August 3, 2017
How the technology is upending conventions that have been in place for 5,000 years
Trade finance has enabled the exchange of goods for millennia. Babylonian cuneiform tablets dating back to 3000 BC mention the kind of promissory notes and letters of credit that still underpin international trade. And, aside from incremental improvements in the ways and means of trade finance, not all that much has changed in the fundamental elements of this approximately US$40 billion sector of the financial services industry over the past 5,000 years.
That is, until now. The advent of blockchain technology is on the verge of revolutionizing trade finance—and it threatens to leave behind any financial services company that doesn’t move with the times.
An outdated process with many pain points
Trade finance makes cross-border trading possible because it introduces trust. You may not trust that some unknown seller will deliver the right goods, but you do trust your financial institution. Your financial institution may not know the seller either, but it does know (and trust) the seller’s bank. Trade finance tools depend on third-party intermediaries (usually a bank) to secure and protect transactions that involve sending goods to/from a foreign country. In completing an international trade transaction, banks require the coordination of multiple agencies to reduce risk and accommodate the demands of each side of a trade.
This process is prone to delays and errors that cost both money and time, and if there is a discrepancy, there is no single source of truth for reconciliation. A delay in payment, for example, can tie up working capital that could otherwise be used more strategically. Delays can also force suppliers to seek additional, and more expensive, financing. The disconnect between the supply chains of financial and physical goods and the manually intensive nature of trade finance heighten the potential for error. Moreover, because the trade finance process is paper-based with no integration in the decision workflow, when delays in shipments and/or payments do occur they tend to create a cascade effect that requires additional steps throughout the process.
A technology tailor-made for trade finance
Blockchain technology is likely to disrupt business as usual in trade finance by addressing these pain points. Its smart contracts allow companies to automate manually intensive processes and authenticate the exchange of value in ways that they never could before. It enables secure interoperation and communication with other internal systems and the auto-updating of clauses through “smart templates.”
Blockchain’s distributed ledger provides every party in a transaction with access to the same data at the same time, embedding complete transparency and accountability in every transaction. Changes can be confirmed in real time. It enables effective monitoring and auditing by participants, supervisors, and regulators, it creates a single point of truth, and it provides shared audit trails that streamline dispute resolution at the enterprise level.
In short, the application of blockchain technology to trade finance offers greater coordination and a host of process benefits. It drives down costs and enhances efficiencies.
The blockchain race is underway
Trade finance can be a complex pursuit, but a few financial services companies and blockchain providers already are moving trade finance blockchains out of the development labs and into the marketplace. In doing so, they are leading what will likely be a major disruption to the established dynamics underlying the international exchange of assets among companies and between companies and their customers.
My colleagues at PwC and I recently conducted a proof-of-concept project with a leading technology company that embedded Blockchain-as-a-Service (BaaS) as middleware in a supply chain finance setting. The project successfully used a blockchain ledger to provide a more automated, centralized, and secure transactional framework. It also confirmed the design of a commercially viable and scalable blockchain solution that the tech company can offer as a trade finance remedy.
In working with trade finance companies and service providers on their blockchain initiatives, we suggest starting small with this new technology. Choose relatively simple instruments, such as standby letters of credit, as a pilot project. Use that project to familiarize the organization with blockchain and to identify and work through any sticking points. The lessons financial services companies learn here will help smooth the way as they apply blockchain to more complex instruments and transactions.
Trade finance exists because international buyers and sellers need intermediaries to negotiate with each other. Blockchain addresses that need in a simpler way by building trust into every transaction. By definition, a transaction is complete only when everyone agrees that it is complete. It makes sense that many players in the market are exploring the technology, and we expect that it could turn the multi-billion dollar trade finance industry on its head. But there’s a lot to learn about how to integrate this technology with your existing operating model. Now is the time to explore how you can take advantage of blockchain technology and use it to give your firm a competitive advantage.
For more of my blockchain perspectives, check out a recent episode of the 7 Day Yield.