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Journal of Payments Strategy & Systems Volume 6 Number 3

Modernising global trade finance practices

Andr Casterman Received (in revised form): 2nd July, 2012
SWIFT, Avenue Adele 1, 1310 La Hulpe, Brussels, Belgium. Tel: +32 26554530; e-mail: andre.casterman@swift.com

Andr Casterman is Head of Banking and Trade Solutions at SWIFT and Co-Chair of the BPO Project at the International Chamber of Commerce (ICC).

Keywords: payments, trade finance, ICC, supply-chain finance, bank payment obligation, ISO20022
EVOLUTION OF GLOBAL TRADE PRACTICES IN RECENT YEARS Until the financial crisis of 2008, around 85 per cent of global trade was being conducted on an open account (OA) basis. The rationales for OA trade are clear: it is convenient and helps to lower cost. During and subsequent to the crisis, however, treasurers and finance managers increasingly recognised that, despite its convenience, there are challenges associated with the OA model, for both buyers and sellers, particularly relating to liquidity and risk. An OA transaction means that goods are shipped and delivered to the buyer (importer) before payment. Under OA terms, trade documents are delivered directly by the seller to the buyer, and banks get involved only at the end of the transaction to execute the payment. As the relationship between trading partners matures, conducting trade through OA can offer substantial benefits to both buyer and seller. First and foremost, buyers can reduce underlying costs associated with trade flows, specifically those relating to bank fees. Turnaround time also improves as a result of straight-through processing, which in turn facilitates cash forecasting and liquidity management for both parties

ABSTRACT The partnership between the ICC and SWIFT will revolutionise global trade finance practices by establishing paperless inter-bank practices and by leveraging electronic transaction data available from dematerialised business-to-business processes. As annualised trade growth is expected to accelerate after 2015, the need for modern trade finance practices based on electronic data flows becomes unquestionable. There has never been an equivalent instrument to enable an exporter to trade on open account terms with the same degree of confidence as a payment that will be executed in accordance with the terms of a letter of credit. Both the ICC and SWIFT believe that, by working together and leveraging their respective positions in the trade finance community, the Bank Payment Obligation rules (BPO) will have an important role to play in supporting the development of international trade in the 21st century and in addressing cost pressures in the face of increased automation and changes in the regulatory environment. The time has now come for banks to prepare for this innovation and start extending their supply-chain finance services from invoicebased processing services (eg e-invoicing, factoring and reverse factoring) to BPO-based services such as payment assurance, pre-shipment and post-shipment finance.

Andr Casterman

Journal of Payments Strategy & Systems Vol. 6, No. 3, 2012, pp. 225231 Henry Stewart Publications, 17501806

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and reduces the need for external credit facilities. Moreover, both parties are also able to cut down operational requirements as a result of less trade-related documentation. As attractive as it sounds, there are a variety of challenges associated with OA transactions. To begin with, while the buyer stands to benefit from improved cash flow and cost savings, the seller faces the risk of payment delay or default after the shipment of goods. When the balance of power between a buyer and a seller does not favour the buyer, it is not easy for the buyer to convince the seller to accept OA terms. In some instances, the buyer may need to provide a standby letter of credit (L/C) or payment guarantee as security, which increases the overall cost. More commonly, the buyer may need to issue a commercial L/C if the seller is not agreeable to OA terms. Some sellers may also require buyers to assist with financing the trade flow as a form of risk mitigation. Operationally, there could also be additional administrative requirements such as reconciliation of payment information with purchase orders. Similarly, the seller also faces a variety of OA trade-related issues besides those associated with risk management and payment. At the top of the list are securing financing and identifying ways to remove receivables from its balance sheet. There is now the opportunity to mitigate these risks and to respond to the various financing needs while still capitalising on the advantages of OA trade. The answer is coming from SWIFT and the International Chamber of Commerce (ICC).
TRADE IS SET TO GROW BY 73 PER CENT IN THE NEXT 15 YEARS According to HSBCs Trade Forecast, the pace of world trade will accelerate over

