participation from 15 members using its Corda platform to process accounts receivable transactions, also known as invoice financing or factoring, and for letter of credit financing.

  • Wave - Another start-up, Wave has developed a blockchain based system that uses distributed ledger technology to give multiple parties in a trade transaction visibility, title transfer and transmission of shipping, and other trade documentation through a secure, decentralised network6.

Banks are working closely with - and in some cases investing in - these fintechs. Standard Chartered, for example, recently announced a strategic investment in Ripple, a leading distributed ledger company.

Challenges impeding large-scale adoption

Despite this progress, a few challenges stand in the way of the full-scale adoption of these developments.

Multiple closed loops

In order to build scale and relevance, a number of participants from different parts of the trade cycle need to be part of the closed loop. A variety of projects are currently underway to explore the applicability of this technology, each being led by different groups of financial institutions and fintechs. While this is to be expected at this stage of the technology cycle, there will need to be a more cohesive effort to define a global solution - otherwise we will be left with multiple closed loops which do not speak to each other.

Standards

The lack of global standards represents another challenge. Banking is a highly regulated industry, and clearly defined standards and legal frameworks are critical to further adoption by industry players. Until a unifying standard technical and legal framework is defined and accepted by major industry players, distributed ledger technology cannot be considered to have addressed the problems it is expected to solve.

Similarly, without a legal framework and international standards supporting digital trade documents and transactions, the industry will only be able to grow on closed networks. To allow digital trade to grow beyond closed loop networks, some global standard rules are required. The ICC and Bankers Association for Finance and Trade (BAFT) have started workgroups focusing on this topic.

Interoperability

With banks trying out different approaches to digitisation, standardising these solutions is challenging. The complexity of a trade transaction, and the number of stakeholders involved, makes it difficult for one technological approach to digitise a trade flow completely and thus, linking diverse technological suite of solutions is critical to deliver an end-to-end digital experience for the client.

Traditional risk intermediation vs smart contracts

While blockchain or a cloud-based system might achieve end-to-end transparency, an exporter may still need a bank or other intermediary to underwrite the importer's payment/credit risk. Smart contracts and house member rules in these digital islands (blockchain or cloud-based) may eventually resolve the need for a trusted intermediary. Alternatively - or additionally - distributed ledgers may assume the role of the trusted intermediary, executing the smart contract obligations based on the smart triggers.

Future developments

These are exciting times. The industry is now moving towards exchange of data instead of actual documents and industry players are committed to leveraging emergent technologies, including blockchain, to drive efficiencies in the traditionally paper-centric trade business. In the future, any large-scale uptake will depend on interoperability beyond the current closed loops, as well as the uniformity of house rules across various players, laws regarding e-instruments and the standardisation of digital documents data packs.

Global trade industry bodies such as ICC and SWIFT are well-placed to introduce standards for digital documents and add physical supply chain data formats into the current formats. However, the laws and regulations surrounding these digital documents are still nascent (for example UNCITRAL recently shared a Model Law for electronic transferable records which seeks to enable the use of electronic transferable instruments to enable trade and title transfer), and customs and EXIM bodies in many markets are a long way away from accepting digital documents.

Where blockchain is concerned, will the industry eventually
see a global digital immutable distributed ledger that retains title and endorsements, and is accepted and integrated with key markets' customs, chambers of commerce, shippers and insurance, as well
as being open to buyers, sellers and banks? Quite possibly - but
such a quantum leap will require cohesion among leading global
and regional players and industry bodies, as well as consolidation among platforms.

In the meantime, what we can be sure of is that the industry will continue digitising trade because the resultant cost efficiencies is of paramount importance to the banking industry. Banks will also continue experimenting with these technologies and ideas, both with clients and third-party networks, as well as internally between front, middle and back office systems, with the aim to digitise, reduce costs, and reduce paper flows in traditional trade.

Samuel John Mathew is managing director and head - documentary trade products, transaction banking at Standard Chartered

 

References

  1. WTO International Trade Statistics

  2. ICC Trade Finance Survey 2016: http://bit.ly/2orrn6j

  3. Boston Consulting Group's paper on embracing digital in trade finance: http://bit.ly/2oUBB30

  4. Standard Chartered announcement on first use of distributed ledger technology in trade finance: http://bit.ly/1PXslAh

  5. Singapore Customs NTP: http://bit.ly/2pB914C

  6. Reuters article, 'Barclays says conducts first blockchain-based trade-finance deal': http://reut.rs/2ctPix9

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