Solving the trade finance conundrum –

Alfaro Recoba

The Metropolitan Museum of Art in New York holds a series of Babylonian clay tablets from Mesopotamia. Dating from anywhere between 300 and 3000 BCE, these relics show promissory notes and letters of credit for everything from fruits to silver. Trade finance has been fuelling global trade for most of human civilisation.

While the industry has moved on from clay tablets, today’s environment still operates within what seems to be an antiquated framework – one that is fragmented and often paper-based. The idea of digitising much of the processes behind the moving ecosystem of corporations, shipping companies, merchants, banks and regulatory authorities has been a top topic for quite some time. But the very nature of trade finance means that digitisation would require a massive worldwide mindset change, rather than solely a technological change. 

Futuristic solutions

Emerging technologies that are often touted as a solution to global trust and identity issues, such as blockchain and distributed ledger technology (DLT), have failed to offer a viable scalable solution so far. However artificial intelligence (AI) and optical character recognition (OCR) technology play a large role in many banks’ digital strategies to support trade finance. 

Trade documents themselves are very complex. “For example, a single bill of lading can have thousands of different data points,” says James Binns, global head of trade and working capital at Barclays Corporate Banking. “Additionally, for a single shipment, documents are often issued by multiple parties across different countries, such as shipping companies, inspection agencies and customs agencies, as well as buyers and sellers. Interoperability is therefore a key barrier from two perspectives: technical interoperability and legal interoperability.”

All of this makes digitising trade finance an arduous task. 

In 2020, the International Chamber of Commerce (ICC) laid out a roadmap for digital trade in financial services. The organisation described the current state of global trade as heavily paper-based, with limited access to finance, relying on outdated laws and operating in a world with an absence of standards. 

It laid out four goals that the industry should strive towards over the next five years. Banks should aim for more automation that will enable faster, more efficient clearance processes, including in trade, reporting, know-your-customer compliance and customer requirements. Finance must become cheaper, allowing for more inclusion and bringing small and medium-sized enterprises into the global trade environment. Global legal frameworks need to become aligned to allow for the universal handling of electronic documentation and the use of trusted data governance principles. And finally, technology platforms and cross-border payments should be interoperable to better verify goods. The main goal is that global trade should operate without any digital islands. 

Stuck at sea

Natasha Condon, global head of core trade at JPMorgan, comments that the recent Covid-19 pandemic highlighted that there is a large amount of global trade that is vulnerable to interruptions in the financial process.

She points to a real-world example: to unload container ships, port staff need a bill of lading — a legal document issued by a carrier to a shipper that details the type, quantity and destination of the goods being carried. During the pandemic, South Korea — like most of the world — went into lockdown. This led to bills of lading not being able to physically reach their destination ports, which caused “hundreds and thousands” of ships to build up outside the port of Hong Kong “because delivery companies couldn’t move”, she says.

To help this problem, Ms Condon’s team put several emergency electronic authorisations in place, along with other procedures to allow electronic communication. 

“But it is still the case that in the vast majority of countries in the world, a bill of lading is defined by law as a piece of paper. When those laws were created, no one had ever heard of a computer — some of these laws are hundreds of years old,” she adds.

Each cross-border transaction can gather up to 40 different documents, resulting in over 200 copies

Marie-Laure Gastellu

Ms Condon goes on to say that trade finance has always been “a slightly clunky process” because of this dependence on paper, with the impracticality exacerbated by both Covid and the various supply chain shortages and commodity shocks of the past few years. 

Marie-Laure Gastellu, head of trade finance, global transaction and payment services at Société Générale (SocGen), estimates that less than 2% of bills of lading are digital.

“It’s about four billion paper documents issued each year to support the trade,” she says. “If you look at documentary credit, each cross-border transaction can gather up to 40 different documents, resulting in over 200 copies.”

Solving a problem

There have been industry efforts to fix these legacy issues, most of which revolve around standards. Earlier this year, the UN Economic Commission for Europe and the International Federation of Freight Forwarders Associations (Fiata) announced the official release of the electronic Fiata Multimodal Bill of Lading data standard.

Created in order to map the ‘Negotiable Fiata Multimodal Transport Bill of Lading’ with the ‘UN/Cefact MMT’ reference data model, this data standard allows for the exchange of data in a standardised way, enabling interoperability between all modes of transport and industry stakeholders.

