Global Trade Rewired: Exploring Blockchain Trade Finance Platforms

How Blockchain Technology can Build the Global and Dynamic Trade Finance Platforms of the Future

A few weeks back we had a look at how blockchain can redesign global supply chains. In this closely related post, global trade rewired – exploring blockchain trade finance platforms, we take a deep dive into the broken state of trade finance and investigate how blockchain can build the dynamic trade finance platforms of the future.

Trade finance is a centuries-old industry that has played a pivotal role in the creation of a competitive and productive global economy.

But legacy trade finance platforms built on old world technologies are rapidly proving ill-equipped to handle the globalized nature of the economy and increased speed of trade flows.

There is now an acute need to streamline trade finance to drive efficiencies, reduce costs and enable the proliferation of trade in emerging economies.

It’s a complex world out there.

As supply chains have grown more intricate, often spanning hundreds or even thousands of stages and dozens of geographical locations, the financing of trade has become more risky and cumbersome.

Beyond the challenges stemming from the geographically dispersed nature of supply chains, rising customer expectations for cheap and customized products delivered on demand require companies to be more time and cost-efficient in every way.

Securing quick access to trade finance is now one of many challenges businesses must overcome. But financing has been made more difficult by the continuing fallout from the 2008 financial crisis as banks de-risk.

According to an International Chamber of Commerce (ICC) survey of 357 respondents located in 109 countries, global trade had yet to recover from pre-financial crisis levels in 2008. 2016 was the fifth consecutive year of world trade falling below 3 percent. 61 percent cited a global shortage of trade finance as a major issue.[1]

The absence of trade financing is especially acute in developing nations where many entrepreneurs are unable to start businesses and established companies remain unable to grow.

“SMEs in developing economies – given their opacity, lack of collateral and audited financial statements, are considered as high risk by banks.” [2]

What’s driving this?

The shortage of trade finance is primarily due to risk and the complexity and high costs associated with regulatory compliance, which today can span across diverse regulatory jurisdictions in multiple regions.

Anti-Money Laundering (AML) and Know Your Customer (KYC) compliance has become a debilitating pressure on financial institutions, resulting in many organizations scaling back their operations due to risk. In some emerging markets, banks have withdrawn their services altogether due to regulations like Basel III.[3]

“Sanctions have now become a political weapon in foreign policy, leading to trade finance business coming under increased pressure from increasingly stringent compliance and regulatory requirements. Both financial institutions (FIs) and corporates must ensure they have the necessary solutions and processes to enforce embargoes, whether they are imposed on countries, FIs or goods. Sanctions are an integral part of foreign policy and as regulations tighten, countries are moving towards a zero-tolerance policy for FIs that contravene them.” [4]

According to the Asian Development Bank, there is a gap of as much as $425 billion in trade funding in Asia alone.[5] A massive market made up of millions of micro, small and medium-sized enterprises has yet to be tapped into by trade finance providers.

The failure to provide trade finance for SMEs is inhibiting economic growth in the developing economies of Asia and preventing global economic growth, as Asia increasingly becomes the world’s main growth engine.

Old world trade finance processes are full of inefficiencies

Inefficiencies are ingrained in every part of today’s opaque supply chains. This makes trade finance complicated, risky and cumbersome.

Here is a summary of the main pain points –

Multiple parties and legacy systems = an inefficient and costly process

As supply chains have become more complex and globalized, the number of parties involved has increased. From the importer, exporter, the importer’s bank, the exporter’s bank to shipping companies, receiving companies, insurers, and other service providers, mass amounts of paper documents must flow through a tangled web at each stage.

All this paperwork must be checked and confirmed by each party to ensure accuracy as well. Manual transaction processing of complex ownership and transfer related documents by multiple intermediaries through a range of communication points is time consuming, costly and often results in a delay in the shipment of goods.

 

“A dizzying number of manual checks must be carried out to verify the legitimacy of a client, its trading partners and the goods that change hands. Most checks require the physical presence of a person, and the administrative work conducted by bank middle offices is overwhelmingly paper-based. The high cost of this process restricts access to trade finance for smaller businesses and especially those in developing economies whose credit-worthiness is difficult to establish.”

[6]

Intermediaries are heavily relied on throughout the trade finance process as the trustless environment demands third parties to verify the delivery of funds to the appropriate entities.

Making things even more challenging is the utilization of disparate and siloed recordkeeping systems by each party. Miscommunications are common and significant version control challenges exist as changes get made to contracts and other documents.[7]

Minimal transparency and traceability increase the risks of fraud

A lack of transparency and traceability caused by fragmented and siloed record keeping infrastructures means trade financing can be used to hide the illegal movement of funds.

