Many businesses have to deal with export and import transactions. Banks have long played an important role for corporations as well as small and medium enterprises in facilitating and mitigating risk between buyers (importers) and sellers (exporters) through trade finance.
A letter of credit (L/C) is an example of a trade finance product. Basically, if the contract between an importer and exporter is validated and fulfilled, a bank will guarantee that the exporter will receive payment after delivering goods.
However, trade finance is riddled with complications and inefficiencies. There are many parties, many processes and many problems that can overwhelm the parties involved. Besides exporters, importers and banks, shipping companies and government authorities such as customs and port authorities enter the picture.
Piles of documents need to be handled and dozens of procedural steps followed across multiple parties. For example, banks have to review the contractual agreements of both importers and exporters to be certain that the correct amount of money will be transferred once the obligation has been fulfilled.
Among the potential threats to a successfully completed transaction are duplicated, erroneous or forged invoices and bills of lading (B/L), a proof-of-ownership document required to claim a shipment, making it difficult for banks to verify authenticity.
All of these inefficient processes underline the lack of transparency and possibly lead to fraud and disputes.
For instance, in 2014 Standard Chartered Bank had to write off US$193 million after a Chinese metal warehouse company committed fraud by using multiple invoices for the same metal stockpiles many times.
How a blockchain can help
Blockchain can be defined by four letters DDCC: Digital, Distributed, Cryptographical and Chronological. It can be thought of as a digital ledger, which is distributed and cryptographically recorded among parties in chronological order.
In other words, all parties — importers, exporters, banks, customs and port authorities — have to agree on each process and each ledger in order for the subsequent process to proceed.
Think of each process as a block. Each block is linked to the others after all the parties confirm their consensus until it becomes a chain representing the entire process, or a blockchain. The order cannot be changed or deleted since all the agreed information is kept with each party and is traceable.
How will the blockchain improve international trade? Blockchain offers opportunity for trade finance in terms of distributing check-and-balance verification among all related parties, and can be traceable. This will eliminate the possibility of fraud, and reduce operational risk, which can reduce operational and credit costs.
The problem of duplicated invoices and B/L is eliminated since all records will be stored on the blockchain platform. Therefore, banks can easily verify information across all exporters and shipping companies. Exporters will be happier since they get more cash faster. Importers potentially have a more efficient way of confirming that their goods have been delivered safely.
Widespread adoption of blockchain in trade finance will depend on two key enablers: smart contracts and instant payment infrastructure. With the proper legal stipulations in place, a smart contract would automatically disburse payment once a triggering event occurs, such as an importer presenting a B/L to a bank. Beyond that, instant payment infrastructure enables shipping companies, and exporters have quicker access to funds, which potentially optimises liquidity in their businesses.
Blockchain technology is already being applied in trade finance in some countries, notably the international trade hub of Singapore. In December 2015, Standard Chartered Bank and DBS Bank cooperated with the Infocomm Development Authority of Singapore (IDA) on the world’s first trade finance platform based on blockchain, called TradeSafe. It gives participants the ability to track the status of invoices across banks while preserving client confidentiality.
As well, the IDA, Bank of America Merrill Lynch and HSBC have developed a trial platform for monitoring L/C among related parties and executing trade processes automatically through smart contracts. And last week, R3CEV, a think-tank representing a consortium of leading financial institutions including Barclays and JPMorgan, launched the Corda trade finance platform with smart contracts.
Blockchain applications for trade finance have arrived on a global level. Some global banks have already joined R3CEV and it is only a matter of time before Thai banks join the consortium. Sooner or later, the application of blockchain will become widespread in trade finance.
Corporations and SMEs alike will benefit from this innovation, which potentially reduces cost, improves security and decreases documentation errors. This will simplify export and import transactions and provide on-demand tracking and reconciliation.
Furthermore, by adopting electronic tracking systems rather than manual document handling, government authorities such as the Customs Department and Port Authority of Thailand can also reap the benefits of streamlined processes and decreased corruption.
The business of moving commercial goods around the planet represents billions of dollars in enterprise revenue—as well as losses and inefficiencies resulting from risk, fraud or anachronistic manual paperwork delays. The good news is that few sectors are poised to so dramatically benefit from the advent of blockchain-based solutions. Given the size of the investment involved, potential efficiencies stand to be monumental.
After a drop-off following the financial crisis of 2007/2008, international trade volumes have been increasing steadily, bringing the infrastructure and mechanisms that underpin the actual business transacted – supply chain management and trade finance – under increasing scrutiny, because of the processing delays and related risks involved.
Supply chain management refers to the structures and processes that guide the flow of goods from raw materials to the delivery of a finished product to an end consumer. Generally this involves a number of different companies, each focused on a step in the chain such as processing and manufacturing, inventory management or quality control.
