Written by Heather McKenzie
Amid the hype around distributed ledger technology and blockchain it can seem they are technologies looking for solutions. In the heavily paper-based business of trade finance, such technology looks promising and progress is being made elsewhere.
The milestones in applying digital ledger technology (DLT) to trade finance are coming thick and fast. In July this year, Japanese bank Mizuho completed a trade finance transaction between Australia and Japan, digitising all necessary documentation and sharing the data with multiple participants across a distributed ledger. In August, software firm R3 and 12 banks developed a prototype trade finance application on R3’s DLT platform.
Trade finance is a complex, paper-based activity. It encompasses lending, issuing letters of credit, factoring, export credit and insurance. Companies involved with a trade finance transaction include importers and exporters, banks and financiers, insurers and export credit agencies, and other service providers, such as customs organisations. Documentation is an important aspect of trade finance, but it isn’t standardised and invoices, letters of credit and bills of lading can differ greatly from country to country.
In the Mizuho project, several benefits were identified: shorter delivery time for trade documents (reduced from multiple days to two hours); reduction of time required to create and transmit documents, as well as labour and other costs through document digitisation; and increased transparency by sharing transaction details with all parties. There were challenges, however, as the bank found it was not possible to transmit trade transaction information in digital blockchain or DLT format to parties that did not use the platform. Also, transactions must be conducted as before, and enabling the transmission of the wide variety of information necessary for trade transactions would require standardising the information for blockchain and DLT at an international level.
The key innovation that blockchain brings to the table is the ability to move to a distributed dataset, says Peter Jameson, co-head of product management, global transaction services at Bank of America Merrill Lynch. “For trade, the adoption challenge lies in the fact that today, much of this data is in paper form. For blockchain to play a role in trade finance, the industry needs to adopt a range of digitisation tools, and a dataset that can then leverage what this technology has to offer. Innovations such as enhanced character-recognition technology, robotics and artificial intelligence can all play a role in this digitisation journey.”
But there are other challenges to consider in the adoption of blockchain technology, he adds. The cross-border nature of trade and the range of participants in any trade transaction make it difficult to drive forward a common set of standards that would make blockchain truly effective. “Add the fact that trade has traditionally lagged other parts of the transaction services world from a digitisation and automation point of view, and it would clearly be somewhat of a challenge to get all players, across all jurisdictions, to agree on the single set of standards that would be key to blockchain’s trade success.” Moreover, the cost benefits would not be “immediately obvious”. Although inefficient, paper-based trade is tried and tested, and players are more inclined – particularly when seeking to mitigate risk – to “stick with what they know” over charting unknown innovative technology territory, he says.
Vinod Madhavan, head, trade at South Africa’s Standard Bank, says the search for operational efficiencies in the largely paper intensive trade finance business, means there should be increased adoption of digitisation and digitalisation in trade finance processes. “By digitisation, I mean the conversion of analogue content into digital form and digitalisation means the use of data or technologies in the trade and supply chain. We would expect adoption to happen across the physical supply chain, the financial supply chain (purchase to pay and order to cash) and in the documents chain, including movement of bills of lading, insurance certificates etc.”
Standard Bank believes the benefits from the digitisation of the “documents chain” can be realised fastest by enabling electronic copies of bills of lading to be sent from the exporter (or exporter’s bank) to the importer (or importer’s bank), in a manner that secures their legal transferability and drastically reduces delays in couriering the documents. Standard Bank has successfully conducted proofs of concept (PoC) using blockchain in the digitisation of documents. It is working with various participants to achieve commercial viability. The bank also recently joined R3.
By the end of 2016, a consortium of seven European banks formed the Digital Trade Chain (DTC) initiative. DTC is a blockchain-based digital platform for managing and tracking domestic and cross-border open account trade transactions. The members of the consortium are KBC, Unicredit, HSBC, Rabobank, Societe Generale, Deutsche Bank and Natixis.
