Trade Finance OVER BLOCKCHAIN
1. What is a trade in finance?
2. How does trade finance work?
3. What are the four pillars of trade finance?
4. What is block chain finance?
5. What are the types of trade finance?
6. How does Blockchain work in trade finance?
What Is Trade?
Trade is a basic economic concept involving the buying and selling of goods
and services, with compensation paid by a buyer to a seller, or the exchange of
goods or services between parties. Trade can take place within an economy
between producers
and consumers.
What
is block chain finance?
Blockchain is essentially a ledger of
recorded financial transactions. This ledger is distributed,
published, and stored in multiple locations. When a transaction occurs, it is added to
each copy of the ledger. This helps ensure an accurate record of transactions.
What
are the types of trade finance?
· Payment-in-advance
· Working capital loans
· Overdrafts
· Factoring
· Forfaiting
How does trade finance work?
o
Trade Finance solutions have been supported
for centuries, yet over the past couple of years they became the centre of attention
again. This renewed interest is driven by a
new technology, blockchain.
o
Over the past decades, advances in
information technology and digital transformation took over the
business world. The financial services industry has changed. Yet, the way trade
finance is conducted would still look very familiar to
merchants from the Middle Ages.
o
While many corporates and financial institutions similarly are focused on supporting fintech solutions, trade
finance specifically has not benefited as much as other financial sectors.
o
Today, this is about to change. Trade
finance utilising blockchain
and distributed ledger technology (DLT) is the next step in the sector’s
evolution. The market interest, available technology and timing are now
right to make it happen.
A
Brief History of Trade Finance
Trade finance gained in popularity in the 17th and 18th centuries, as the practice was expanded to
America. Here it financed long-distance trade between the American colonists
and their English, and subsequently Central European trading partners.
Prior to 1930, trade finance was mainly used in the garment and textile
industries and in the form of factoring. However, after the second
world war, it became clear that it could benefit any trading business with new
trade finance solutions being launched.
The developments of logistics solutions that followed and the introduction of new technologies made trade finance increasingly
strategic for companies in various industries.
Today, it can be supported by SMEs (Small and Medium-sized
Enterprises) and large corporations alike, globally, and in any sector.
Along with this growth occurred challenges that the sector still faces today. The
digitisation of trade finance using blockchain technology aims to solve these
challenges.
Today,
financial institutions and their corporate clients are faced with four major challenges
when it comes to financing trade.
1. The Trade
Finance Gap
In a
recent report by the Asian Development Bank (ADB), the global gap
in trade finance is estimated at about $1.5 trillion. This could reach $2.5
trillion by 2025 according to the World Trade
Organisation (WTO). The global gap is a major barrier to global trade and economic
growth affecting particularly developing countries, mid-market firms and
SMEs.
2. Trade
Finance Processes: still paper-based and manual
Trade
finance processes are not
yet entirely digitised. Data is still entered manually without automated
cross-checking with parties submitting financial data on a spreadsheet or via
printed and scanned documents. These processes are cumbersome, slow and prone to errors.
Also, data
fields are entered in various documents, which themselves are duplicated,
creating a chain that generates discrepancies. This drives huge inefficiencies.
3. Trade
Finance Systems: warehoused and disconnected
Trade
finance generally involves numerous parties such as a buyer, a seller, their
respective banks as well as insurance providers, logistics companies, etc. Yet today, there is not one platform where
all these parties can connect between each other. Instead, they need to connect
to a multitude of platforms in order to initiate
business, share documents and communicate.
These disconnected and ageing systems place hard limits on both banks and their corporate
clients. For financial institutions, it limits their ability to develop
new offerings and scale new revenue streams at a low marginal cost.
For
corporates, it makes access to trade finance solutions complex or
even sometimes out-of-reach.
The low adoption rates of certain trade finance products, particularly among
SMEs and mid-market companies, reduce growth perspective and hampers economic
development.
4. Supporting
Trade Finance: still risky and costly
The lack of connectivity forces all participants in trade finance transactions to undertake
a variety of complex and costly systems integrations. These
different systems also must be updated and maintained.
It also hampers the effective
digitalization and automation
of trade finance, forcing all parties involved to rely on
manual processes. This leads to transactions taking
months when they
could be completed in a matter of days. Errors are common and expected, causing
delays and adding costs for time-consuming
reconciliation processes.
Participants
in a given transaction do not have access
to a shared source of truth to know if delivery or a payment took place.
The absence of transparency results in a lack of trust and consequently a
high-risk assessment and costs.
·
The evolution of trade finance
is now at an inflexion point. After experiencing a slow start, the
conditions to accelerate its digital transformation are here.
·
There is the technology to
transform trade finance: blockchain or DLT (Distributed Ledger Technology),
a ground-breaking vision: distributed
trade platforms and networks, and the resources: a
complete ecosystem led by its biggest players embracing coopetition.
