In the second part of the EPI
series on trends and opportunities in Supply Chain and Trade
Finance, Duygu Tavan analyses an impending payment code for trade
transactions developed by SWIFT and backed by the International
Chamber of Commerce: the Bank Payment Obligation
Go deeper with GlobalData
Nobody likes to be excluded from a group or
activity they feel they can contribute to and benefit from. Banks
are no different– but in international trade finance, suppliers and
buyers do not necessarily rely or depend on banks until they have
to actually execute a transaction.
Buyers and suppliers can indeed agree their
trade terms between themselves, an action that is called Open
Account. Open Account trade terms nowadays make up about 85% of
world trade as a result of globalisation and the rise of the
internet. The remaining 15% of world trade is based on Documentary
Credits, mostly Letters of Credits, which are issued by banks.
There are benefits and pitfalls in both trade terms, but a new
solution by SWIFT and the International Chamber of Commerce (ICC)
is going to marry the best of both worlds when it comes into effect
during the second quarter of next year. The Bank Payment Obligation
(BPO) could enable banks to reposition themselves as the valuable
and necessary link between trade counterparties, a crucial
requirement for banks to succeed in the profitable business of
Supply Chain Finance to corporates.
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By GlobalDataBefore the rise of the internet and more
efficient and easier access to trade connections, banks were
corporates’ essential partners in trade:
“A local company from the US would
request the issuance of a letter of credit, which we create that on
behalf of their supplier and forward it to the supplier’s bank, for
instance, in China,” says ????. “The supplier’s bank then contacts
the seller and requests documents required in the letter of
credit.” Apart from issuing the Letter of Credit, the bank
does not get involved in the supply chain until the time of the
payment.
The terms of the Letter of Credit are based on
the ICC’s rules on global trade practises to streamline
cross-border trades.
Banks issue a Letter of Credit at the request
of a buyer. This Letter details payment terms, such as the maturity
date, and the agreements between the buyer and supplier, such as
how many or what types of goods will be shipped. This Letter is
then sent by the buyer’s bank to the supplier’s bank through the
SWIFT or another network. The supplier’s bank then contacts the
supplier and requests the documents that are required in the Letter
of Credit. If the documents of both parties match, the supplier’s
bank can finance the supplier’s manufacturing costs.
“There are quite a few steps involved in
Letters of Credit, which can be streamlined depending on the terms
the buyer and seller agree upon,” says Bruce Proctor, head of
global trade and supply chain finance at Bank of America Merrill
Lynch (BofA ML).
With so many steps, Letters of Credit are
costly to issue and handle, and take a long time before a financing
solution by the bank can be offered to the supplier.
That is the main reason why Open Accounts have
now account for about 85% of worldwide trade – trade terms can be
agreed between the two parties without the involvement of a
bank.
“It is easier for buyers and sellers to agree
trade terms between themselves,” says BofA’s proctor.
The pitfall regarding Open Accounts is in the
lack of bank presence: Without the bank, the agreement between the
supplier and buyer is based on trust, which can be risky business
if the companies are new trade partners, and if the supplier or
buyer is based in an unstable economy.
Enter the BPO
In order to cancel out the negatives
by-products of both Open Accounts and Letters of Credit, SWIFT has
created the BPO – a virtual Letter of Credit that can be cited as a
payment code on Open Account trades.
SWIFT’s head of banking and trade solutions,
Andre Casterman says the BPO is an irrevocable commitment to
payment. It assures payment security just like a Letter of Credit
does. But because the mechanism of the BPO is electronic, it costs
a fraction of what a Letter of Credit would.
By using the BPO, banks become the crucial
link between suppliers and buyers. The BPO creates a bank-to-bank
trade corridor, placing banks at the heart of Supply Chain
Finance.
The BPO is based on the ISO 2022 messaging
standard by SWIFT, which has developed a special cloud-based
matching engine, the Trade Services Utility (TSU). The TSU contains
trade-relevant and necessary data, such as corporate purchase
agreements, invoices, transport and insurance documents, so that
when an invoice is received, the matching process is automatic,
without the expensive and time-consuming paperwork that that led to
the decline of Letters of Credit.
But senior Aite Group analyst Enrico
Camerinelli emphasises that the BPO is not exclusively linked to
the TSU, “although that’s what initially happened”. Camerinelli
explains that SWIFT created the BPO and used the TSU as the
matching technology. But when SWIFT got the ICC on board to support
the adoption of the BPO in trade, the BPO required a “simple
matching engine”.
Casterman agrees, saying the BPO simply
requires software that trade finance vendors offer.
