Swapping manual complexity for digital efficiency: the future of trade finance

By Alisa DiCaprio, Head of Trade and Supply Chain at R3 

Trade finance is going through a period of unprecedented evolution. Once an industry notorious for its stubbornness in the face of change, new and innovative digital technologies have now matured to the point where they are finally transforming it into a more streamlined and cost-effective place to do business for all participants.

Some of trade's biggest operational challenges – like incorrect documentation and KYC, non-interoperable systems, poor visibility, manual reconciliation – are now being addressed and overcome by forward-thinking digital solutions.

Enterprise blockchain is perhaps the most promising – and appropriate – technology to emerge for this sector. Trade is inherently a decentralised system. The industry is heavily intermediated – predominantly by banks that help to facilitate transactions and provide the financing behind them, but also by insurers, customs officials and other market participants. Over and over again firms have tried to apply centralised solutions to this decentralised system, which of course has never really worked.

The decentralised nature of blockchain makes it a perfect fit for trade finance. For the first time the entire industry is getting behind a technology and moving it into real world deployment at record pace.

Meanwhile, regulators are working with technology providers to understand how to audit and gain insight into the transactions taking place on these new blockchain-based platforms, and ensuring suitable laws are in place, including those relating to electronic documentation and electronic signatures.

The architecture underpinning the entire ecosystem of trade is undergoing complete digital transformation – but how are participants benefiting from this change?

Unravelling complexity

Many of the processes and technologies underpinning trade finance have not been modernised in decades. The result is that those transactions continue to rely on paper-heavy processing, unsuitable for the current digital age. Traditional technology required corporates to log into multiple portals and juggle relationships and documentation for each shipment.

These inefficiencies in trade finance mean that nearly USD $1.5 trillion of demand for trade finance is rejected by banks, according to the Asian Development Bank (ADB), with 60% of banks expecting this figure to increase over the next two years. Developing markets that rely heavily on access to trade can be severely hindered through these outdated processes.

In addition, businesses all over the world must navigate the growing threat of cyber-attacks, changing regulations, and ever-changing sanctions lists. Despite this complexity, cumbersome and time-consuming paper-based exchanges are still commonplace.

Take, for example, invoice financing. While a common activity, managing invoice payments and terms can be slow and inefficient for companies and their trading partners. They must navigate different currencies and jurisdictions, each with unique requirements in terms of contract terms and payments.

By digitising these manual processes and superseding ageing legacy systems, a technology such as blockchain has a real impact on reducing the costs, risks and delays to participants involved in trade finance.

If applied effectively, the technology has the potential to unlock the potential $1.5 trillion opportunity in global trade finance. Companies of all sizes will benefit from better visibility into trading relationships and easier access to financing options, beyond point-to-point relationships, to a global network of trading parties.

A decentralised, global network

Blockchain's integration across the financial services ecosystem has delivered some encouraging results so far. While the rollout has been more gradual than some of the more over-enthusiastic predictions, many see it as a brilliant innovation capable of remedying a lot of the operational pain-points perturbing financial services. As such, there is growing debate about how blockchain can provide decentralised solutions to solve many of the problems facing trade financing.

One such solution is real-time visibility, which is available via permissioned access to authorised network users, and gives buyers and sellers unprecedented transparency into the status of their transactions.

This single source of truth and use of smart contracts could remove a number of inefficiencies in the paper-heavy processes that exist in trade finance, such as negotiations of letters of credit. In addition, settlement finality removes the need for intermediaries to perform reconciliations. All of these applications could streamline the entire process.

Achieving the network effect

In order to move towards a truly digitised and connected ecosystem for trade finance, mass adoption on a global scale is essential. This elusive network effect can only be achieved if technology players prioritise forward-thinking and inclusive integration solutions that lower the barriers to entry for all types of companies involved in the trading process.

If only a handful of firms adopt a blockchain solution for invoice financing, for example, the solution is useless if one company needs to trade with another that is outside this circle of early adopters. All the other benefits of blockchain such as speed, efficiency and lower costs mean nothing if you cannot use the platform to connect with the necessary counterparties.

Like any piece of enterprise technology, blockchain will be most useful when used in conjunction with existing systems. The reality is that most businesses are not full digitally native and so will continue to rely on legacy systems – all to different extents – in the near future.

The key to unlocking blockchain's true potential, therefore, is not to try and oust these but to make sure the technology fits into the right places, with minimal cost and disruption to a firm's day-to-day business. Put simply, integration holds the single most important key to rewiring the $8 trillion global trade finance market.

As Head of Trade and Supply Chain at R3, Alisa is responsible for trade strategy, standards and governance design. Alisa was previously a senior economist at the Asian Development Bank and holds a PhD from MIT.