the next ten years and will be driven by two things: first, demand from the emerging economies for commodities and infrastructure to facilitate economic development; and secondly, the increased integration of global supply chains driven by the worlds largest commercial businesses. The Trade Forecast is predicting that world trade will grow by 73 per cent in the next 15 years, with merchandise trade volumes in 2025 hitting US$48.5 trillion, compared with todays US$27.2 trillion.To achieve this growth, the forecast is predicting that companies across the world will increase their trade activity by a combined 4.1 per cent between 2011 and 2025. The Trade Forecast anticipates that Egypt, India, Vietnam, Indonesia, China and Brazil will be the international powerhouses driving world trade growth in this period. The international business landscape will be reshaped through new emerging trade trends. The Trade Forecast predicts: a rapid expansion in exports and imports between newly emerging economies; a redistribution of global supply chains as developed economies integrate emerging markets into their supply chains to maintain their position as leading trading nations while competing in the new global landscape; and a sharp rise in commodities and infrastructure trading fuelled by the development of emerging economies around the world.
A UNIQUE PARTNERSHIP TO ACHIEVE AN AMBITIOUS GOAL The present author advocated in his initial Opinion Piece1 that the time had come for the International Chamber of Commerce (ICC) to embrace the Bank Payment Obligation (BPO) rules, and help the industry establish best practices in supply chain finance. He also suggested that a set of ICC rules governing collaborative supply-chain finance will be a key

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milestone for the trade banks, as such rules will offer a legally binding, valid and enforceable risk mitigation instrument for financing open account transactions. One year on, at Sibos in Toronto, the ICC and SWIFT confirmed their joint ambition and action plan to provide the global trade industry with new rules and tools in support of the development of international trade in the 21st century. The ICC was established in 1919 to facilitate the flow of international trade. It was in that spirit that the Uniform Customs and Practice for Documentary Credits (UCP) were first introduced in 1933 to alleviate the confusion caused by individual countries promoting their own national rules on L/C practice. The objective was to create a set of contractual rules that would establish uniformity. The ICC rules on documentary credits, UCP 600, are the most successful privately drafted rules for trade ever developed. SWIFT is a member-owned cooperative through which the financial world conducts its business operations. SWIFT provides a worldwide communications platform, products and services that allow customers to connect and exchange financial information securely and reliably. SWIFT also acts as a catalyst to bring the financial community together collaboratively to shape market practices, define standards, such as the ISO 20022 financial messaging standards, and develop global technology solutions, such as SWIFTNet messaging and transaction matching services. The recently signed partnership is now well under way, with an ambitious timetable aiming to establish the new BPO rules by Q2 2013. The goal of both industry-owned organisations is to enable banks to extend the benefits of the L/C to the OA world by re-using electronic transaction data available from their corporate customers. Using the BPO, sellers

will benefit from timely payments, whereas buyers will be able to support pre-shipment finance of their strategic suppliers and avoid conceding advance payments. The importance of the involvement of the ICC cannot be overestimated, as it will mean that the BPO will benefit from the ICCs extensive experience in managing trade-related industry rules, and it also provides the BPO with another critical component: an industry-recognised dispute resolution capability. Under the agreement, the ICC will develop industry standard rules for the BPO. These rules will apply to any BPO transaction and will form the bedrock of the future standing of the BPO, potentially elevating the BPO over time to a position similar to the L/C. The future ICC BPO rules will be platform agnostic, meaning that they will apply to a BPO transaction irrespective of the electronic matching platform that has been used to create and transact the BPO, resulting in the obligor and recipient banks under a BPO no longer being limited to using SWIFTs own platform, the Trade Services Utility (TSU).
OPPORTUNITY FOR THE TRADE FINANCE INDUSTRY The physical supply chain has significantly increased efficiency through the use of new technologies and business models. By doing so, trading counterparties have accelerated their industry-specific processes, reduced handling costs and inventories, increased visibility and improved forecasting and planning. Some industries have succeeded in shortening order and delivery processes from an average 20-plus days to same-day execution. On the banking side, however, most of the supporting global trade finance processes have not been optimised sufficiently, owing to, for example, paper-based prac-

