FX International Payments
By Mike Faden
A considerable amount of global trade finance still relies on slow and expensive paper-based processes, despite banks’ efforts to digitize operations. Most banks’ technology initiatives have not yet resulted in increased efficiencies, experts say. As a result, the cost and complexity of trade finance continues to present significant obstacles to SMEs, particularly in emerging markets.2 There is currently a $1.5 billion global trade finance “gap” of unmet need; that figure could rise to $2.4 trillion by 2025 if the problem remains unsolved, according to the WEF.3
Traditional trade finance relies on financial instruments such as letters of credit, which require an importer to prepay for shipped goods. These instruments are relatively expensive, making them particularly unattractive for smaller transactions such as those typically conducted by SMEs. The WEF notes that the cost of processing trade documents is estimated to be up to one-fifth of the cost of physically transporting the associated goods.
Partly due to this cost and complexity, many companies have shifted to “open account” relationships, where goods are shipped and delivered before payment is due.4 Another fast-growing financing method for international trade is supply chain finance, in which suppliers typically sell their receivables to financial-services companies. Buyers benefit by lengthening their payment terms while suppliers get paid more quickly. Bain estimates that demand for supply chain finance is expanding by 5 to 15 percent a year in the Americas and Western Europe, and 10 to 25 percent in Asia, with much of that demand remaining unmet or underserved.5
Despite efforts to increase the efficiency of traditional trade finance and supply chain finance, structural inefficiencies such as highly fragmented supply chains and the continued heavy reliance on paper have prevented a broad transformation, according to the WEF. Many corporate participants have been unwilling to invest in integrating with freight forwarders, government bodies, and document preparers to streamline trade finance processes, and many banks have been reluctant to invest as long as corporate adoption remains low.6
In an attempt to break the trade finance logjam, banks, businesses, and technology providers are turning to new technologies, with many investing in blockchain trade finance initiatives. Most of these initiatives are at the proof-of-concept or early deployment stage, but full commercial take-up is expected in many cases within three to five years, according to the WEF report.
Blockchain trade finance is well suited to solving problems in international trade, according to the WEF. Trade flows often involve many loosely connected participants, which traditionally has made reconciling and verifying information painful. With blockchain trade finance systems, a shared database holds all data related to each transaction, and each participant has a copy. When a transfer of funds or information about a shipment is recorded, it is validated and made available to all participants almost immediately. Only certified parties can initiate transactions, which are typically executed using “smart contracts” that execute without manual intervention or the need for third-party verification.
Bain estimates that blockchain trade finance, if adopted by all participants in the trade ecosystem, could reduce trade finance operating costs by 50 to 70 percent and cut the turnaround time for trade finance processes three- to fourfold. Those benefits would be achieved through faster credit risk assessment, reduced human error, instant verification and reconciliation of records, automatic execution of workflows and low-cost data exchange.
At least five major consortia are currently working on blockchain trade finance platforms, according to one analysis. These consortia involve dozens of commercial banks and several different blockchain platform providers, as well as state-owned banks and shippers in some cases. Some are focusing on digitizing letters of credit, while others are aiming to support other processes including supply chain financing and shipment tracking.7 China’s central bank is also testing a blockchain trade finance platform.8
Blockchain trade finance platforms may not always be necessary or the best choice, the WEF report notes. Some companies already offer digital platforms that streamline trade processes using a central ledger that’s not based on blockchain, for example. These include cloud-based networks connecting buyers and suppliers.9
Governments can also help SMEs become more competitive exporters by accelerating adoption of digital technologies for trade processes, according to the WEF. For example, some countries are developing web-based systems that provide a single point of contact for submitting documents when merchandise is imported or exported, thus eliminating the need to separately submit information to multiple agencies. In Senegal, this electronic “single window” reportedly reduced border clearance processing time by 90 percent.10
Traditionally, banks have been the primary organizations involved in providing trade finance. That is likely to change as the digitization of trade finance expands, with several types of organizations building different solutions, according to the WEF. While many banks are joining blockchain trade finance consortia, some large corporations are directly investing in their own technology platforms to provide financing to suppliers while supporting the broader goal of improving their supply-chain operations. Specialized platform providers that connect buyers and sellers for trade are using their systems to cross-sell financing to those companies.
In addition, e-commerce marketplaces and payments providers already have extensive data about the small businesses that use their services, and they are using that information to assess SMEs’ transaction history and directly offer them financing. Logistics, transport and freight forwarding companies are also investing in digitizing their operations and partnering with blockchain trade finance companies.
These initiatives have proceeded in piecemeal fashion, with little or no interoperability between them, the WEF notes. Adoption will depend on factors such as their cost-effectiveness and ability to scale securely to support more participants. The WEF report predicts that over time, the various different platforms and technologies should become more interoperable.
Over the next few years, new technologies such as blockchain trade finance systems promise to finally make it easier and less expensive for SMEs to obtain trade and supply chain finance.
Mike Faden has covered business and technology issues for more than 30 years as a writer, consultant and analyst for media brands, market-research firms, startups and established corporations. Mike also is a principal at Content Marketing Partners.
1. Trade Tech – A New Age for Trade and Supply Chain Finance, World Economic Forum; http://www3.weforum.org/docs/WEF_White_Paper_Trade_Tech.pdf
2. “Blockchain could boost global trade by $1 trillion,” World Economic Forum; https://www.weforum.org/agenda/2018/09/blockchain-set-to-increase-global-trade-by-1-trillion/
4. Trade Tech – A New Age for Trade and Supply Chain Finance, World Economic Forum; http://www3.weforum.org/docs/WEF_White_Paper_Trade_Tech.pdf
7. “How Banks Are Teaming Up To Bring Blockchain To Trade Finance,” CB Insights; https://www.cbinsights.com/research/banks-regulators-trade-finance-blockchain/
8. “Chinese Central Bank Launches Testing Phase of Trade Finance Blockchain Platform,” Coin Telegraph; https://cointelegraph.com/news/chinese-central-bank-launches-testing-phase-of-trade-finance-blockchain-platform
9. Trade Tech – A New Age for Trade and Supply Chain Finance, World Economic Forum; http://www3.weforum.org/docs/WEF_White_Paper_Trade_Tech.pdf