The aim of the project is to enable authorised European small and medium-size enterprises (SMEs) to increase and enhance trade transactions. Transactions will be initiated on a paperless and secure basis, with transactions tracked at each stage of the transaction lifecycle, through to the point of settlement and payment. Launch is scheduled for in 2018 Belgium, France, Germany, Italy, the Netherlands and the UK. Inclusion of other countries and additional service providers may be considered in the future.
“The DTC initiative is helping us to understand the difference between a blockchain proof of concept and launching a real product,” says Anne-Claire Gorge, global head of product management & innovation – trade services & finance. “All of the banks involved are working very well together, but it is still a very complex and challenging project.”
The challenge does not come solely from a technology perspective, says Gorge. “We are creating a brand-new solution that is not defined by regulators. The project has started with a restricted scope of seven banks in Europe, which is designed to help keep complexity to a minimum. The aim is to ask other banks to join the initiative to extend the geographical reach as much as possible.”
Vinay Mendonca, global head of product and propositions at HSBC, says unlike previous digitisation attempts in trade finance, some of the current DLT work streams are considering interoperability. “In the past, digitisation occurred only in islands as particular processes were digitised. Now we are looking at the full breadth of trade finance. If we get DLT in trade finance right, with seamless interoperability, our clients and other parties in the trade chain will benefit greatly,” he says.
The key step-change for trade on the journey to blockchain adoption is how information could be digitised and captured early in the transaction cycle, so it can be further leveraged to the benefit of banks and clients, says Jameson. Capturing data up-front would mean that banks could use it for deeper analysis and profiling of client flows – either for enhancing risk management; supplementing compliance controls; or identifying client needs that could drive the cross-selling of other capabilities. “Taking it one step further, by driving automation, banks could achieve greater scale and reduce the reliance on people thereby improving efficiency, mitigating human error, reducing costs and managing risk more effectively,” he says.
Many clients’ frustrations in trade finance are related to what banks think of as “ancillary processes”, such as onboarding, the management of KYC, paper-based account opening, identity management and contract negotiation. Blockchain could arguably have a greater short-term positive impact on these processes than on trade or payment flows themselves. This is where the industry could begin its focus, to deliver tangible, short-term benefit, says Jameson.
Despite the challenges, the potential benefits blockchain could bring to trade flows cannot be ignored, says Jameson. “The distributed nature of the data could significantly reduce cycle times – for example, by making data simultaneously available to all parties in a transaction, each could perform their respective checks in parallel, reaping immediate benefits over today’s slower, linear approach. Furthermore, the availability of this data could significantly increase risk management and compliance checking. And when combined with the internet of things – by integrating data on the physical location of goods, containers or vessels – it’s fair to say that blockchain infrastructure could become a very powerful tool for the industry.”
Standard Chartered Bank’s Hong Kong subsidiary announced in March that it had completed a DLT PoC for smart contracts in trade finance. Standard Chartered is the lead bank of the DLT Trade Finance Working Group under the Hong Kong Monetary Authority’s Fintech Facilitation Office, collaborating with Deloitte Touche Tohmatsu and four other banks in Hong Kong.
The bank said the PoC was a “significant milestone in the digitisation journey of trade finance”. Gautam Jain, global head, digitisation and client access at Standard Chartered’s transaction banking division said DLT will deliver improved efficiency and greater transparency to trade finance clients. “We see significant potential in the application of smart contracts in trade finance and will continue to work with industry partners and regulators to make this a reality in the near future.”
His colleague, regional CIO, Greater China and North Asia, Peter Clark, said DLT in trade finance was not just about digitising the processes, but also standardising the data models and enabling more collaboration among industry participants. In the next phase of the project, Standard Chartered will invite clients and a number of intermediaries to join the pilot.
Russia’s Sberbank believes blockchain technology will significantly influence the financial sector in the future, says Evgeniy Kravchenko, senior managing director and head of Sberbank’s trade finance and correspondent relations division. “We have about 20 projects under way related to the implementation of blockchain in various activities, including documentation exchange with state authorities, factoring, trade finance, payments, etc,” he says. “As the technology is relatively new, most of our projects are at prototype or pilot stages. There are certain legislative issues that need to be addressed before most of the projects can be put into production.” Most regulatory authorities, including those in Russia, realise the necessity of creating transparent rules for this new sphere, including cryptocurrencies and smart contracts, for example.
