Blockchain fatigue? A brief look at the Trade Information Network venture
The recent announcement that seven banks have agreed to develop a global digital network for trade finance, Trade Information Network, is interesting for a number of reasons. For a start, this network does not use DLT (more commonly, but often less accurately referred to as “blockchain”). Instead, the participating banks have partnered with an established trade finance technology provider, CGI, whose current offering is a Software-as-a-Service (SaaS) platform.
When we look at new technology developments such as this, it is worth asking a fundamental question: “what problem will it solve?” or “what business benefit will it deliver?” for the development to gain widespread adoption, it has to solve a problem for, or deliver a business benefit to the key stakeholders. In the world of supply chain finance, the key stakeholders include the seller and the buyer as well as the finance provider. Depending on the scope of the technology solution, we might add other parties to the stakeholder group, including: carriers; freight forwarders; warehouse-keepers; insurers; inspection agencies and customs authorities.
The scope of the Trade Information Network appears to be quite contained, which might be a good approach in terms of driving adoption as the stakeholders appear to be limited to the buyer, the seller and the finance provider. The stated objectives focus on fraud prevention, reduced cost and increased availability of finance to smaller companies.
The core processes involve the ability to upload and verify purchase order data followed by invoice data once the goods have been shipped. This provides reassurance that the underlying trade transaction is genuine. In addition, the verification of the purchase order provides an element of performance risk mitigation, enabling the bank to provide pre-shipment finance.
Digging a little deeper, one might challenge the fraud prevention logic. The idea that the verification of the purchase order and matching of the invoice will prevent double-financing is sound. However, on the face of it, there is nothing to prevent an unscrupulous seller from uploading a valid invoice that they have already used to secure finance from a bank that is not a member of the network. It is not clear whether the platform will provide the required transactional control, ensuring that the buyer’s payment can only be made to the participating seller’s bank. Of course, there are existing legal procedures in many countries that prevent a seller from assigning the same invoice twice.
The risk mitigation benefits that are expected to encourage banks to provide pre-shipment finance and increased levels of post shipment finance, especially to SMEs, will depend on the participating banks having credit appetite. Credit policy and practice is often a bigger challenge than technology in this regard. Banks with well-informed, supportive credit policies will already be familiar with the benefits of visibility, security and transactional control inherent in trade finance. In this respect, the added efficiency and comfort provided by the network should reinforce and hopefully extend their appetite.
Speaking of credit, an end-to-end finance solution, covering pre-shipment as well as post-shipment periods, results in credit risk against both seller and buyer. The source of repayment is the buyer but, until the invoice is approved, there is performance risk on the seller and any performance failure converts performance risk into credit risk as the bank seeks to recover its pre-shipment advance. For this reason, most traditional trade finance structures employ the “four-corner model” in which the seller’s bank takes risk on the seller and the buyer’s bank takes risk on the buyer. Some form of conditional payment undertaking between the two banks may be required in order for the end-to-end finance aspiration to be fully realised. Such instruments do exist in the form of the bank payment obligation (BPO) and the payment undertakings incorporated in smart contracts in DLT-based solutions. It will be interesting to see how this new network accommodates and builds upon concepts such as these.
Overall, the Trade Information Network looks like a positive step towards the digitisation of trade finance. Its limited initial scope reduces the barriers to adoption, but it seems likely that the network might in future want to include third-party data from carriers and other key stakeholders. This would significantly improve the risk mitigation benefits and increase credit appetite but also make adoption more difficult. The functionality to support the “four corner model” and to integrate with financing, payment and risk platforms may also prove to be critical to its success.
By Lionel Taylor and John Bugeja, founders of Trade Advisory Network, a specialist consulting firm in trade and supply chain finance