The Letter of Credit, one of the oldest trade finance instruments, is being transformed through the use of blockchain.
We have all heard about blockchain and since its origination, a huge number of articles about this topic have been published on numerous media. The technology behind blockchain is interesting, but what’s been happening beyond a lot of hype? What will it bring to the business and to our clients in the near future? This article explains why trade finance is one of the most active areas for blockchain innovation, even though international trade seems like an unlikely place to achieve a breakthrough.
Blockchain and LC
Trade finance is internationally applied as a tool to minimize risk to the benefit of buyers and sellers of doing business across international borders. Trade finance products (bank guarantees, letters of credit (LC) stand-by LC, and collections) are long-established and universally recognized financing products. The global LC market amounts to approximately US$4.0trn p.a., of which around half is LC. The market is substantial, because LCs are widely accepted and secure tools for mitigating risk and enabling the financing of trade transactions.
The LC is a secure and proven instrument, but until today the process has not been digitized, and there are a large number of stakeholders involved. As a result, issuing an LC is cumbersome and error-prone. It is still mainly based on physical documents and manual processes, involving many stakeholders (see chart). The process involves paperwork to complete transactions, certificates, couriers, scanning, checks, hard-copies and originals, Bills of Lading to prove ownership, jurisdictions require originals, stamping etc.
It’s not surprising that this process is vulnerable to human error. Small discrepancies can lead to rejection of documents and the need to do some work again. This in turn means time delays (can be days), demurrage costs (up to US$-000’s per day) in ports, and pressurized working capital (fines and late payments). Individual innovations to the LC have been tried before, such as the Bank Payment Obligation (BPO) but have not become widely used.
Can the use of blockchain replace the paperwork surrounding the LC? The answer is ‘yes, it can’, and more besides: payments can be faster and more secure, bringing down other costs. There are several important solutions to the problems faced by businesses involved in international trade, which blockchain brings within reach, from reducing fraud; to retaining ownership and control of data; to sharing secure access to KYC data; and implementing smart contracts. However, international trade has proved a tough environment for innovation over the decades.
Can trade (finance) change?
Reflecting its potential to bring down costs and enhance security, there is a hive of activity surrounding blockchain in different parts of the trade industry. Over the past few years projects have targeted the different products and processes involved, in the shipping and logistics industries as well as in trade finance. In the background there is also a wave of related technologies (internet of things, machine learning, artificial intelligence, cloud computing, API (automated programmable interface) big data, quantum computing (see: WTO2019), which all increase the potential gains of digitization and standardization.
What’s the hold up in international trade? Every innovation has certain barriers to overcome before it can move beyond a proof of concept. In international trade, innovation has not been lacking, but breakthrough technologies have been rare. Players in the industry have digitized their own infrastructure to an extent, creating ‘digital islands’. But between the islands the ability to share and exchange digital data securely to multiple parties in real time is lacking. A single platform for the whole industry is not feasible, though increased standardization, when it comes, will help, as would international consensus about the legal status of e-signatures and e-documents.
But while we wait for standardization initiatives to bear fruit, interoperability is the key to achieving a critical mass of users, which is necessary for any innovation to be adopted. There is more logic in developing a highly interoperable product than in seeking to develop a single global platform. The most versatile networks will be able to connect different Digital Ledger Technologies; between specific applications and platforms; and between the digital and physical worlds (including back-office systems, and smart contracts).
The future is there: CONTOUR, transforming global trade
CONTOUR currently offers a complete, based on blockchain, digital letter of credit service, and will be further developed to provide other documentary trade services. With a mission of “transforming global trade”, CONTOUR significantly simplifies and accelerates international trade businesses from weeks to just hours: it will make trading easier and faster across the globe.
CONTOUR started as a consortium of trade banks – HSBC, BNP-Paribas, SCB, ING, Bangkok Bank, CTBC, SEB -, R3 (Corda), CryptoBLK (application builder) and Bain & Co (PMO) to digitize the Letter of Credit (“LC”) process, client/segment agnostic and leveraging on blockchain technology. CONTOUR was incorporated in December 2019 and has its registered office in Singapore.
CONTOUR aims to transform global trade and to become the market standard for LC’s, with easier initiation, shorter issuance processing thanks to less errors, leading to fewer disputes and more efficient exchange of (digital) documents. An additional key value is the shorter time to settlement, which is also achieved through e-presentation of underlying documents and e-Bill of Lading. This goes much faster, and the more the reliability of instant discrepancy resolution and simplified sanctions screening is proven, the more that throughput time will reduce. An important aspect that may contribute to the success and adoption of CONTOUR is that its LC is governed by the ICC standards for digital issuance of LCs (e-UCP).
