Trade Finance: An Introduction to The Key Challenges
Trade financing refers to the financing of the exchange of commodities, finished goods and raw materials. It is a centuries-old industry valued at more than $10 trillion USD. The trade finance industry hasn’t seen any significant change over the past decade despite the explosive global trade growth.
There are many parties involved in a typical trade transaction. Banks, shippers, importers, exporters, regulatory bodies and the customs officers. These parties each act as a key verification point on the supply chain. Each of them plays a vital role in completing the transaction and any fault at any of these verification points would cause a delay/complete voiding of a transaction. Each party faces different pain points in the trade financing process.
Trade financing today is still a very paper-based business. The absence of electronic and digital processing means that typically a trade financing transaction would rely on a long paper trail and hence a prolonged process of document exchanges. Typically this exchange of documents takes about five to ten days to complete, if not longer, and manual verification is required. Since each party across countries operates on different platforms, miscommunication is common and the propensity for fraud is high.
For both the financing party and the financier, this process is long and inefficient. For banks, the waiting of physical trade documents to be delivered and the verification of which is a time consuming process. This involves a lot of human effort. It also causes problems for the financing party as funding could be delayed if the delivery of the documents are delayed.
This could lead to a domino effect where the delay in document delivery would cause not only the delay in the disbursement of financing, but also the delivery of the physical goods. The exporter may also face a delay in the receipt of the final instalment of funds as multiple intermediaries need to verify that physical goods have been delivered to the importer as agreed prior to the disbursement of funds.
More serious problems could also occur in the event of fraud, where the same batch of goods is being financed multiple times with different banks who do not share the same information. Or, where certain trade documents are faked to obtain financing inappropriately.
Blockchain As a Solution
Blockchain technology could offer a solution for the problems in trade finance. Blockchain can replace the use of paper documents and ensure trust, security and overall transparency of the supply chain — thereby reducing processing time to a minimum level.
With the immutable and trustless nature of the network, the risk of manipulation by participating members of the network will also be minimised. In general, a peer to peer finance network which removes the intermediary party is going to increase the efficiency of facilitating trades directly between institutions.
Potential Key Steps to Blockchain Application
A simple illustration of how blockchain could be applied in the trade financing world:
Step 1
Once purchasing is done, the sales agreement between the exporter and importer is shared with the import bank through a Blockchain Smart contract. (Replacement of paper documents)
Step 2
The import bank will be able to review the purchase agreement and draft terms of credit in real time. (Save time)
Step 3
Upon review and approval of the payment obligation provided by the export bank, a Smart Contract will be created to cover the terms and conditions provided. (Save time)
Step 4
The Blockchain-based letter of credit will be verified and accepted by the exporter. This will be done within the Smart Contract and shipping of goods will be initiated. (Save time)
Step 5
Inspection of goods by third parties and the customs agent in the exporting country will be done. All agency involved in the inspection will then provide a digital authorization of approval on the Blockchain smart contract. (Instant tracking of the status of the goods)
Step 6
Goods will then be transported from point A of one Country to point B in another country.
Step 7
A digital acknowledgment will be made by the importer on the smart contract, upon goods delivery. Once done, payment will be initiated. (Faster disbursement of funds)
Step 8
The Blockchain will automatically make payment from the importer to exporter via a smart contract, once the acknowledgment is provided the importer.
A Few Illustrative Examples
A couple of different blockchain based platforms have already been developed and tested in real life:
1. Marco Polo https://www.marcopolo.finance/
Parties
The Marco Polo project is named after the famous Venetian explorer. The blockchain-based trade finance solution project is the product of collaboration with trade finance technology firm TradeIX, Blockchain consortium R3 and a network of financial institutions. BNP, Commerzbank, and ING were initially involved to explore how to deploy blockchain to enhance trade finance operations. The project was launched in September 2017 and has since then also included DNB, Standard Chartered, and OP Financial Group.
An expansion to include more third-party players was seen earlier this year. These third-party players include: logistics companies, credit insurers, and several others as they begin testing the solution.
The Solution
Marco Polo provides mutual benefits for financial institutions and their corporate clients and elevates the delivery and management of trade finance solutions. It is a joint undertaking with trade finance techno
The project has provided an effective solution for post-shipment trade financing. Marco Polo focuses on being an open-source, interoperable trade finance network, powered by APIs and blockchain technology.
In the early stages, the solution has focused on three distinct areas of trade finance:
1. Risk mitigation by the provision of payment commitments based on the matching of trade data:
2. Payables finance:
3. Receivables finance.
Pilot operations have been commenced by a group of major international banks and their partners in the blockchain ecosystem. The blockchain solution is looking to expand its association this year to include additional banks and third-party service providers such as Enterprise Resource Planning (ERP) and credit insurers providers and various logistics firms. As a result of this, the collaborative nature of the platform will be leveraged to create a fully interoperable open-sourced trade finance network.
2. We.Trade https://we-trade.com/
2017 started with some of Europe’s biggest banks forming a consortium with KBC’s blockchain prototype to promote an increase in trade across the continent by SMEs. The collaboration was aimed at commercialization and development of Digital Trade Chain (DTC), which is a cross-border trade finance platform based on distributed ledger technology in collaboration with IBM.
In 2018 nine big banks in Europe has taken a significant step by proving blockchain solutions to their numerous corporate clients. A legal entity under the name We.Trade was also created for the expansion of the Digital Trade Chain platform. This joint venture has 9 equal shareholders which are HSBC, KBC, Natixis, Deutsche Bank, Nordea, Santander, Société Générale, Rabobank, and Unicredit.
During the first stages of the project, eleven countries will be covered including the Netherlands, Norway, Spain, Belgium, Finland, Italy France, Germany, Denmark, the UK, and Sweden.
We.Trade solution is powered by the Hyperledger Fabric blockchain framework. It is designed with the goal of being a platform for tracking, managing and protecting trade transactions amongst SMEs.
The platform will work by connecting all participating members of a trade deal which includes the seller, buyer, seller’s bank, buyer’s bank and transit operators on a single network (online and via mobile devices). This will greatly increase the rate at which new trading relationships are initiated by SMEs, and also make access to trade finance easier.
The We.Trade app will document every stage of the trading process; right from the point of order to shipping and payment. This information will be displayed in the form of a flowchart for easier understanding and payment initiation is assured upon the meeting of the contractual agreement by all parties involved in the transaction.
The 24/7 availability of the platform and its full automation makes the payment chain much shorter, effective and quicker than the traditional documents exchanging processes. Far less back-office administration is also required.
The nine equal partnering banks and their huge networks of SME clients who must have already undergone know-your-customer (“KYC”) and anti-money laundering (“AML”) checks with those lenders and so are known and permissioned entities, will be allowed onto the DTC platform.
It will also bring in logistics companies using the latest track-and-trace technology to verify the arrival of goods in agreed condition at key points in the journey from supplier to buyer that will then trigger payments automatically.
In its next stage, which is fixed to go live this summer, We.Trade is going to be expanding its services to other markets in Europe and outside the continent, by taking on new banks to its platform. As the platform grows and expands, it is expected that port authorities and national customs departments at some point might become nodes on the network, but for now, it will depend on logistics companies to be the key network participants.