The combined steps of the overall chain of activities result in the final supply of the product – and by the time the chain is complete, a number of physical and financial transactions have taken place.
But the business of global supply chain management is far from perfect. Transactions often involve manual paper (and unstructured electronic) transfers of records (purchase orders, invoices, bills of lading, customs documentation, certificates of authenticity and makeup) that accompany physical goods.
Keeping track of the ownership of physical goods and inventory at each step, along with the corresponding paper flows, can be a major undertaking, especially with manual processes that are subject to human error, loss, damage and even theft and fraud.
Blockchain-based solutions to both physical and financial supply chain issues are being proposed by a number of startups. Vendors in the physical supply chain space include CargoChain and Everledger, which is focused on ensuring authenticity and minimizing fraud in the international trade of diamonds (and also, more recently, fine art). Blockchain immutability, together with the transparent, multiple-party access it provides to the same shared ledger, are seen as key functional attributes to improving efficiency in the supply chain process of tracking the changing ownership of goods.
As goods pass from seller to buyer in the supply chain, so monetary payments are required. Enabling these transfers to take place, and ensuring that companies are paid faster (against a backdrop of higher credit costs and corporate priorities for increased cash flow) is facilitated by financial services companies, whose mechanisms for this are commonly referred to as either supply chain finance or trade finance. Managing supply payments against invoices and related cash management can be a burden, and increases greatly in complexity when transactions are across national borders, involving correspondent banks as intermediaries.
Trade finance processing has historically been supported by offerings from vendors such as Misys, SAP and Surecomp, and implemented by traditional banks as a service to their corporate customers.
A common trade finance offering provided by banks (and increasingly by alternative financial services providers) is known as factoring, and involves a bank paying the seller of goods before the buyer of those goods makes the payment. Naturally, banks charge rates (typically 4 percent to as high as 8 percent) to the supplier for this service, but assume the risk that the buyer delays payment or even defaults. Despite that protection, factoring is a costly undertaking for suppliers, eating significantly into margins and introducing an element of insecurity to the payment picture.
For all parties, factoring involves multiple risk factors including nonpayment, duplicate payment, misrepresentation and even fraud. And setting risk aside, processing costs related to manual due diligence, document collection and coordination of remittances are high.
However, blockchain approaches are also being proposed to boost efficiency in this area, with developments from the likes of Skuchain and Fluent.
“Currently, bank-run trade finance programs require a tremendous amount of resource-intensive due diligence, document collection and processing, including coordination of remittance information.
Financing rates are high for the businesses despite the low and shrinking margins for the financing provider. This is especially true at smaller banks who lack this infrastructure and must outsource these services for their larger clients,” notes Lamar Wilson, CEO of Fluent.
Founded in 2014, Fluent offers a number of blockchain-based services for banks, other large companies and non-bank lenders. These include applications for real-time B2B payments, supply chain finance and a peer-to-peer working capital marketplace.
By leveraging purpose-built blockchain technology in its Fluent Network, the vendor is able to improve upon current trade finance in a number of ways:
- – Invoices can be tokenized once a buyer approves them, avoiding duplicate and fraudulent invoices across the network.
- – Such approved payables can be split up and sold in a variety of ways, including incrementally, in a multi-lender marketplace. Lenders can purchase parts of invoices to reduce risk, lowering the cost of capital to the supplier.
- – There’s no more need to track and coordinate remittance information. The blockchain immutably captures the data attached to each invoice, allowing a buyer to easily pay without needing to know who owns the invoice.
“On the Fluent Network, finance providers are sure the risk associated with duplicate and fraudulent invoices is mitigated by the tokenization of each invoice, creating a digital asset that can be transferred between markets, partially financed by multiple parties and grouped together to create new assets,” notes Wilson, adding: “Payments are programmatically tied to each invoice so buyers do not have to collect additional remittance information and can simply pay the invoice directly on the Fluent platform no matter who owns the assets across the globe.”
Since its founding, Fluent has raised $2.5 million in financing from a number of sources, including ff Venture Capital, Digital Currency Group, Fenbushi Capital, Crosscut Ventures, Lindbergh Tech Fund, the St. Louis Arch Angels, Draper Associates, Thomson Reuters, 500 Startups, UMB Bank, SixThirty and others. The company also recently announced Kansas City, Missouri-based Commerce Bank as a pilot user of its services.
Information and media giant Thomson Reuters’ investment in blockchain is driven by a desire to understand the technology and its potential real-world applications. According to a blog post, the company is working on “delivering a couple of early proof-of-concepts to test the effectiveness of blockchain on Thomson Reuters use cases. We are in the game to be a leader and trusted advisor to our customers about blockchain, and to develop real applications as this technology matures.”