Inter-operability is a strength for CONTOUR, both thanks to its underlying Corda technology, and thanks to the network of partners ING has developed it with. There is no limit to the application of CONTOUR in terms of segment, industry, jurisdiction or geography, although at launch we will start with the most important trade corridors. Having the trade banks on board gives a head start in driving the widespread adoption of CONTOUR, and gives a real chance of creating an industry-standard product.
Stakeholders face diverse opportunities and challenges in coming on board with CONTOUR. For corporates, CONTOUR will further enhance the LC process for existing corporate clients. The challenge will be to expand the network quickly and extensively enough through the third parties who play a vital role in the chain: logistics providers, warehouses, shippers and insurers. Success requires adoption of the application, API’s to the reporting systems (SAP, Oracle, etc.) and if not already licensed, e-presentation applications such as Bolero, essDocs, and CargoX and the likes need to be connected.
What about banks? CONTOUR represents the digitization of the LC process, but does not fundamentally change banks’ role within: they remain the trusted intermediary between buyers and sellers.
Does CONTOUR as an LC solution work? What did we learn from our clients?
The CONTOUR application has been developed to improve the process of using LCs, but we have to be sure that the application is better than what is now offered in the market, so it has to be faster, efficient and has to meet the market’s expectations.
In particular, blockchains used to support business transactions, as opposed to those underpinning digital currencies such as Bitcoin, need to support our clients in their day-to-day work while meeting some extra requirements. Both the client and ING need guarantees of data security, privacy, and a robust mechanism for identifying counterparties in a transaction (KYC). Other items on the wish list are the ability to handle high volumes of transactions per second (TPS); and the availability of technical support is a requirement for network participants to guarantee continuity.
In order to test whether the partners were meeting the grade with CONTOUR, the partner banks conducted multiple pilot transactions and obtained important client feedback. ING did the following:
May 2018: ING did the world’s first commercial trade-finance transaction using the CONTOUR application together with one of its CONTOUR partners, HSBC. The trade involved a cargo of soybean meal shipped from Peru to Malaysia. ING and the other bank validated the LC application in this pilot transaction for a US food group. CONTOUR works on one central platform, which minimizes the time and paper trail needed to make the trade.
In October 2018, the trade finance team at ING Bank Belgium (Geneva branch) executed a trade transaction using the further enhanced digital platform enabling a cross border transaction from a US client to their counter party in India, banking with HSBC in a totally digital form. The main improvement to the first pilot was that this second one allowed a digital transfer of the e-bill of lading presented by Bolero, integrated in CONTOUR from the seller to the buyer in the underlying trade. In order to achieve full digital throughput of trade transactions, this is an important milestone.
In September 2019 the trade finance team at ING Śląski Poland validated the platform and issued an LC for the delivery of hardware on the account of one of their Polish clients in favor of a Taiwanese supplier, advised by CTBC. CONTOUR was tested for its additional features, functionality and customer experience. Valuable information, both on technology and functionality was gained from this pilot.
We have learned from these pilots that full digitization reduces the time from initiation to payment by 9-11 days. We also learned that straight through digitized processing will erase time consuming hand-overs and reduce the through put time for LC’s by 3-5 days for each bank in a single transaction. Overall, CONTOUR offers a substantial reduction in the time taken for transactions. As well as saving time, users will also enjoy transaction risk reduction as a result of better availability and matching capabilities of their data.
Over the last 2 years, CONTOUR has seen tremendous success and its partners conducted multiple live pilot transactions, all focused on the digital LC.
CONTOUR is launching the Beta Network, which is available to all banks and corporates. Beta provides the ability to onboard to a temporary network under a lightweight legal framework, until the full production rulebook and hosting options are available.
As investor in CONTOUR and one of the initiating members of the project, ING is in a position to guide the next steps of this project. In the first 2-4 years we expect CONTOUR to be used by our existing clients alongside traditional products. While the network of members and users of the application will expand gradually in the coming years, banks like ING will be able to attract new volumes based on the assumption that the technology will be further developed to cover all LC types; shipping companies and clients are connected to P&I-certified e-bills of lading vendors; the CONTOUR network expands, i.e. other banks and companies (traders and corporates will adopt CONTOUR, and digitization further continues in the full supply chain easing the use of LC.
The coming months and years are an exciting time as the next steps in CONTOUR’s journey could disrupt one of the oldest products in trade finance, to the benefit of trade finance banks, suppliers, buyers, logistics providers and others involved in international trade.