Trade finance, in both domestic and international financial transactions, is often utilized when one company seeks to import a shipment of goods from a supplier (or exporter). These transactions comprise an enormous amount of global trade. It is estimated that approximately 80 to 90 percent of world trade relies on trade finance. In fact, almost any time goods or services are bought or sold across any border, there is some form of trade finance involved.
Due to the cross-border nature of the transaction, payment and shipment do not occur simultaneously (or in the same day or even week). The importer needs to pay for the goods but wants to ensure that the goods will arrive as ordered. Meanwhile, the exporter is hesitant to ship the goods without being certain that payment will arrive for the goods. Because neither party wants to bear the risk, a trusted third party is used to bridge the payment/delivery gap.
In addition to the lag in payment and delivery, another downside to trade finance is the involvement of massive amounts of paperwork. One of the main difficulties is facilitating the flow of large volumes of documentation between the parties. With each step of the process, all the paperwork must be confirmed between various parties to ensure its accuracy. This structure of trade financing arrangements has been in place for hundreds of years with fairly little change in methodology.
Distributed Ledger Technology (DLT) or blockchain technology, however, is now providing a novel way to both reduce costs and increase efficiency by replacing the flow of paper for trade finance with digital data flows, as well as providing a streamline payment between the parties. DLT was born out of the operational platform behind bitcoin transactions. DLT is touted as an emerging technology that can provide a transparent way to digitally track the ownership of assets, expedite transactions, facilitate secure payment processing, and electronically initiate and enforce contracts. At a very high level, DLT creates a digital ledger of transactions that can be distributed through a network of computers, allowing details of the transaction, or the transaction’s database, to be accessed, viewed and potentially updated by a number of different parties. This differs from the traditional, centralized ledger system, where a single party is responsible for maintaining the details of the transaction.
DLT is made possible through the application of encryption and algorithms that allow new transactions to be aggregated, encoded, and appended to an existing chain of transactions. Put simply, any time a change to data or an asset is proposed, a unique digital fingerprint is created. That fingerprint is sent to another part of the network chain for validation, which is organized around the networks’ previously agreed-upon rules. These features enable network participants to validate the accuracy of new transactions and prevent the history of transactions from being modified.
Blockchain is seen as a way to streamline the trade finance process. Because a distributed ledger can be updated to reflect the most recent transaction, it removes the need for multiple copies of the same document stored on numerous databases among various entities. Instead of constantly reconciling documents and databases against each other, documents stored on the blockchain are already validated and verified.
The advantages of utilizing blockchain could accelerate transactions, increase transparency between the parties, and provide access to capital that would otherwise be unavailable in a slower-paced transaction.
Because of these advantages, DLT is disrupting a centuries old process. Companies have already begun investing in, developing test programs, and, in some cases, are now utilizing blockchain in trade finance and receivables finance. Just last year, a Fintech company established The Fluent Trade Asset Marketplace, which is a blockchain-based open financial network and payment platform. The advantages to this type of blockchain-based network is that it provides global access to banks and capital providers while streamlining and automating the lending process and reducing costs. The allure of blockchain is spreading. Recently, Bank of Montreal (BMO), CaixaBank, Commerzbank and Erste Group have joined an initiative launched by UBS and IBM to launch a new trade finance platform built on blockchain, dubbed “Batavia.” Batavia is constructed on the Hyperledger Fabric Blockchain Framework, which powers the IBM Blockchain networks. Batavia is targeted for pilot transactions with customers on the network in early 2018.
Blockchain is poised to be an innovative and exciting platform for many different types of commercial loan transactions and highlights the growing importance of efficiency and transparency in the financial services industry. As this technology develops, businesses should be apprised of these new platforms and the expansion of global innovations in the financial services sector, as well as the legal and regulatory requirements that flow from the use of these novel and revolutionary technologies.