Industry Cooperation is Key to Trade Finance Innovation

R3’s Henry Roxas discusses the prevalence of paper-based methods in trade finance and the need for broader industry efforts to digitise practices.

In recent years, a rapid wave of digitisation has swept across just about every industry, prompting businesses to take stock and examine the legacy processes that have characterised their operations for some time. Certain industries have seen technological innovation at a much higher rate than others, often prompted by a focus on customer-centricity in their respective sector. Trade finance is one industry that remains relatively beholden to legacy processes, dragging its heels in the face of a new era of digital.

Despite trade finance lagging behind other industries when it comes to technological advancement, the sector supports some 80-90 percent of world trade, according to World Trade Organization estimates. As such, trade finance remains a hugely underserved market, with potential for high yields in return for relatively stable investments. As of last year, the trade finance gap stood at a mammoth USD 3.4 trillion, according to Standard Chartered Bank.

In order for trade finance to realise its true potential and the benefits digitisation can bring, a coordinated, industry-wide approach is required. This is best supported with new technologies that are built for purpose, to support the many counterparties that make up trade finance networks. Among these, Distributed Ledger Technology (DLT) is the most obvious choice.

DLT has been growing in prominence in recent years and has gained significant usage across just about every industry conceivable, from mining to capital markets. With the events of the past year making the case for intervention across trade clearer than ever, the time has never been better to take stock and introduce new technologies across the entire industry.

The state of play

Many of the inefficient and cumbersome processes that characterise trade finance in its current state stem from a prevalence of paper across the industry. Paper documents and trails have plagued trade finance for centuries, with a trade finance deal for a single commodities cargo by sea said to require up to 36 original documents and 240 copies from as many as 27 parties.

As such, paper-based trade finance transactions sometimes take weeks to receive approval from banks. However, digitisation has crept in and touched some areas of this largely antiquated sector. This in turn has threatened banks’ historical dominance over the trade finance industry.

Letters of credit are the traditional method of undertaking trade finance across borders, and these are largely the domain of banks. However, as trust is building between buyers and sellers, there is a new wave of fintechs and non-bank financial institutions that are staking their claim, entering the market to extend supply chain financing.

In order to connect the many counterparties that make up global trade, as well as bringing together banks and the new cohort of fintech and non-bank institutions that are entering trade finance, an end-to-end exchange is required.

An overarching, digitally distributed ledger is the ideal candidate to deliver here. DLT offers absolute trust and certainty to the respective transacting parties that information has been shared successfully and securely.

With a traditional trade finance system, each counterparty such as the importer, exporter, shipper, and bank, must all maintain their own record of documentation relating to a transaction. Each of these records must be constantly reconciled against each other, which is a laborious process. DLT presents the opportunity for a ‘single source of truth’, embodying all the necessary information into one digital document. It can also help speed up settlement time, and increase transparency between all parties while decreasing the risk of fraud.

In the paper-intensive business of global trade, DLT is a gamechanger, offering the ability for real-time review of trade documentation, traceability, and transparency of ownership. However, the technology can only bring real benefits to the industry if leveraged by all parties and used in a coordinated effort.

An industry-level approach

While technology has seen significant uptake in recent years, any real benefit it can bring to trade finance must be supported and enabled by industry-wide coordinated responses.

Although DLT has seen rapid uptake in recent years and is continuing to do so, it is yet to achieve the mass adoption that is required for it to deliver its full potential. As trade networks become increasingly complex in the face of a globalised world, it will become increasingly important that nations appreciate the role that a single, overarching digital ledger can play in aligning common goals.

To achieve this widespread adoption, engagement is required at the industry level and cannot be the sole remit of businesses. This means a diverse set of industry stakeholders coming together across different jurisdictions, to set mutually beneficial and realistic goals for implementation.

At the inter-business level, firms with established payment rails to support scalable transactions can benefit from collaboration with nimble fintechs that can propel their offering. A good industry example of this is TradeIX’s Marco Polo Network, which partnered with established player Mastercard to plug into a vast global ecosystem of hundreds of millions of registered entities worldwide. For companies already connected to Mastercard’s infrastructure, this partnership dramatically reduces the time and complexity of integrating the Marco Polo platform.

Although encouraging, Marco Polo is just one example that bucks a broader industry trend of firms lagging behind when it comes to digitisation. The real change will be led by governments, where economic goals recognise the ever-growing trade finance gap and the case for change.

Any realistic attempt at digitising and connecting global trade needs to embrace the importance of such a network effect and build technology that drives it by enabling seamless and straightforward integration.

Like any piece of enterprise technology, blockchain will be most useful when used in conjunction with existing systems. The reality is that most businesses are not yet ‘digitally native’ and so will continue to rely on legacy systems – all to different extents – in the near future.

The technology is ready, the industry is waiting and the case for a revolution in trade finance is clear. Now is the time to come together and make it a reality.

Henry Roxas is Head of Trade Finance at R3.

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