Applying Blockchain to Make Trade Finance More Shock-Resistant
Overreliance on physical documentation, archaic and opaque supply chains, and regulatory hurdles are severely affecting trade finance as world trade wades through the disruption unleashed by COVID-19. Here are four steps for building blockchain-based trade finance that can alleviate the pain.
Beyond the unprecedented global health crisis, the COVID-19 pandemic has also drastically impacted world trade, affecting both demand and supply. While the demand side has been badly hit by the disruption of normal economic activity, the supply side has also been adversely affected by restrictions on travel and disruptions in value chains, leading to an increased cost of doing business.
In fact, the World Trade Organization (WTO) estimates global trade could plummet by up to one-third in 2020, a decline that would exceed that of the 2008-2009 financial crisis. The WTO also calls the prospect of a strong recovery in 2021 uncertain (see below).
In such an environment, governments and businesses are looking at new technologies and digital channels to sustain the flow of trade and financing across the trade finance landscape, and to make the system more resilient to future shocks. To that end, we note the following possibilities:
Letters of Credit Automation.
The UCP 600 rules, published by the International Chamber of Commerce (ICC), govern the use of Letters of Credit (LCs) worldwide and apply to banks and lending institutions that issue these LCs. According to the guidelines, delays in presentment of required documentation for an LC past the due date result in non-compliance and could lead to delayed or denied payment to the seller. In the current environment, physical presentment and delivery of documents is hampered by the lockdown and restricted availability of delivery channels, putting exporters at risk of LC violations.
This scenario is ripe for accelerated adoption of blockchain, since distributed ledger technology provides a secure and tamper-proof way to digitally issue and manage LCs and to enable timely electronic presentation of commercial, transport, insurance and financial documents.
One key hurdle to digitizing LC processes is that in many jurisdictions, only paper versions are accepted and legally enforceable. In 2019, the ICC issued eUCP guidelines, a supplement that extends the LC contractual rules in UCP to acknowledge and safeguard electronic presentation. With today’s COVID-19 restrictions, many regulators are focusing on easing laws to make eUCP-based electronic presentment of documents legally acceptable.
Recently, the ICC issued a memo urging governments to remove regulatory impediments on electronic trade documentation and allow legal enforceability for these. This legitimizing of digital versions of compliance documents would provide more flexibility to exporters for faster and in-time presentment.
Another benefit of eUCP guidelines is that if the issuing or nominated bank is open but unable to receive electronic documents, this is considered force majeure and the presentation date can be extended. By contrast, for paper presentation, as long as a bank is open, any presentment delay is considered an LC violation.
LC issuance and presentation over blockchain also provides other benefits — minimizing contractual ambiguities, reducing errors and enabling faster LC amendments. This not only helps get companies through the current crisis, but also prepares them for the inevitable digital future of trade finance.
Supply Chain Tracking.
The COVID-19 crisis has amplified the fragility of complex global supply chains. This, coupled with the need to rapidly procure essential commodities from different parts of the world, has increased the importance of visibility in trade transport. Increased visibility of in-transit shipment is crucial for businesses that must respond quickly to changing conditions and take corrective action to reduce supply shortages and delays — by planning alternative routes, for example, or onboarding additional suppliers. For essential items sourced globally from new suppliers and channels, the reliability of quality controls and inspection measures is important for both downstream traceability and quality assurance.
Blockchain can play a key role during and beyond the coronavirus outbreak by improving trust, transparency and supply chain certainty. Tracking shipments over blockchain provides real-time visibility and verifiability, reducing delays and relieving strain in the supply chain. Numerous parties involved in the transport chain (freight forwarders, carriers, insurers, port operators, chambers of commerce, customs authorities, inspection agencies) can also provide certifications, sign-offs and overall quality assurance faster online and in a seamless and tamper-proof manner. With supply chain disruptions and restrictions on physical channels, this helps ameliorate transport risks by expediting the flow of goods and reducing delays and fraud.
Access to Financing for Businesses.
The COVID-19 downturn has led to increasing cost of business, liquidity crunch and restricted financing. An April 2020 report from the U.S. Chamber of Commerce indicates that one in four small businesses in the country are two months or less from permanent closure. While governments around the world have announced support packages for small- and medium-size enterprises (SMEs), the operational burden of due diligence (application processing, gathering required documentation, Know Your Customer checks) falls on banks and other financial institutions. Obtaining and verifying credentials — including past performance, payment history, disputes, litigation and other financial health indicators — increases the time and cost of loan processing for banks, potentially delaying the origination process and release of funds.
Blockchain-based financing platforms can reduce these information asymmetries and expedite financial credit support for small businesses. SME financing on blockchain provides increased insight into the receivables lifecycle and associated trade transaction information, as well as verifiable data on SMEs’ past payment history and credentials, enabling better and faster assessment and credit approvals.
ANT Financial, an Alibaba-owned company that uses blockchain to speed the loan application process, has been included in the UN list of companies helping organizations cope with the financial crisis by offering loans to SMEs and startups. In March 2020, as part of COVID-19 relief measures, the Chinese government added $7.4 million funding for a cross-border pilot of a blockchain-based financing platform run by that country’s central bank. The program provides lower interest rates and faster loan approvals for SMEs than conventional methods.
How COVID-19 Alters the Equation.
Traditionally, blockchain’s benefits lay in its promise to make trade finance processes more efficient by reducing costs and business risk. In the aftermath of COVID-19, maintaining business as usual has become more important value proposition since physical and established channels for the flow of documents, information and financing have been disrupted. The recognition that in times of global emergencies, blockchain can provide infrastructure and operational tools to address supply chain volatility and the SME credit gap has led to wider acceptance and a push for adoption from regulators and businesses.
A recent flurry of statements have emerged from industry groups and governments to promote blockchain adoption — from recommending legal enforceability for electronic LC acceptance to support for blockchain-based SME financing platforms. New blockchain-based products and platforms have been launched for trade financing and supply chain tracking, and many banks are accelerating their blockchain enablement journey.
While the efforts discussed here are steps in the right direction for sustaining global trade in these uncertain times, it remains to be seen how many will translate into action. Crises often support disruptive innovation, and the coronavirus may be the catalyst that accelerates blockchain implementation in trade finance (see our four action points, below).
However, it could take a long time to re-imagine end-to-end trade finance processes on blockchain due to the challenges involved in digitizing archaic, fragmented and paper-based business processes; accommodating variations in country-specific trade procedures; building stakeholder trust and getting buy-in; putting technical prerequisites in place; and addressing change management issues.
Further, such networks would need to be scalable, interoperable with other electronic trading systems and pluggable into existing infrastructure of trade applications, corporate ERP systems and the carrier networks to ensure support for documents across networks and coverage of all aspects fundamental to financing of trade. The technology must be accompanied by favorable regulations and policies, as well as evangelization that builds industry momentum and accelerates implementation.
Regardless, however, today’s push is welcome. In the short term, it increases awareness, improves adoption, legitimizes blockchain use cases, and provides business validation for adoption. In the long term, the proliferation of blockchain-based trade finance solutions and platforms will better position the global economy to deal with shocks by making the supply chain and trade financing processes more robust and resilient.