Keeping up with digital trade finance

Khalil Hegarty and Tyler McDonald

Associate Director and Consultant at ITS Global

The single-most important issue to hit global trade over the past two years has been trade tension between China and the US, a tension with knock-on effects into trade in the broader Asia-Pacific region.

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Much of this is due to falls in aggregate demand in both China and the US.

" Trade finance is one of the oldest types of finance.”

Although there are some potential winners, most economies are simply caught in the crossfire with little recourse. So what can economies and companies do in order to mitigate the impacts?

Overcoming trade inefficiencies is a clear area for improvement.

In the past five years global output growth has been quicker than trade growth, suggesting more barriers to cross-border trade. In its latest forecast, the Organisation for Economic Co-operation and Development (OECD) found growth in global trade volume slowed to around 3 per cent in the first half of 2018, down from 5 per cent in 2017. Protectionism is a drag on trade but the administrative systems underpinning trade also have an impact.

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Closing the gap

Trade finance is one of the oldest types of finance. It is essentially an IOU guaranteed by a bank or financial institution that helps bridge the trust gap between buyers - who want guarantee of goods or services - and sellers - who typically want up-front payment.

The importer’s bank acts as an intermediary for the transaction; they issue a letter of credit to the exporter via the exporter's bank. The letter of credit promises to pay the exporter's bank once documents (such as a bill of landing) have been provided by the exporter.

These documents prove the goods have been loaded onto the cargo ship, truck, or train. In this way, both the importer and exporter are protected. The banks take on the role of holding the money for each party.

The ‘trade finance gap’ is an estimate of world trade without access to conventional trade finance products. The Asian Development Bank estimates the gap is worth around $US1.5 trillion. Asia's share of the trade finance gap is about 40 per cent of the global total.

What that means is potential trade does not go ahead for no other reason than a financial system is not in place.

As much as two thirds of the unmet trade finance demand is accounted for by SMEs in remote regions of emerging markets without the creditworthiness or collateral to make them bankable.

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Speeding up

The trade finance market is in need of a tech overhaul. The system has been in place for hundreds of years with few changes in the process and the amount of paperwork. The market is antiquated, time-consuming and inefficient. JP Morgan estimates Fortune 500 companies spend over $US81 billion annually on unnecessary working capital and supply chain costs.

Although fintech and digitisation represent a huge opportunity for trade finance, it is inherently complicated. Any reform requires mass adoption, interoperability, legal and regulatory acceptance.

Many trade financiers believe blockchain can close the trade finance gap. Blockchain keeps records of chains of transactions under a secure, coded lock that can be seen by all the participants. It's not possible to make changes to earlier transactions but it is possible to add a new transaction (or 'block').

Trade transactions require multiple pieces of documentation and approvals for different elements of the transaction (e.g. finance, shipping, customs, etc.) making blockchain appear to be an ideal solution: it removes the need for multiple copies of the same document stored on different databases.

Among the best of blockchain's advantages is the speeding up of transaction settlement time (which currently takes days), increasing transparency between all parties, and unlocking capital that would otherwise be tied up waiting to be transferred between parties in the transaction.

Future of soybeans

In May, HSBC and ING carried out the first commercially viable trade finance transaction via blockchain for a Cargill shipment of soybeans from Argentina to Malaysia.

The transaction, on a single shared platform, took less than 24 hours to complete after details were shared with the banks, compared with 5 to 10 days for conventional paper-based, letter-of-credit transactions.

Recently the Hong Kong Monetary Authority's E-Trade Connect went live using distributed ledger technology. This platform is being developed by OneConnect, the tech arm of Chinese insurance giant Ping An, and involves ANZ, Bank of China, Bank of East Asia, DBS, Hang Seng Bank, HSBC and Standard Chartered. The system has been in train for almost a year and will specifically bring letters of credit on to HKMA's platform.

HKMA and the Monetary Authority of Singapore are also collaborating on the Global Trade Connectivity Network (GTCN), which aims to harmonise platforms such as HKMA's with others in the region. It is due to be launched this year.

The question Australian businesses and policymakers should be asking is how and when Australia will participate in what is clearly a regional shift towards digital integration.

The Joint Standing Committee on Trade and Investment Growth's Inquiry into Trade and the Digital Economy reported in September 2018. It recommended making the 'single window' for trade a priority, promoting digital trade standards. However, DHA's submission to the Inquiry was talking about introducing a single window over the course of the next decade – more than 10 years behind counterparts in Singapore and New Zealand.

The business and economic case for digitising trade is simple: it speeds up trade and automates compliance, reducing trade transaction costs (TTCs) and making trade more efficient.

The compliance case is also compelling. Digitisation holds the potential for regulatory agencies to gain better data on transactions, with a view to preventing fraud, specifically trade-based money laundering (TBML). This can include misrepresenting the price of goods or shipping nothing at all with false invoices.

Regional trade hubs such as Singapore and Hong Kong thrive on trade; they are among the busiest ports in the region. It is absolutely vital they maintain their competitiveness and efficiency.

Australia is an export-oriented economy. This is one of the reasons Australia has pursued relatively aggressive trade liberalisation strategies over the past decades. However, streamlining trade transactions, and moving ahead with the best technology, is essential to Australia's immediate and long-term interests.

In a time of trade policy uncertainty, making trade cheaper for Australian exporters - from trade finance to customs clearances - will go a small way to offset growing protectionism around the world.

Khalil Hegarty is Associate Director and Tyler McDonald is a Consultant at ITS Global

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.