DLT

BLOCKCHAIN & CRYPTO: DLT consortia are racing for the lion's share of the $1.5 Trillion Trade Financing Gap

Financial products -- including their embedded processes and inherent risks -- are transforming from legal paper to software. And as that happens, it is technology companies that are best positioned to manage, analyze, report on, and safekeep our money. The latest victim of this is Trade Finance - a practice that facilitates $16 trillion of trade around the globe on an annual basis. In short, trade finance covers the financial products, processes, and instruments involved in financing domestic and international trade and commerce. Each transaction often involving multiple actors (+20 in some cases), such as importers, exporters, banks, carriers, customs officials, and insurers. The juicy bit is the potential to digitize and modernize the manual, paper-intensive, and prone-to-risk processes involved in each transaction e.g., managing the cost and time implications of a trade war between two countries -- US v China showdown.

Enter distributed ledger technology (DLT), which has taken aim at the 1-2 week long paper-pushing documentary credit process. Essentially, a documentary credit is a commitment of liability by the issuing bank (representing the buyer/importer) assuring the seller/exporter that payment will be made once the goods have been received -- reducing the credit risk associated with the trade. The immutability of data and speed of distributed ledgers helps reduce the need for manual verification, as well as the risks associated with fraud, human error, and credit. Essentially, reducing the time it takes to execute the process of documentary credit to just 24 hours using smart contracts, and a purported 35% reduction in overall costs.

Interestingly, the first live end-to-end trade finance transactions on a scalable application for a fully digitized documentary credit using DLT took place in May last year, involving HSBC, ING, BNP Paribas, and Bangkok Bank. A year later, and trade finance is the 3rd most targeted sector for DLT use, involving industry consortia such as Voltron and Marco Polo -- built on R3's Corda DLT Platform, we.trade and eTrade Connect -- built on IBM's Hyperledger Fabric platform, and komgo -- built on JP Morgan's Quorum platform, all of which are after the lion's share of the $1.5 trillion trade financing gap and a piece of the $1.1 trillion of increased trade volumes by 2026.

This week at IFLR's Fintech Europe 2019 conference, we learnt that Voltron - a consortia of 12 banks building a single platform to digitize all document collection, tracking, and the facilitation of exchange for Documentary Credit via its network - has recently completed global trials which saw over 50 banks and corporates participate in the simulation of multiple digital Documentary Credit transactions across 27 countries, covering a range of goods traded including soybeans, plastic derivatives, metals and wool.

So what does this mean for the future of Trade Finance? Firstly, it's likely that the International Chamber of Commerce (ICC) will release a governance framework consisting of technology standards and business rules to oversee the practices of industry consortia. Secondly, interoperability of industry consortia platforms will be critical to how they integrate with existing bank systems. Finally, it's easy to relate what Voltron is trying to achieve in trade finance to what the SWIFT Network did in cross border payments -- transferring digital data between banks and corporates, although without the help of DLT. Given this, the possibility of a platform like Voltron to become the next generation SWIFT network -- adding a payments mechanism to its Documentary Credit platform is highly likely. Such a payment mechanism could use tokens enabled by smart contracts linked to IoT devices (See Project Forcefield) tracking the goods traded. In effect, removing the need for multiple intermediaries (e.g., Issuing Bank) required to alleviate risk exposure. We can dream.

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Source: Digital Innovation in Trade Finance (BCG), Trade Finance & Blockchain ReportRebooting a Digital Solution to Trade Finance (Bain&Co)