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tices slowing down key processes such as discrepancies handling. The time has now come for the trade finance industry to link the delivery of financial services to what is actually happening in the physical supply chain in a more efficient way, ie using electronic transaction data. The emergence of trading hubs in some countries (eg South Korea, Taiwan, Hong Kong) and business-tobusiness e-commerce/e-invoicing platforms (eg Ariba, GXS, PayModeX, Peppol, Tradeshift, OB10) has significantly increased the dematerialisation of business-to-business processes such as sourcing, negotiation, quotation, ordering, shipping and invoicing. Such new electronic business-to-business processes are creating a new paperless world where efficiency gains and cost reduction are achieved to the benefits of both buyers and sellers. Buyers and sellers now expect their banking partners to follow suit.
ICC BPO LEVERAGES ELECTRONIC TRANSACTION DATA The dematerialised business-to-business processes offer banks the opportunity to extend todays paper-based trade finance services to new services based on electronic transaction data. The cooperation between the ICC and SWIFT is delivering a complete package made of new rules (the BPO) as well as new messaging standards (ISO 20022 standards) and a new SWIFT cloud application (TSU) for supply-chain finance (SCF). The new rules and messaging standards enable banks to leverage electronic transaction data available from the business-to-business world (see Figure 1). Using data representing the purchase order, the invoice, the certificates and the transport documents offers banks the ability to accelerate global trade finance processes as well as increase visibility on

transaction details (eg line items) in order to mitigate risk and finance transactions better.
ICC BPO OFFERS A MODERN INSTRUMENT There has never been an equivalent instrument to enable an exporter to trade on OA terms with the same degree of confidence that a payment will be executed in accordance with the terms of an L/C (see Figure 2). The BPO is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date, after a specified event has taken place. This specified event is evidenced by feeding the relevant data elements taken from a range of associated OA documentation such as purchase orders, commercial invoices, advanced shipment notices and bills of lading into a shared matching application, which then generates a match report to show that the description of goods shipped matches precisely the description of goods ordered. The BPO places a legal obligation on the issuing bank to pay the recipient bank, subject to the successful matching of compliant data. In short, the BPO delivers business benefits and security equivalent to those previously obtained through a commercial L/C, while at the same time eliminating the drawbacks of manual processing typically associated with traditional trade finance. Certainty of payment not only facilitates access to flexible forms of financing, but also supports the more efficient management of working capital, enabling the release of substantial volumes of cash which might otherwise be trapped in the supply chain. Whereas banks have attempted in part to plug the gap, such as through the issuance of conditional payment guarantees or standby L/Cs, the BPO acts as an electronic inter-bank con-

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Delivery of goods

Carriers e commerce e-commerce e-invoicing

Shipment(s) Transport documents Certificates

Sourcing

Quotations

Buyer

Purchase order Transaction data for risk & financing services Buyers' Bank

Invoices

Seller Transaction data for risk & financing services

Figure 1 The ICC BPO rules and SWIFTs TSU enable banks to leverage electronic transaction data available from business-tobusiness platforms and to accelerate risk and financing services

ICC BPO ICC BPO SWIFT TSU SWIFT TSU

Seller's Bank

Source: SWIFT

Contract

Contract

Contract

Buyer
Application Documents

Seller
Documents Advice

Buyer
Data

Documents

Seller
Data

Buyer

Documents

Seller

Letter of Credit
Documents

Bank Payment Obligation

Data

Open Account

Figure 2 The BPO brings the benefits of the L/C to the OA market

LC Issuing Bank

Issuance

LC Advising Bank

BPO Obligor Bank

Payment

BPO Recipient Bank

Buyers Bank
Payment

Sellers Bank

Payment

Bank services based on paper document processing

Source: SWIFT

Bank services based on electronic trade data exchange

Bank services limited to payment processing

ditional promise to pay, offering a comprehensive and cost-effective risk mitigation and financing tool to all trading counterparties.
ICC BPO EXTENDS THE SCOPE OF SCF Although data-driven SCF solutions are widely available from large banks and from some third-party vendors, most are limited to the last mile of the transaction, ie using the invoice approved by the buyer to finance the suppliers receivables. Although

