Merely one fifth of world trade is settled on the basis of prepayments. The remaining part requires financing through the use of documentary letters of credit or various forms of supply chain financing (e.g. intra-EU trade), which is risky. The Boston Consulting Group analysis indicates that the process of financing foreign trade generates up to 20 documents containing 5,000 data fields that have to be filled, which involves the participation of up to 20 different entities. Only 1 per cent of these activities creates added value.
Tedious paperwork
What this means in practice is well illustrated by an experiment conducted by the Maersk company, which concerned the shipment of roses from Kenya to the Netherlands in a refrigerated container. The entire delivery process involved the participation of 30 entities, including correspondent banks, represented by over 100 people, and the total number of interactions between them exceeded 200. The delivery took 34 days to complete, including 10 additional days associated with the processing of all the documents, which together formed a stack with a thickness of 25 centimeters.
The tedious, long processes based on paper documents are not the only problem associated with the financing of global trade. Many companies, especially SMEs, cannot obtain financing from banks, because they do not have adequate collateral, they have no credit history or lack the sufficient funds to carry out the transactions — this applies to as many as 74 per cent of all the rejected credit applications. This results in a trade funding gap, which is estimated by the World Economic Forum (WEF) at USD1.5 trillion.
To put it simply, we can say that foreign trade of that value is not carried out due to the lack of financing. If nothing changes in this regard, by 2025 the funding gap will increase to USD2.5 trillion. This phenomenon applies primarily to Asian economies, as about 40 per cent of the global funding gap occurs there. The Asian Development Bank (ADB) estimates that an increase in the volume of global trade financing would increase global employment by 1 percentage point.
The main problem in financing global foreign trade is the lack of trust between the contracting parties and the resulting high transaction risk, which in turn translates into high credit costs or the rejection of credit applications. Both banks and export credit insurance institutions lack access to centralized and digital information about the parties to transactions.
Benefits from innovation
A report prepared by the WEF and the Bain consulting company indicates that blockchain technology could limit or even eliminate many of the existing problems in the financing of international trade. This would involve the elimination of the paper trail and a significant reduction of the duration of document circulation, from more than a dozen days to less than 24 hours.
Blockchain-based registers provide a permanent and indelible transaction history, significantly reduce human errors, enable faster risk assessment, and automate processes, exchange of data and payments thanks to so-called smart contracts (e.g. the payment is made automatically once the purchased goods are unloaded in the specified port). Bain indicates that the adaptation of DLT could reduce operational costs in the area of trade and transport financing by 50-70 per cent, accelerating the implementation of processes by up to four times.
Another study conducted by Bain together with HSBC shows that the total impact of these changes on the global trade turnover — currently amounting to about USD16 trillion — would reach approximately 7 per cent. The effects of the solutions provided by blockchain can give the companies in emerging markets greater benefits than the lifting of customs duties — said Wolfgang Lehmacher, the Head of Supply Chain and Transport Industries at the WEF. These benefits can be even greater, if blockchain technology is supported by innovations in artificial intelligence combined with analytics, solutions in the field of the Internet of Things (IoT) and chatbots.
The first foreign trade financing transaction based on a private blockchain was carried out by the Barclays bank in cooperation with the Wave fintech company in September 2016. The contract for USD100, 000 involved the sale of cheese and butter by the Irish cooperative Ornua to the Seychelles. The letter of credit was issued by SWIFT, and the payment was carried out in a traditional way: it wasn’t automated. However, only 4 hours passed from the moment it was issued to the moment of acceptance, while normally it takes a minimum of 10 days. A year later the Spanish bank BBVA successfully carried out a digital transaction financing the import of frozen tuna from Mexico, where the time of circulation and verification of documents was reduced from 10 days to two and a half hours.
Over the past several years, an increasing number of banking consortia have implemented pilot projects for the processing of transactions using the DLT technology. The first such transaction between independent banks involved the Commonwealth Bank of Australia, Wells Fargo and Brighann Cotton, and IoT was also applied alongside blockchain technology. Special sensors enabled the parties to monitor the delivery route, and the smart contract software released the payments for cotton when it reached the designated locations.
Legislation is not keeping up with the technology
An example of a broader consortium specializing in the financing of international trade using blockchain technology is we.trade. It brings together, among others, Rabobank, KBC, Deutsche Bank, HSBC, UniCredit, Santander, Nordea and Société Générale. Banks in Hong Kong also established a digital platform based on DLT called eTrade, which reduced the waiting time for financing to four hours.
One special case is Batavia — a fully blockchain-based global trade financing platform developed by IBM for a consortium of five banks: UBS, Bank of Montreal, CaixaBank, Commerzbank and Erste Group. It operates as an open ecosystem that can be accessed by other banks and companies. This could be a way to popularize DLT solutions in the financing of international trade. Experts from Bain argue that this goal could be achieved through the use of so-called super-connectors which will connect various individual platforms, suppliers and carriers, providing banks with access to data on collateral and the history of many transactions, thus allowing for better and faster assessment of the risk with regard to previously unknown clients.
Blockchain’s potential to promote the growth in international trade was recognized by the World Trade Organization, which stated that this technology provides an interesting tool supporting the implementation of the Trade Facilitation Agreement, as it significantly reduces costs and supports business and intergovernmental relations.
However, blockchain will not solve all the problems of international trade, because it has its own limitations and requires support in other areas. There are many elements that require legal regulation, such as the liability of the parties in the event where the smart contracts contain coding errors.
Skeptics also point out that the documentary letter of credit may be issued on the basis of forged documents, and that the technology cannot prevent it, propagating the false facts and data on goods or payments involved in a given transaction. Therefore, in order to eliminate this risk, it would be necessary to create a network of trustees certifying the authenticity and credibility of the documents, and that could extend the duration of transactions. Blockchain technology certainly offers a number of advantages, such as cybersecurity, transparency, protection of intellectual property, the ability to carry out transactions in real time or the practically unlimited ability to include new participants. However, it is not a panacea for all problems, and its application requires us to carefully weigh all possible risks.