Before jumping into the future, let’s put things into perspective. In 1970, letters of credit accounted for half of world trade settlement. Now over 80% of transactions are conducted on open account1 terms. New instruments and techniques have been developed including the Bank Payment Obligation (BPO)2, essDOCS3 or Bolero4 and SWIFT MT7985. The BPO, which was launched in 2007, has gained the reputation of being one of the most significant developments in trade. After almost 10 years, perhaps it’s time for other players & technologies to claim that reputation.
The share of trade finance (EU mostly) conducted electronically increased from 39% in 2012 to 44% in 2014, says McKinsey quoting Greenwich Associates, which means that there is no going back from digital.
The EBA’s cryptotechnology working group has stated that “the biggest challenge in the evolution of trade is that bank’s trade finance offerings are not well integrated into the trading cycle”. This is an accurate description of the current situation as the industry if struggling with the usage of different platforms for different elements of a trade transaction (one for financing, one for invoice exchange, one for ownership documentation).
Enablers for innovative trade finance: blockchain & smart contracts
Based on the problem mentioned before, EBA identified two uses cases for the use of cryptotechnologies in trade finance: the exchange of trade data and financing. What makes cryptotechnologies particularly interesting for trade finance? First of all, it is the exact nature of the technology. A cryptotechnology is a shared, uniform ledger that is replicated among all participants over a network of interconnected computers. The security and accuracy of the ledger are assured through the use of cryptotechnology and control of the ledger is decentralised among participants, meaning that there is no single authority responsible for updating and maintaining the ledger. In other words, cryptotechnologies help secure trust between trading parties, help provide credit ratings to improve financing terms, create a level playing field, reduce the risk of errors or fraud, and, not to forget, ease the exchange of payments.
Embedding blockchain is a blockbuster in trade finance. The technology could cut banks’ infrastructure costs for cross-border payments, securities trading and regulatory compliance by USD 15 bn-USD 20 bn a year from 2022, according to a recent report by Spanish bank Santander, management consultancy Oliver Wyman and venture capital investor Anthemis. At the moment, there are at least 40 banks interested in blockchain and one initiative got a lot of attention. Almost two dozen of the world’s largest banks, including JPMorgan, UBS, and Barclays, have shown their interest in R3 CEV, a start-up venture, by setting up a private blockchain open only to invited participants who among them maintain and run the network. What’s more, it’s fair to say that history has been made in the banking industry when ATB Financial, a USD 43 bln-asset bank based in Canada, sent USD 1,000 to Reisebank in Germany in only eight seconds, using the Ripple protocol.
Zooming in a bit more on the blockchain story, one use case attracts a lot of attention: smart contracts. Some exciting players to follow: CoinSpark, RootStock, bitshares, SmartContract, ETH Baas. CoinSpark, for instance, allows you to add private messages to bitcoin transactions, create an asset and contract in minutes and ultimately transfer any asset over the internet. RootStock (RSK) is an evolution of QixCoin, a cryptocurrency created back in 2013, which provides ‘an improved payment experience with near instant confirmations’. It confirms most payments in less than 20 seconds. Even the software giant Microsoft declared blockchain open for business: they teamed up with ConsenSys to release Ethereum Blockchain-as-a-Service (ETH BaaS).
Why are smart contracts appealing? Because they execute actions after a trigger event has occurred, eliminating the possibility of one party to perform a specific task such as initiate payments, release goods, etc. before the necessary trigger event has actually been completed. Also, smart contracts could be used to ensure that funds will not be transferred to banned parties or countries or provide protection against duplicate invoice financing, as the contract will not allow for an invoice that has already been financed to receive extra financing.
Enablers for innovative trade finance: instant payments infrastructure
Current trade transactions suffer from inefficient processes and late payments caused by outdated payments infrastructure, thus the latest developments in real-time payments is a breath of fresh air. Already almost 20 countries worldwide have already implemented instant payments infrastructures and major markets such as the US, Eurozone and Australia are in the ongoing developments stage.
EuropeFaster Payments Service is a UK banking initiative to reduce payment times between different banks customer accounts from three working days using the long-established BACS system, to typically a few hours.
SWIFT’s global payments innovation initiative (GPII) offers an ambitious roadmap for reinventing the correspondent banking model as we know it today. With ever increasing competition from new entrants offering same-day, or even real-time payment facilities, SWIFT is uniting the banking industry to provide corporates with a cross-border payment service that offers greater speed, transparency and predictability. Launched in December 2015 to much anticipation in the industry, the initiative has received strong backing with more than 50 leading banks already signed up.
USThe Federal Reserve System’s Faster Payments Task Force is set out to identify and assess alternative approaches for implementing safe, ubiquitous, faster payments capabilities in the US since 2015.
NACHA has adopted a rule to provide a new, ubiquitous capability for moving ACH payments faster. The rule will enable the same-day processing of almost any ACH payment.
AustraliaThe New Payments Platform is a major industry initiative to develop new national infrastructure for fast, flexible, data-rich payments in Australia. The program proceeded to the fourth phase, build and internal test in August 2015. The NPP is on track to being operational in the second half of 2017.
Should we hold our breath for mainstream innovations in trade finance?
Not yet. Although developments look promising, “the consensus amongst banks and non-banks is that mainstream blockchain applications in trade finance are at 5+ years away”, argues Boston Consulting Group and instant payments infrastructures are a long way from becoming mainstream. What’s more, to be truly beneficial, cryptotechnologies need mass adoption and a network effect which in their own right bring about the concerns of lack of interoperability between distributed ledgers (as well as between distributed ledgers and legacy systems).
1 Open account trade is a trade transaction where the goods are shipped before payment is due.2 Bank Payment Obligation is an interbank instrument used to secure payment against the successful matching of trade data and championed by SWIFT and the International Chamber of Commerce (ICC) Banking Commission3 essDOCS is a company specialising in electronic trade documentation.4 Bolero is a company that offers electronic document presentation and settlement for the trade finance market.5 A SWIFT messaging standard that allows corporates to integrate all trade transactions into an ERP system to gain a single, consolidated view of all trade transactions.
About Mirela Amariei
Crafting large-scale industry reports, carrying out interviews and writing about innovation in payments and fintech are Mirela’s daily treats. As the Senior Editor at The Paypers, she speaks frequently with key thought leaders to identify trends and trendsetters. She can be reached at mirela@thepaypers.com via Linkedin and Twitter.
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