Trade Finance Transformation: The multi-billion dollar opportunity

The past few years have emphasised the importance of efficient global trade, and how easily supply-chain disruptions can negatively impact countries, industries and general day-to-day life. The fundamentals of trade revolve around supply and demand, but what we often don’t consider are the intricacies associated with funding, executing and fulfilling trade obligations.

The global trade finance ecosystem is characterized by an interconnected network, ranging across international governments, regulators, banks, insurers, logistics firms, port authorities, buyers and sellers. Inherently, there exists a requirement for reliable technology, processes and governance to be in place, to enable factors such as contract development, transactional efficiency, compliance and security – sounds like a solid pitch for Blockchain (or distributed ledger technology, if we’re being careful with wording). If you’ve got a spare hour, the following video depicts the current state of the ecosystem and future trends:

https://youtu.be/DsSzQfejwMk

When we refer to the interconnected network, it’s important to note that technological maturity and funding availability of stakeholders varies widely. The digital acceleration towards automation, optical character recognition, advanced analytics and blockchain platforms such as R3 Corda, has the potential to leave-behind those who can’t afford to participate and hence creating digital islands.

Ultimately when investing in trade finance related technologies, firms must consider network-facing, front and back-office touch points – an expensive and complex caper. Digital islands, technological complexities and inclusiveness have been described as the some of the key reasons why digital transformation has not scaled within trade finance. However, the benefits associated with blockchain network effects (for example) may support in building a solid foundation, to scale a multi-year transformation across bank-intermediated (traditional) trade and intercompany (open account) financing.

1. So, what does the ecosystem look like?

The topic isn’t one you can briefly glance at and get the gist. Logically, it’s beneficial to break down the complex ecosystem across networks, solutions, rule makers and encompassing technology.

Networks: this refers to the market-facing trade finance software, that brings together groups of geographically dispersed stakeholders, on a privatised and secure platform. Leaders in this space consist of Marco Polo, Contour and Komgo– each of which have been capitalising on blockchain innovation (via Corda and Quorum).

Solutions/Instruments: consist of how trade finance is facilitated and the technological solutions that support in its execution, across traditional and open account financing. Tying back to blockchain fundamentals, you’ll notice the pattern continually involves contracts, communication, trust, transparency, speed and security.

Rule Makers: a relatively dry consideration but an important one nonetheless, stakeholders including the World Trade Organisation, USITC and the International Chamber of Commerce set the rules of the game and intentionally/unintentionally stifle innovation. These are layered by international, national and regional; sprawled across legislation to cover fraud, taxation, financial crime, consumer protection, ethics, foreign exchange etc.

Banks and Insurance: The Bank of International settlements (2014) estimated that the top 40 global banks facilitate over 30% of global trade finance. Perhaps this is contributed to by their global presence and geographical positioning, the leaders in facilitating trade finance (and innovation) vary between Citi, HSBC, ING, Standard Bank, Bank of America, Santander and BNP Paribas.

What we begin to see, is that international trade and financing is far more complex than relationships between a buyer and a seller; and changes have a wide-spanning ripple effect that could potentially harm a supply chain.

2. What are some of the core pain points?

Based on the multitude of considerations associated with the trade finance sector, to stand back and point out inefficiencies and problems wouldn’t be difficult. The real exam question might be – which areas make sense to be addressed first, who is already doing it and what are the anticipated benefits?

Lack of Inclusion and rejection (sounds familiar)

McKinsey has valued the global trade ecosystem at ~$5.2 trillion in 2021, or ~$5.6 trillion as of 2023 if we account for recent inflation. This figure could be greater, if there was an improved rate of inclusiveness for contributors in developing nations and SME’s. A World Bank study conducted in 2017 determined that 65 million SME‘s globally, were restricted by their credit availability and an overall 40% of SME’s were rejected financing – as opposed to only 7% for multinational corporations (WTO, 2019).

Further, figures provided by the WTO stipulate that Africa accounts for ~2.14% of global trade and developing nations within Asia account for 12.5%. This is a key example where if a strategic approach were to be taken, encompassing international governance (to set and monitor targets), technology enablement (to provide the accessibility/efficiency) and amended processes (to enable lesser sized firms to partake), significant transformation efforts could be made to open up the trade economy and flow of cash. If we suggest that there exists a $900bn opportunity across these developing nations, this could be a time for fintech’s and Web3 to step up.