The UN Commission on International Trade is spearheading a new model law on electronic records (MLETR). The MLETR aims to enable the use of electronic transferable records (ETRs), both domestically and across borders, by recognising the legal validity of ETRs that are functionally equivalent to their paper-based counterparts.

Ms Gastellu says the G7 countries, starting with the UK, and now France and Germany, are looking into how to transpose these rules into domestic law.

“Once we have the MLETR adopted, then the adoption of standards will be much easier,” she adds. While most banks and corporates use the Swift messaging standard for payments, there is no legal standard. By adopting the new legal standard, together with the Swift messages, “will be really the basis of the utilisation of all trade, an end-to-end value chain”, she adds. 

Mr Binns agrees: “Legal interoperability is a huge issue. The [UN publication] is a great step in the right direction. Some countries like Singapore and the UK have either implemented the MLETR or are in the process of doing so. At the same time, other initiatives, such as the ICC Digital Standards Initiative, are also starting to drive progress.”

Michael Vrontamitis, lead industry principal of lending business at software company Finastra, who spent 25 years at Standard Chartered, says work on a standardised legal framework is where he has seen the most progress. 

“I co-chaired the ICC digitisation working group for digital trade and finance,” he says. “When we started in 2017, there was a lot of talk with no clear direction. We developed the ICC digital trade roadmap … one of the things that we identified was that the legal framework for trade and trade finance was lacking.”

Slow progress

One of the issues the working group found, back in 2017, was that only one country out of the top 15 global trading nations could accept an electronic bill of lading. “You need more than one country,” says Mr Vrontamitis. “There was a lot of focus around ensuring that we had the right legal framework globally to enable the digitisation of the core documents, because you can’t digitise 80% of documents and [have] two key documents [that are still on] paper — if so, you still have a paper process.”

He expects to see the number of bills of lading issued in electronic formats to increase significantly over the next five years.

“It’s like a jigsaw puzzle,” Mr Vrontamitis adds. “While the legal framework must be in place, the technology is already there. Whether it’s DLT or cloud-based technologies, all the technology that you need is there.”

It is that jigsaw puzzle nature of global trade that presents the major barriers to digitising the process. “The first problem we have is that we talk about trade as if it’s a homogeneous thing, whereas globally — and from even from company to company — trade is completely different,” says Marc Smith, founder and director at Conpend, a provider of document checking software using AI and machine learning, who works with several banks in the trade space. 

WE TALK ABOUT TRADE AS IF IT’S A HOMOGENEOUS THING, WHEREAS GLOBALLY TRADE IS COMPLETELY DIFFERENT

Marc Smith

Mr Smith argues that at a transactional level, each trade is a bespoke construct that a bank is processing for the counterparties. “One of the big problems is that, on an abstract level, we talk about trade as a generic thing. In reality, it’s absolutely the reverse,” he explains. “This is where I think AI can play a role, because it can help generalise something that is not general.”

According to Joon Kim, global head of trade finance at BNY Mellon Treasury Services, there are many types of fintech companies that can create value for the trade finance space. Those companies range from platform providers, as well as automation and back-office providers that eliminate manual work and create efficiencies.

A platform also facilitates a certain degree of efficiency. For example, instead of approaching 15 different banks for a quote, a corporate can enter its request on a platform where banks can review and see whether they can help, he adds. 

Blockchain solution

When the industry first started making serious moves to digitalise the trade finance process, DLT was frequently mentioned as a solution to many global issues. However, that technology has failed to live up to its promise. 

“I totally see that there is an angle for blockchain here, in the sense that having a public transparent record of the ownership of goods is something that blockchain is designed for,” says Ms Condon.

However, fundamentally, what is needed is a system where everyone in a digital transaction is confident that everyone knows who owns the goods at any specific moment, and that is often still determined by who is physically holding the bill of lading, she says.

“Whether you solve that through blockchain or not, I’m pretty neutral,” she adds. “I don’t think it needs to be a blockchain.”

HAVING A PUBLIC TRANSPARENT RECORD OF THE OWNERSHIP OF GOODS IS SOMETHING THAT BLOCKCHAIN IS DESIGNED FOR

Natasha Condon

Atul Jain, global co-head for trade finance and lending at Deutsche Bank, believes that while DLT is “absolutely the backbone against which a lot of these problems could be addressed”, it is not the “defining constraint”. 

