Introduction to Trade Finance
Trade finance represents the financial instruments and products that are used by companies to facilitate international trade and commerce. Trade finance makes it possible and easier for importers and exporters to transact business through trade. Trade finance is an umbrella term meaning it covers many financial products that banks and companies utilize to make trade transactions feasible.
Trade finance is the backbone for international trade. So much so that the Director-General of the World Trade Organization, Roberto Azevedo, even stated, "Today, up to 80 percent of global trade is supported by some sort of financing or credit insurance".
Challenges in the Trade Finance Industry
Despite its crucial role, the trade finance industry faces several inefficiencies. Unstructured data, document volume, compliance checks on a massive scale and eroding manual accuracy, to name a few.
These problems make analysing and processing trade finance transactions more time-consuming, error-prone and costly. Additionally inefficient methods of managing data and compliance checks may lead to excessive delays, higher risk margins and difficulty in maintaining absolute transparency and accuracy.
The Role of Blockchain Technology
In order to resolve this conundrum, the finance sector is turning to Blockchain technology in order to simplify transactions while offering a secure, transparent and automated platform for trade finance operations.
Blockchain technology is a distributed ledger that is secure transparent and immutable. This technology can be used to create a tamper proof decentralized database that has the potential to revolutionize the way we interact with the digital world.
Essentially, Blockchain eliminates the need for a central authority, allowing participants to interact directly. Data recorded on the blockchain is also immune to alteration. This improves upon paper documentations which can easily be altered or forged.
Transforming a Paper-Dominated Sector
In a paper dominated sector, the trade finance process has been run on massive amounts of paperwork and manual systems for tracking trade activities. This leads to an absence of transparency and excess expenditures.
However, in the new era, Blockchain technology can cut down processing time and heighten security, transparency and trust in the transactions.
How Blockchain Processes Work
A buyer will create a transaction or a block. The transaction is then distributed and validated through cryptographic hashing. The transaction is committed to blockchain and miners are rewarded. The seller then receives the transaction.
The role of miners are to maintain the integrity and security of a cryptocurrency network. By validating transactions and adding them to the block chain, miners prevent fraudulent activities such as double spending, where a user attempts to spend the same coins twice. This increases the security of the crypto network, preventing potential losses.
Efficiency Gains Through Blockchain
Efficiency is also increased through the Blockchain. Transactions can be completed without the presence of an unbiased intermediary. Both parties can also build contracts that can automatically be used to initiate commercial transactions. This speeds up contract writing by eliminating the slow process of manual verification, negotiation and reliance on intermediaries.
Improved Risk Assessment and Visibility
Blockchain provides end-to-end visibility into the supply chain, enabling financiers to assess risks. By tokenizing invoices and purchase orders, Blockchain facilitates faster financing and reduces the risk of duplicate filing of data. Traceability of assets and goods can be seen in real time, allowing owners to pass down relevant information to the stakeholders for action.
Streamlining Auditing and Compliance
Auditing is overwhelming. However, with Blockchain it doesn't have to be. This technology makes it possible to audit every single transaction sequentially and indefinitely. Due to the digitalised nature of the transaction, a permanent and digital audit trail of the traded asset exists, allowing for easier auditing and tracking. This technology also lowers the overall compliance expenses and betters the capability to authenticate the assets.
Digitalization of Trade Assets Blockchain also enables the digitalization of assets, such as letters of credit, which can be traded securely on the platform. A letter of credit can be defined as a letter issued by a bank to another bank (especially one in a different country) that serves as a guarantee of payments that will be made to a specific person under specific conditions. An example of how this otherwise document-heavy process works on blockchain-based trade finance would look something like this,
- The Applicant and the Beneficiary enter into a trade agreement stored on the blockchain network.
- The Applicant then issues a 'purchase order' for The Beneficiary in their Billing System, which acts as the contract for LC.
- The Applicant, next, gathers the LC Application details through their system, which is also on the Blockchain Network. The system then interacts with 'The Issuing Bank' and requests his bank to issue an LC. 'The Applicant' gives all the information for LC, consisting of the purchase order in digitized form to the bank.
- The LC details are received by the bank and it processes the same before sending it to the Advising Bank.
- 'The Advising Bank' gets the LC and advises it to 'The Beneficiary' in digital form – all through the blockchain network.
- The Beneficiary provides the digital acceptance/rejection of 'The Advising Bank' through the blockchain network.
Blockchain in Forfaiting
Blockchain also plays a role in forfaiting. Blockchain allows exporters to get cash by selling their medium- and long-term foreign accounts receivable at a discounted rate on a "without recourse" basis. Banks like HSBC and Bank of Communications use Blockchain for trade finance through forfaiting. In a transaction on the China Trade Finance Union blockchain platform, a Bank of Communications client selling paper products received a 180-day payment undertaking from their buyer's bank. The Bank of Communications sold this payment obligation to HSBC via the blockchain platform. All related documents, including confirmation letters and transfer of rights, were created and transmitted digitally within hours, demonstrating the efficiency of blockchain in trade finance.
Conclusion
Blockchain technology has certainly improved the industry of trade finance, from making more secure transactions, to making auditing and filing data quicker, to even forfaiting easily and efficiently. Blockchain technology is a step in the right direction towards enhancing trade finance.
How our panel of lawyers can assist:
- structuring your blockchain-based business
- legal documentation for the business
- licensing and regulatory advice
- corporate compliance and general advisory
- external counsel advisory
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