addressing suppliers working capital issues, this type of offering only represents a small, yet relevant, step when considering the real potential of SCF across the full transaction life cycle. With the BPO, banks are involved from the very early stage of the trade transaction, ie the raising of the purchase order, and at every stage of the transaction life cycle (see Figure 3). This is a key difference for banks that wish to provide, for example, payment risk mitigation and/or pre-shipment finance in a secure, efficient and collaborative way, ie leveraging their

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Figure 3 The BPO allows banks to extend their SCF services to higher-value risk and financing services using electronic data

Tomorrows extended scope of SCF services using the BPO to offer risk mitigation and financing using data

Today's SCF services focus on low-margin invoice-based processing and discounting services

Goods ordered

Production of goods

Goods shipped

Invoice issued

Payment & cash mgmt

Purchase Order

Certificates

Transport Documents

Invoice

Approved Invoice

Payment Initiation

Pre-shipment finance Payment assurance

Source: SWIFT

Post-shipment finance

E-invoicing Factoring

Reverse Factoring

Payment processing

Timely payments

network of correspondent banks. Such services represent much higher value for corporates. Both large and mid-caps sellers will enjoy timely payments when dealing on OA terms, since payment will be done by their own bank, independently of effective payment by the buyers. When necessary, buyers with strong credit ratings will be able to facilitate pre-shipment finance to support their critical suppliers while not using their own capital, as is often the case today. Contrary to todays reverse factoring services, which are driven by large buyers, the BPO is offering an industry-wide multi-bank instrument relevant to any type of corporate in any industry.
CONCLUSION Both the ICC and SWIFT believe that, by working together and leveraging their respective positions in the trade finance community, the BPO will have an important role to play in supporting the development of international trade in the 21st

century and in addressing cost pressures in the face of increased automation and changes in the regulatory environment. Using electronic transaction data, the banking industry is preparing itself to respond better to the desire of their corporate clients to accelerate financial processes and optimise working capital. The time has now come for banks to prepare for this innovation and start extending their SCF services from invoice-based processing services (eg einvoicing, factoring and reverse factoring) to BPO-based services such as payment assurance, risk mitigation, pre-shipment and post-shipment finance. Banks will be able to respond better to key issues for sellers, such as delayed payments, whether dealing on L/Cs or open accounts. They will also be able to speed up processing and enable buyers to optimise credit lines and to reduce handling costs and inventories. Finally, buyers will be able to avoid supplier defaults by facilitating pre-shipment finance without using their own capital.

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A total of 38 banking groups have understood the opportunity offered by the BPO and confirmed their decision to adopt the BPO rules. As corporates will discover the benefits of the BPO in 201213, they will be expecting their banking partners to react quickly. Waiting for the ICC publication of Q2 2013 and missing the opportunity to get ready in

2012 is in the authors view a mistake that banks ought to avoid making.

(1)

REFERENCES Casterman, A. (2010) Collaborative Supply Chain Finance: A Few More Steps to Go, SWIFTs Dialogue Magazine, October, pp. 1820.

APPENDIX List of banks adopting the BPO (June 2012)

Americas Banco do Brasil Banco Ita BBA Bank of America BMO Capital Markets BNY Mellon Citi J.P. Morgan EMEA Barclays BNP Paribas Byblos Bank Commercial Bank of Dubai Commerzbank Deutsche Bank FIMBank First National Bank of S. Africa HSBC ING National Bank of Greece Qatar National Bank SEB Standard Bank of South Africa The Royal Bank of Scotland UBS Unicredit Asia/Pacific ANZ Bangkok Bank Bank of China Bank of Communications BTMU China Citic Bank China Minsheng Bank Hua Nan Bank Kasikornbank Korea Exchange Bank Siam Commercial Bank Standard Chartered Bank SMBC

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