Legislation lagging behind technology

Nearly all documents associated with international trade are still generated and supplied in paper form (UK Law Commission, 2022). We all know the hassles involved with printing, completing, scanning, sending and editing paper-based documents – it is important to pinpoint this as a significant driver for trade finance inefficiency.

If we take a letter of credit (LC) as an example, governed by the International Chamber of Commerce’s Uniform Customers and Practice for Documentary Credits (UCP 600), they set the terms to be followed; the global trade network then must comply with these terms or risk disruptions, sanctions and penalties. An on-going grey area is the amendment of terms to allow for e-documents, rather than existing manual processes. The ambiguity between e-documents vs. paper-based, is enough for parties to stick with the tried method of scanning and sending - which is understandable, but increases efforts associated manual intervention, error and labour costs.

The UK has taken the initiative to drive digital documentation, and open the floodgates for technology firms to support in letter of credit efficiency uplifts, through introduction of the Electronic Trade Documents bill (2022) – which supports in guiding LC's to wide-scale digital transformation. The ICC estimate that digitisation of trade documents could generate $25bn of economic growth by 2024 and incur cost savings of ~$220bn (UK Law Commission, 2022).

Lack of incentive and ownership

After reading countless articles on the subject, there is no doubt that there’s a multi-billion dollar opportunity for governments, banks and consultants to capitalise on trade finance transformation; there’s no point in suggesting that this is being driven solely to enable SME’s and developing nations. Yes, if we were to standardise processes, implement inclusion programs and utilise new technologies – a side-effect may be that SME’s would gain access to funding, where they may not have been previously.

3. A case for change; who’s doing what?

Digitised Letters of Credit - HSBC

Who: HSBC has been in the media in recent years, as one of the leading finance providers in the global trade ecosystem. They’ve also been frontrunners in their collaboration with blockchain provider R3 and Contour trade systems, to not only establish and grow their trade network but to digitise the highly controversial topic of paper-based letters of credit.

What they are doing: aside from being technologically strategic, planning for the future of trade and gaining exposure to different tiers of customer in their network e.g. Tier 1. seller, Tier 2. associated suppliers, Tier 3. raw materials providers, they have been realising benefits of digitised LC’s. Since 2018, HSBC have executed over 20 transactions across different countries and financial institutions, via the Contour platform – saving millions.

How they are doing it: By partnering with Contour, gaining access to the R3 Corda blockchain and opening up to fintech API’s, they have begun to transform the way they execute trade finance activities. From LCs, to bills of lading and customer acquisition/profiling; true network effects are beginning to be seen. Key partners in the Contour network consist of Citi, BNP Paribas, Standard Bank, Bain, R3 – the digital transformation relationship between technology, banks and consultants is already well underway.

Anti-Fraud and Due Diligence – DBS, Standard Chartered

Who: An array of stakeholders in Singapore are tackling fraud in trade finance, through forming an alliance across banks (DBS, Standard Chartered), the Singapore Trade Finance Registry (TFR), Enterprise Singapore and blockchain provider dltLedgers.

What they are doing: In response to highly publicised instances of fraud e.g. ZenRock, banks and governance committees in Singapore worked to develop an anti-fraud solution, which focuses on enhanced due diligence efforts, and removal of the duplication and false signage of documents, being used to obtain finance/secure payment for trade services. In commodities trading for example, fraudulent claims that goods were delivered – when they were not, could initiate payment and leave the buyer out of pocket, without their goods.

How they are doing it: By forming an alliance across national governing bodies, banks and technology providers, there is better assurance of transparency, standardisation, compliance and security, to address a growing issue of fraud.

Summary

The trade finance sector is financially lucrative for most stakeholders involved, aside from the buyers and sellers. Due to a variety of complexities including lagging legislation, legacy technology, lack of inclusion, limited incentives and disjointed global communications – there is a distinct opportunity for efficiency enhancements, which may or may not include blockchain. (Don’t fool yourself, it will include blockchain).

The Singapore case of micro-transformation at a national level, makes sense from a manageability perspective; they’ve determined a core problem (fraud) and rather than waiting for the industry to catch up, they’ve embarked on their own transformation and included all relevant industry bodies.

It could be argued that rather than waiting for a complete industry overhaul, countries should look to improve where they can – by partnering with leading governing bodies, consulting firms, banks and technology providers and pursue their own agendas…in line with global guidance.