Going back to issues around standards and global agreements, Mr Jain says the real issue is simply getting all the relevant parties around the same table. “It’s aligning them towards a shared approach, not just a shared vision, but really shared execution,” he adds. 

The problem that the industry is trying to solve is not how “company X gets goods, distributed through a DLT solution from country A to country B,” he says. “It’s about how do you get company X to work with companies Y and Z across markets A, B, C and D, and have that work in the same seamless and frictionless way … no one has really been able to do that yet.”

Hybrid approach

Madhav Goparaju, product executive and head of digital transformation for global trade and supply chain finance, global transaction services at Bank of America (BofA), argues that it is not so much as looking towards blockchain or any other emerging technology as a solution, but offering a flexible “hybrid” product to customers. 

“We have come up with a solution offering by partnering not just with a DLT provider, but also a provider that leverages AI technology to digitise paperwork and feed it into a DLT network,” he says. 

Previously, many DLT solutions fell apart because they expected all the parties to be in the blockchain network. “Then you have to go to each supplier for any large corporate and basically try to force them to get onto that DLT,” he adds. If a corporate is not ready to use that technology, that is not an answer from the BofA’s perspective, he says. 

This hybrid approach allows corporate clients to move at their own pace, says Mr Goparaju. “We are telling suppliers, you don’t have to change your process, just give us the same paper that you were issuing before and we can convert that paper to a digital process,” he adds. “It alleviates the need to go to each corporate client and say: you have to tell all your suppliers to be all digital, otherwise the solution doesn’t work.”

To emphasise this point, Conpend’s Mr Smith points to a conversation with a bank in Bangladesh. Its customers were small clothing factories, whose only access to a computer was the one located in the branch of the bank. It would be “ridiculous”, he says, “if that bank started mandating them to use some sort of DLT or blockchain technology.”

These banks are not in a position “to go and convince a small family-owned company to move from having a set of forms that they fill in by hand to investing in technology, simply because someone else in the chain will benefit. That’s a really hard sell,” he adds. 

Fraud prevention

BNY Mellon’s Mr Kim believes that blockchain can offer “tremendous value” to trade finance in the area of fraud prevention, in addition to considering environmental, social and governance ratings by determining what types of goods and services each corporate is providing. 

“We’re focusing on this type of DLT,” he says. “The blockchain itself can create full visibility transactions that have been completed by other institutions, and other banks would have access to that information to eliminate double financing.”

Mr Binns from Barclays notes that while “blockchain has seen some success, [it has] yet to gain real traction across trade finance and supply chains … application programming interfaces, though, are radically advancing interoperability between different platforms and represent a simpler solution to full DLT.”

We can influence the kinds of tools in the market, but we can’t force customs in another country to change how they operate

Valeria Sica

SocGen’s Ms Gastellu agrees that while blockchain can be useful for trade finance, other technologies are more relevant and important right now — such as AI and OCR, which recognise text within a digital image.  

“This technology enables efficiency and cuts costs by speeding up the processes that have to be performed by a human,” she says. “We have a combination of technology that is needed to achieve the digitalisation and efficiency in trade, while maintaining the same level of trust that we have today between parties.”

There are a lot of costs tied up in the manual checking of documents related to trade finance, and banks are fully embracing AI and OCR because they form an element of the trade finance process that the banks can completely control. 

“Many years ago, Citi made the decision to start using imaging to move the papers around different locations; then we implemented OCR technology to extract information from the paper,” says Valeria Sica, global head of trade product development for treasury and trade solutions at Citi.

“We continue digitising our processes for compliance, for example, but our scope really is from the minute we receive the paperwork. We can influence the kinds of tools in the market, but we can’t force customs in another country to change how they operate.”

While there are industry bodies working on legal standards and technology companies delivering solutions in the trade finance space, many in the banking world are looking for a more coordinated and collaborative approach from the industry. 

“I think it’s much more likely that we’ll see a marketplace of digital solutions, different platforms that all find a way to talk to each other,” says JPMorgan’s Ms Condon. “Then the conversation becomes less about ‘who’s going to be the winner here — is it a consortium of banks, is it shipping companies, is it some fintech?’ Instead, it will be more around what are the standards that all of those different platforms use to talk to each other, because until they interoperate, none of this is going to work.”

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