From the misrepresentation of prices, quality or quantity of goods to faking the existence of a product altogether, fraudulent activities are easy to disguise.[8]

 

“Because there is no common platform for banks to screen transactions financed by other banks due to confidentiality concerns, there is a possibility that customers may capitalize on this information-sharing gap to obtain financing from multiple banks using the same invoice.”

[9]

With separate and siloed infrastructures housing vital information like invoices, contracts, approvals and previous financing transactions, duplicate invoices are hard to detect, and any malicious activity is difficult to identify.[10]

Unable to gain a complete picture of internal processes in real-time, companies and the financial institutions have limited capabilities to investigate fraudulent activities efficiently.

Regulatory compliance and reporting is a constant drain on resources

Financial institutions that offer trade financing services must complete several compliance steps as a part of the onboarding process for new clients.

These steps which create significant time and cost delays include the collection, validation, and verification of key documents such as proof of identity, proof of address, proof of business registration and many others.[11] [12]

The introduction of stringent regulations like Basel III is forcing financial firms to dedicate more resources to compliance than ever before and placing enormous burdens on them.

New regulations also necessitate intensive reporting of counterparty exposures and transactions by companies and the maintaining of accurate records to be audited by the regulators. Due to disparate legacy systems, paper-based documentation processes and siloed record keeping, the aggregating and assessing the large volumes of data for reporting is difficult and a constant drain on resources.

“Until fairly recently, compliance in trade finance was limited to the examination of documents. Nowadays, added to this is extensive screening – against multiple country lists – of numerous data elements embedded in ancillary documents, regardless of their role in the letter of credit (LC) and international guarantee. The traditional view that the main risk within trade finance is one of fraud has been superseded by a modern three-part categorisation of risk – namely embargoes; terrorist financing (including fraud); and sanctions/proliferation financing.” [13]

Regulatory and compliance challenges have been exacerbated by the global nature of trade and the increase in both volume and speed of international trade flows.

Using blockchain trade finance platforms to transform the financing of trade

Efforts to improve centuries-old processes that sit at the heart of trade finance have failed to provide the necessary reforms.

“There still exists a fundamental divide between vital business information, like invoices and trade contracts, and the financial transactions that need to be executed by banks and other institutions to complete the transaction. At the end of these processes remains a herculean effort to reconcile the business logic and related documents with the financial transaction.” [14]

Unlike most ‘technology wrapper’ solutions, blockchain is no band-aid fix.

It’s the real deal.

The technology’s promise lies in its ability to remove the cause of almost all the pain points within trade finance.

By replacing rigid, siloed and insecure centralized trade finance systems with a unified IT and record keeping infrastructure, blockchain technology provides trade parties the ability to track and immutably record the movement of goods and information across entities on a shared ledger. [15]

The manually intensive and paper-based processes which have opened trade finance to human error, fraud and settlement delays are eliminated as all documents are digitized and stored on an unchangeable ledger.

By digitizing documentation like contracts and invoices and storing them on a unified ledger, it becomes safer and more efficient to move documents around between parties.

 

“We’re moving pieces of paper around, moving information between banks and other players in the supply chain, and that is where we will see lots of efficiencies created as a result of blockchain.”

[16]

Storing all ownership documentation and transaction records on a single and immutable ledger that is accessible and visible to all entities also stops the need to manually check document changes and share data other parties which have traditionally taken a considerable amount of time.

With a blockchain trade finance Platform, there is no need to store copies of the same document on numerous databases across various entities. Fixing needless errors, duplications and reconciling data sets across geographically dispersed parties is no longer necessary.

Beyond these game-changing benefits, companies, financial institutions, and government regulators can also gain granular traceability and auditability into the trade financing process as blockchain enables real-time, system-wide visibility into a single source of truth.

A quick note on privacy in blockchain trade finance platforms

Privacy and confidentiality are vital considerations when it comes to solutions for trade finance and other financial services as well.[17] It’s understandable that many trade finance professionals may be wondering how privacy is protected in a shared ledger system.

 

“The challenge of maintaining Chinese walls or data privacy among counterparties to trade transactions could be overcome by utilising tokenisation as a form of cryptography, whereby parties are only allowed to access permissioned information.”

[18]

Due to privacy-related considerations, permissioned blockchains are likely to see faster adoption as issues of this nature are more easily resolved within a consortium of known parties. Private or consortium blockchains, can restrict access to information and deliver members of the network greater control over privacy.

Trade finance is ripe for automation

Blockchain enabled smart contracts have the potential to make transformational improvements in trade finance.