“Like most leading banks, we have analysed the impact of DLT on traditional trade finance products and definitely believe that its use will be beneficial for all parties involved. Our pilot cross-border letter of credit transaction has proved the benefits of transparency and increased processing speed due to the electronic exchange of documents. This technology is definitely the future.”
While trade finance efforts are well under way, financial institutions are investigating other potential applications for blockchain and DLT. Nigel Dobson, general manager, transformation projects, ANZ, says: “There has been a lot of hype surrounding blockchain and distributed ledger technologies, which is why we have kept our proofs of concept to specific use cases that solve real-world problems.”
The bank has undertaken a PoC of DLT for bank guarantees for commercial property leasing. ANZ digitised and improved the process for issuing, tracking and claiming on guarantees for Scentre Group, the operator of Westfield shopping malls. The Group leases retail space to about 11,500 retailers across Australia and New Zealand, who – instead of putting down a cash rental deposit – often use a rental bond, which is issued by a bank. “These bank guarantees are typically manual, paper-based, and can be difficult to verify,” says Dobson. “Also, tracking any changes to the rental agreement – and thus the bank guarantee – is particularly onerous. The trial addressed these issues and successfully showed how DLT could be used to digitise and standardise bank guarantees.” ANZ partnered with IBM Research and Westpac to test the technology for Scentre Group. Dobson says it is “highly desirable” for banks to collaborate in developing DLT solutions for customers, so they can be scaled for an entire industry sector. The next step for the bank guarantee is to move to a pilot stage where additional organisations from banks to large landlords are expected to take part.
JP Morgan has been researching blockchain technology and potential use cases since 2014. “When Ethereum [a decentralised platform that runs smart contracts] emerged in 2015, it quickly stood out to us for its ability to handle business logic via smart contracts and its uptake among early adopters and developers,” says Umar Farooq, head of channels, analytics and innovation, JP Morgan Treasury Services. “As we began developing use cases using Ethereum, we realised there were technical challenges we needed to address – privacy, scalability, throughput – before we could see a path to production.”
Because few players were looking at these issues from an enterprise perspective, JP Morgan tackled them itself by developing Quorum, an enterprise-focused blockchain platform based on Ethereum. Quorum was released to the public in open source in 2016, making it freely available on GitHub and open to external contributions, with key features – enhanced performance, enterprise-grade privacy, peer permissioning, configurable consensus, and a full IDE/SDK to support rapid deployment.
“Quorum is now attracting contributions from leading blockchain startups and developers,” says Farooq. For example, zCash is adding privacy enhancements in a zero-knowledge settlement layer for Quorum and Amis Technologies in Taiwan is incorporating its recently released Istanbul BFT consensus. Also, Microsoft and Synechron are creating developer tools to make it easier to build on Quorum. “We’re seeing other institutions like Santander, IHS Markit, Broadridge and the Monetary Authority of Singapore use Quorum to build blockchain prototypes with support from the Enterprise Ethereum Alliance. A Quorum ecosystem is emerging beyond any single firm, JP Morgan included.”
Bank of America’s Jameson says during the past year, blockchain has morphed from idea to practical reality. “I believe 2018 will see us defining common industry goals and ensuring we take these forward on a pragmatic basis. We should also not ignore the other technological leaps that are contributing to a sea change in trade. Advances such as those in optical character recognition or voice recognition software have the potential to generate significant benefits too, helping to drive paper to electronic data early in the process.”
HSBC’s Mendonca says digitisation of trade finance is a journey, not a jump. “There will be steps along the way – for example, we will begin with digitising bills of lading and have already established an electronic bill of lading solution that is live with some title registry companies.”
With each proof of concept initiative, the industry gains practical knowledge of DLT, he adds, which will take it ultimately to a truly digital future.
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