The longer a transaction chain, the greater the cost, complexity, and risk of errors and missteps. The vast transactional chains of the financial industry are the livelihoods of many providers, but do not benefit the end users.
Challenges in Trade Finance
Trade finance is a notoriously cumbersome process dominated by intermediaries. It has made little progress in terms of automation. Settlement can take weeks depending on the jurisdictions involved, and the process is often opaque. This opacity can lead to oversights and duplications in the authorisations of instructions for remittances, verifications and approvals.
Trade finance involves many intermediaries outside of the financial services industry, including customs agents, health and safety inspectors, and transport groups. It is often contingent on unique rules and mechanics across different countries, at conflicting levels of development.
Analysis by the Organisation for Economic Co-operation and Development (OECD) estimated 15% of the overall value of traded goods comprised of hidden costs, much of it a result of manual processes. The OECD added this translated into losses of $100 billion per year. At a time when revenues are under significant pressure, this is a huge sum.
This lack of automation is not only inefficient, but puts organisations at risk of fraud, or unwittingly failing to spot criminal transactions. In an era where banks and other corporates have been slapped with record fines for sanctions breaches or substandard anti-money laundering protections, trade finance is an area where vast improvements need to be made if regulators are to be kept at bay.
Criminals are increasingly sophisticated, and adept at forging documentation to facilitate money laundering activities. While banks and financial services have made inroads in other areas of fraud detection, trade finance lags behind. Its operational flaws urgently need correcting. Blockchain is playing a meaningful role in addressing them.
Blockchain in Trade Finance
So how can blockchain address these issues? A report by the European Banking Association (EBA) acknowledges the important role blockchain can play in automating trade finance. This would eliminate manual processes, duplication, and other paper-trails. The real-time settlement and reporting characteristics of blockchain would also hasten transactions in these complex supply chains, and scale down costs through digitisation.
Transparency and risk mitigation are key. Banks’ risk analytics will be improved by having a digitised record of trade financing transactions that cannot be tampered with, and which is stored in real time. Such a system would make it easier to monitor payments and the transportation of goods. Automation will also reduce human error, and potentially facilitate standardised practices and processes across diverse markets. The legal and administrative paperwork long associated with trade finance could be significantly reduced through the use of smart contracts.
Smart technology can also help banks in their fight against money laundering and other criminal activities. They can be deployed to identify fraudulent or suspicious transactions throughout the chain. Such tools will be vital given the underlying complexity in global supply chains and trade financing activities.
The technology is already being beta tested by a number of financial institutions. Deutsche Bank, HSBC, KBC, Natixis, Rabobank, Société Générale and UniCredit are cooperating and helping to build a blockchain platform — “Digital Trade Chain” — to streamline trade finance processes. A statement from the consortium said the platform would simplify trade finance processes for SMEs by addressing the challenge of managing, tracking and securing domestic and international trade transactions.
The statement acknowledged large corporates often utilised documentary credits to reduce business risks, but this was not always suitable for SMEs or companies that prefer open account solutions. The platform, it said, would accelerate the order-to-settlement process and curb administrative paperwork, and provide total transparency. Other providers are experimenting with similar blockchain concepts.
However, before blockchain can be widely accepted in the trade finance world, two things need to happen. Firstly, a common blockchain standard and platform allowing total interoperability must be created. Secondly, regulators must accept blockchain. Fortunately, there is significant regulatory support for blockchain concepts in major economies, but this cannot be taken for granted in all markets.
Blockchain will become mainstream in trade finance, but we must be patient.
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