“Trade finance vendors that are powering the
back office of banks for Letters of Credit are able to offer the
same functionality based on the BPO, since the BPO is similar to
Letters of Credit, but the mechanics are different. BPO guarantees
that the seller can get the money earlier, if it wants to,”
Casterman says.
But Casterman makes one crucial
distinction:
“What we see from large exporters is not that
they want to get their money earlier, but that they want to get
their money on time. And this is a major issue in Open Accounts.
Payments do get delayed. The main reasons are internal
inefficiencies. The liquidity crisis has also led to corporate
keeping cash as much as possible.
When the Letter of Credit is used, there is a
risk of a non-payment. The payment may not be performed on time
because the payment is conditional to the matching of
documents. If there are discrepancies, documents will have to
be resent.
This is where the BPO can add value because
discrepancies are handled electronically and can be solved in
hours, rather than days or weeks.”
With the BPO, the supplier’s bank issues the
agreed payment, provided that the documents presented by the
supplier match those provided by the buyer. The banks thus takes on
the risk of non-payment because even if the buyer does not pay, the
seller does get paid.
But Casterman says that the whole business of
trade finance is about risk – and charging customers for that
risk.
This is where the ICC’s role comes into play.
The ICC’s latest rules on global trade terms are called UCP600 and
have been in place since 2007. The UCP abbreviation stands for
Uniform Customs and Practice for Documentary Credits.
“In international trade, you have local
jurisdictions and those rules have to work together. This is what
the Letter of Credit has been facilitating. Letters of Credit have
helped create a chain of trust through the banks between the buyer
and seller,” explains SWIFT’s Casterman.
The ICC has also created an electronic version
of the UCP600, the eUCP600, which meet the requirements of the BPO.
Directives of the UCP rules include five banking days for
acceptance or refusal of documents by a company, as well as a
definition of provisions for discounting on deferred payment
credits.
The BPO is not live yet, but some 31 banks
have agreed to adopt the BPO including Citi, JPMorgan, Barclays,
BNP Paribas, Korea Exchange Bank and Bank of China.
SWIFT’s Casterman, however, highlights that
trade finance is a complex world and “any adoption of technologies
requires all parties to move together.”
IT and interoperability
An integrated and seamless IT system is
crucial for optimal operating results for banks, argues Hans
Tesselaar, executive director at the Banking Infrastructure
Architecture Network (BIAN).
“The problem with SCF,” says Tesselaar, “is
that everyone has their own ideas. The banking industry has to
agree on what we mean by SCF. To decide whether you want to
outsource or insource a technology, you need to have to have a
clear understanding of all the functions in a bank,” he argues.
BIAN is a non-profit community that consists
of banks, software providers and system integrators.
BIAN is working on a common service-oriented
architecture (SoA) for the banking industry to identify IT
requirements and enable the execution of faster and more efficient
IT system upgrades.
Its 2010-2012 strategy includes establishing
itself as a complement to other industry standards, such as the
SWIFT 20022 messaging service, but also IFX (Interactive Financial
Exchange Forum; provides an XML-based financial messaging standard)
and OMG Finance Domain (a computer industry consortium that
promotes financial services and accounting software based on its
own standards).
BIAN’s SoA framework is service oriented, which
is meant as a complementary element to SWIFT’s ISO 20022
standard.
This means that banks share their core banking
solution requirements with each other. BIAN collects these
disclosures and defines what it describes as “semantic
specifications” of IT needs and requirements.
“We identified 248 unique functions within a
bank in our Service Landscape. Each of these 248 should be
self-supportive. So one of the BIAN criteria is that there should
be the possibility to outsource each of those 248 functions,”
Tesselaar says.
According to Tesselaar BIAN identifies how the
different functions within a bank relate to each other, so banks
can model their IT strategy towards the BIAN standards, while the
IT technology providers in the BIAN community, including Microsoft,
Temenos, Infosys and IBM, tailor their products towards these
models.
“The aim is that, without huge
integration costs, banks can easily replace or renew functions
within the bank.
“If you want to integrate a new functionality,
you have to add three to four times the purchasing price to
calculate the integration cost. We will probably never bring the
integration cost down to zero, but we strive to decrease it 30 to
40% [of the purchasing cost].”
Long way to go
This vision may be far off still, as David
Toubkin, the executive director for trade finance at Surecomp
points out:
“You can have two banks in the same street
doing the exact same type of business – but they will have
different legacy systems, and an IT implementation will require a
different set of developments.”
Banks that commenced a SCF strategy after the
global liquidity crisis “made a good choice in buying something
from technology vendors to close the gap and catch up,” according
to Dr Eugenio Cavenaghi, head of global trade and supply chain
finance products development and facilitation.
“But just because you may have the technology,
it doesn’t mean that you have a good SCF programme. Technology is
just one part.”