An
Introduction to Distributed Platforms and Networks
·
Trade finance powers global trade which is
driven by companies supporting opportunities to do business with new partners. But today, these
numerous firms and B2B transactions compose a global network supported by no
common infrastructure.
·
Costly integrations to connect, data supervision, control
and privacy remain major challenges for participants helping trade finance
to conduct international trade.
So what is needed to solve
these challenges?
·
In place of the current
systems and manual intensive processes, parties
should start transacting via a
truly digital and connected ecosystem for global trade.
· This can be defined as an ecosystem “that
connects the majority of participants involved in global trade and allows them
to exchange trade data and assets as seamlessly as one would exchange text
messages and emails”.
A new technological
paradigm makes this possible: distributed platforms and networks.
By
design it enables:
·
Independent software systems to
transact seamlessly, securely, and in real-time over an open, distributed
network that has no single owner, operator, or point of failure.
·
Each user to retain control and custody of their own data. Allowing them to comply with all their jurisdictional,
regulatory, and organizational requirements.
·
Users to connect-once-to-connect-to-many
(COCM) and automate complex multi-party trade finance transactions.
·
To maintain one single source
of truth across independent systems and trading parties who do not know or
trust one another. Keeping data in sync and verified through complex math and
cryptography, not human
intuition.
Over the past few years, there’s been a
growing interest in blockchain triggered by the launch of the cryptocurrency,
Bitcoin.
DLT
can be used to bring significant value to various sectors, including B2B
(business to business) transactions and financial services. The advantages of
using distributed ledger technology and blockchain for trade finance is
certainly a game-changer.
Understanding
the Concept of Blockchain and DLT
·
A distributed ledger is a database that
exists among multiple users
or across several locations
i.e. each user/location has a copy of the database. It is thus
“distributed” as opposed to a single, “centralised” database to which many
users connect to.
·
Blockchain technology enables the recording
of transactions on a distributed ledger across a network of users.
The data from these transactions is stored into blocks. Each block includes a time-stamped record of
the transactions. These blocks are linked to each other in chronological order,
thereby creating a chain or blockchain.
·
Thus, blockchain is one type
of distributed ledger. All blockchains are distributed ledgers, but not
all distributed ledgers
are blockchains.
·
The publicity around Bitcoin
made the term blockchain very popular and used to
refer to any type of distributed ledger or DLT application.
·
Today, several companies are
developing DLT protocols
to suit various business needs such as Corda by R3, Hyperledger Fabric and
Ethereum and leveraging different programming languages including Java, Kotlin,
C++, or Python.
The core advantage of this technology is that it creates a
single, shared source of truth to connect
parties that do not initially trust one another. It also enables real-time
exchange of data and assets between parties.
·
Trade finance is a perfect use
case for blockchain application. Blockchain in trade finance facilitates unprecedented levels of
connectivity while preserving the data ownership and privacy levels expected
for financial transactions.
·
In addition, it provides
financial institutions with superior audit and compliance capabilities.
·
This is enabled through the
provision of a forensic audit trail as well as improved transparency and
tracking of trade assets.
·
Corda blockchain technology, developed
by enterprise software company R3, is particularly suited to financial services
and trade finance in terms of permissions and interoperability to connect
business networks. Moreover, it provides inherent identity management,
automated contract enforcement, asset verification and tracking.
· Trade finance transactions involve numerous parties, financial Institutions, their corporate clients but also
logistics companies, insurers, electronic invoicing, procurement and compliance
services, ERP providers, and various technology providers.
·
Trade finance is truly an
optimal use case of blockchain and its transformation will impact and benefit the entire
ecosystem. As a result, many are getting involved which is not only good
news but a requirement for its success.
·
They do so by becoming
members of various initiatives and trade finance blockchain consortia, launched
to connect the value of this technology to improve trade and working capital
finance solutions. Together,
they define, challenge, develop, test and deploy
new products and processes, in order to design the new normal for
efficient trade finance transactions.
·
One of the main projects
focusing on trade finance blockchain solutions is the Marco Polo Network, a
global network developing a range of open account trade and working capital
finance solutions. The Marco Polo Network is the largest and fastest
growing trade and working
capital finance network in the world.
·
Other large projects include we.trade
focusing on Bank Payment Undertaking (BPU) for SMEs, VAKT and Komgo
addressing needs in Commodities, TradeLens and Cargo for Shipping and Freight and Voltron as well as eTradeConnect
focusing on Letters of Credit and e-bills of Lading.
·
These initiatives are
important for the industry and lead to compelling projects and collaborations.
They gather financial institutions, their corporate clients and technology
providers to work
towards a common goal.
·
These are very
exciting times for the trade finance sector, and blockchain is an attractive technology with
a lot of potential. Professionals need to develop their knowledge of the
different concepts to drive innovation in their organisation and understand the
benefits of joining trade
finance networks.