When run on a blockchain, smart contracts become self-executing contracts where contractual enforcement, rights, and obligations, performance, and payment are automatically executed by an autonomous system that’s trusted by all signatories.[19]

Smart contracts can end the reliance on costly and inefficient intermediaries and eliminate many of the manual and paper-based processes involved in trade finance like letters of credit and structured commodity finance as well.[20]

“For example, various inputs can be collected on a blockchain platform to automatically execute the release of funds or transfer of digital assets (such as receivables) based on smart contracts.”

“This process allows for a qualitatively different approach to trade that has the potential to marry information, transactions, trade contracts and business logic to provide automated digital asset transfer alongside real-time settlement.This idea, taken to its logical extreme, could mean truly automated supply chain and financial operations between businesses (and even machines) with no-touch straight-through processing.”

[21]

With secure, tamper-proof digital trade documents available to all parties, fraud and other execution risks can be reduced or even eliminated as the immutable and programmable nature of a blockchain enabled smart contract prohibits manipulation and nonperformance.

Just imagine a blockchain trade finance platform that tracks goods and automatically releases payments as these goods move around the world? An automated trade finance platform.

Realizing a new inclusive digital era of trade finance

Blockchain trade finance platforms have the potential to solve debilitating inefficiencies in trade finance.

The technology is uniquely qualified to replace the outdated, siloed IT systems and paper-based processes which facilitate the exchange of data and serve as the backbone of trade finance workflows.[22]

By digitizing the entire trade finance process from order to settlement and bringing all the participants to a single platform, blockchain technology transforms trade finance into a more efficient, less complex and risky process.

 

“Blockchain technology continues to show the greatest potential to streamline trade finance and maximise the value it delivers to business and financial institutions alike.”

[23]

With many of the inefficiencies, risks, and complexities taken out of the trade finance process, financial institutions can begin to address the financing gap experienced by small and medium enterprises (SMEs) in Asian emerging economies and around the world.

A shortage of trade finance which has inhibited business growth and slowed financial inclusion can finally come to an end as the risks, complexities, and costs associated with the provision of finance are almost eradicated altogether.

“Small and medium-sized enterprises (SMEs, i.e. companies defined as employing 250 or fewer workers) constitute the vast majority of companies registered in both developed and developing countries. Their role in economic activity, generating growth and innovation cannot be overstated. According to the World Bank, SMEs contribute to over 60 percent of total employment in developed countries and 80 percent in developing ones, including the estimated informal sector.” [24]

New and dynamic blockchain trade finance platforms have the potential to provide millions of micro and small businesses access to trade financing as improved efficiencies and risk assessment abilities give financial providers the ability to offer more affordable financing terms.

Trade financiers gain access to previously inaccessible revenue streams, new trading relationships are initiated and unprecedented economic growth can be unlocked.

Progress has little to do with technology

When it comes down to it, realizing a new digital era of trade finance through the utilization of blockchain has little to do with technology.

Legal and structural challenges need to get resolved if blockchain trade finance platforms are to become a reality. This will require unprecedented inter-industry cooperation, industry-government partnerships, and the development of new paradigms of understanding.

This will not be easy.

Governments must begin to understand blockchain technology on a deeper level and start to build new regulatory frameworks.

Without updated regulations alongside the introduction of blockchain based trade finance platforms, the impact will be minimal.[25]

“The extent to which this new technology realizes its potential will depend in substantial part upon how well stakeholders steward its development. There remain important open governance questions regarding both the functioning of the technology and its current and potential applications.” [26]

Major players in the trade finance industry have already begun to build blockchain trade finance consortiums of mutual interest.

IBM has been chosen by a consortium of seven of Europe’s largest banks to construct and host a new trade finance platform. The platform is designed to simplify trade finance processes for small and medium enterprises in Europe by addressing the challenge of managing, tracking and securing domestic and international trade transactions.

“Consortiums make sense because the success of shared ledger and blockchain technologies requires significant levels of market participation, collaboration, and investment.  The consortium is less about a technology solution or a particular business model.  It’s more about how companies who haven’t been able to trust each other in the past can come together and collaborate and share information.” [27]

With enhanced and efficient trade finance processes come far-reaching benefits.

These go beyond the game-changing advantages delivered to the providers of trade finance. The effective use of blockchain based trade finance platforms will also lead to the realization of greater levels of financial inclusion for millions of people living in developing economies.

The flow-on impact for global economic growth will be unparalleled.

If you like this article on blockchain trade finance platforms, discover how blockchain technology can transform identity, global supply chains, insurance, compliance, civil services and national healthcare systems.

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Realizing the revolutionary nature of blockchain technology and the existence of a significant knowledge gap among entrepreneurs, industry, and government, Anthony now concentrates his time on creating educational content, researching potential use cases and analyzing the impact of the technology on global industries.


Also published on Medium.