Blockchain is coming to the heart of wholesale financial markets and it is coming fast now.
In January, seven European banks signed a collaboration agreement to put into production later this year a new platform called Digital Trade Chain (DTC). This will be built on the back of a prototype designed by the Belgian bank KBC that has already been tested to the proof-of-concept stage with its own corporate customers.
Hubert Benoot, KBC
The platform uses distributed ledger technology to bring new levels of simplicity, efficiency, security and transparency to the paper-heavy blizzard of often manual and insecure processes companies undertake today after a buyer has agreed to purchase goods and a supplier to deliver them.
The theoretical value of blockchain in trade finance has been obvious for some time. Now it is coming closer to reality.
The DTC platform will allow onto it the seven banks and their networks of small and medium-sized enterprise (SME) clients that have already undergone know-your-customer and anti-money laundering checks with those lenders and so are known and permissioned entities.
It will also bring in logistics companies using the latest track-and-trace technology to verify the arrival of goods in agreed condition at key points in the journey from supplier to buyer that will then trigger payments automatically.
Company executives such as purchasing and stock managers as well as treasury officials will be able to access DTC on tablets and mobiles. It’s almost like a smart-phone app for trade that registers the entire process from order to payment, displaying it in an at-a-glance flowchart and guaranteeing payment when all contractual agreements have been met.
The platform is fully automated and available 24/7, so the order-to-payment process is much quicker than the traditional exchange of documents. It also requires far less back-office administration.
DTC brings new transparency at every point in the process which we believe will bring new levels of trust and so expand trade
- Hubert Benoot, KBC
Roberto Mancone, global head of disruptive technologies and solutions at Deutsche Bank, a member of the DTC consortium, says: “Blockchain is one of three disruptive technologies – the other two being artificial intelligence and the internet of things – that are now rapidly converging to change the banking business profoundly.
“Last year we saw lots of proofs of concept both to confirm use cases and test if the technology was mature and viable. Now in 2017 we will see banks coming together to use these technologies and establish new legal frameworks to put useful products into commercial production.”
There are several intriguing aspects to the story of DTC.
Perhaps most important, while the discussion around most such ventures centres around what blockchain can do for banks’ clients – casting development of the product or service as a defensive move banks have to undertake to see-off tech savvy disruptors – a key driver of DTC is that it promises both to increase the overall volume of trade between SMEs and also to open up new opportunities for banks to intermediate those flows.
This is not blockchain cutting banks out or slashing their margins. Rather, it is blockchain bringing banks new opportunities to profit from what they have always been good at: lending money, selling guarantees to weaker credits, managing cash and handling payments.
Hubert Benoot, general manager of trade finance at KBC, explains: “We have been focusing on intra-European trade among SMEs that often takes place on an open account basis, much of it requiring advance payment from the buyer to the seller.”
Benoot suggests that 50% of open account trading between European SMEs is based on advance payment. Other bankers say the proportion is even higher. That brings obvious risks to buyers – that goods might not be delivered on time and in the right condition – which, in turn, might restrict companies to dealing only with buyers that they know well and trust. And it doesn’t offer much to banks.
So a platform of SMEs from across Europe already approved by leading banks in each country and using new digital technology to record the delivery and receipt of goods is a potential game-changer.
It probably helps that by focusing on SMEs, the new platform, which has been showcased to the European Commission, might garner some political favour.
Benoot tells Euromoney: “DTC brings new transparency at every point in the process which we believe will bring new levels of trust and so expand trade.
“It also allows banks to intermediate in new ways in the open account space where their involvement today is generally limited to simply executing the payment. It might, for example, now allow buyers to execute payments once they obtain digital confirmation of the delivery of the goods at a certain point.”
He adds: “Also payment terms could now take more often the form of deferred payment, certainly when the buyer’s bank guarantees in a digital way the payment on a transactional basis. These trade receivables could then again be forfeited by the seller’s bank.”
At a time when many banks are engaged in formal consortia and less formal bilateral arrangements to test new financial technology, including blockchain, news of the seven-bank consortium behind DTC came as a surprise to the rest of the industry.
R3, the 50-strong consortium testing use cases for blockchain, has a 15-bank working group focused on trade finance that announced in August successful prototyping of blockchain technology to process accounts receivables, invoice financing or factoring, as well as letter of credit transactions.
However, there has been little news since and some of the founding banks behind R3 have drifted away, perhaps in a sign of renewed commercial aggression as blockchain-based products and services come closer to production.
The seven banks behind DTC are KBC, Deutsche, HSBC, Natixis, Rabobank, Société Générale and UniCredit.
Andrew Betts, head of global trade and receivables finance for Europe at HSBC, tells Euromoney: “Many banks are undertaking various pieces of work around trade finance and blockchain. For example, we are also working with Bank of America Merrill Lynch on new ways to manage letters of credit on a distributed ledger.
“What intrigued us about the DTC project was the fact that it relates to open account trading, that it focuses on SMEs – who we have committed to the UK government to help – and that it is a genuine collaboration around something KBC had already developed, to pool knowledge and expertise, and to share the cost equally of delivering something into production this year.”
He adds: “Commercially it’s very intriguing, in that it will allow authorized buyers and sellers and the banks on both sides to initiate transactions digitally, taking paper out of the system. It will then attach banking services such as payment initiation first and eventually invoice financing.
“And finally it will have a halo effect, connecting a trusted network of companies, each on-boarded and permissioned by their own banks, which even if they do not know each other today, may trade with each other with confidence in future.”
|Andrew Betts, HSBC|
Betts says: “There is no reason, for example, why UK businesses could not also deal with each other on such a platform in purely domestic transactions.”
Intriguingly, KBC first tested the DTC technology after 17 SME clients had assessed it last year between two Belgian companies in the textiles industry, Bru Textiles and Aristide. It then extended testing to include a Dutch company banked by Rabobank.
Next steps are to include more SMEs on the platform from across the seven member banks’ European networks and also logistics companies. IT company Cegeka built the proof of concept for KBC. A new tender will go out for a tech provider to build a larger version for the consortium, with an announcement likely in March.
KBC’s Benoot tells Euromoney: “Of course we are closely monitoring initiatives among all the other consortia that we know about developing trade finance on blockchain and we are mindful of ensuring inter-operability where we can.
“We have already had other banks asking to join – and indeed we have also received interest from bigger companies than the SMEs we are focusing on at the start – but for now we will limit the DTC project to the SME segment and to seven banks to keep it manageable. In a second phase, more banks will have the opportunity to join because the more banks on the platform, the bigger the added value for customers.”
He adds: “This whole mindset of banks being open and sharing commercial development with each other is still rather new.”
The initial build-out will be simple and focused. Payments might be triggered automatically by receipt of digital confirmations by logistics companies, but payments will not be processed on blockchain in DTC version 1.0. Rather, they will be executed along traditional existing payment rails, such as via Swift.
Regulators are not yet ready to bless blockchain at the heart of the payments system, although there, too, testing between banks is progressing fast now for interbank payments.
Forefront in technology
It’s worth remembering that banks are not at the forefront in technology anymore.
“The logistics companies are way ahead in digital technology,” says Mancone at Deutsche. “They have the technology not just to know exactly where goods are at any moment but also to monitor in real time the exact temperature inside containers carrying sensitive goods, for example.”
At some point, port authorities and national customs departments might become nodes on the network, but in the first instance it will depend on logistics companies.
Mancone says: “What I like about DTC is that it springs from assessing the fundamental problems of the clients, not from the capacity of the technology. What is the biggest problem in trade between SMEs that don’t know each other? The seller wants to be paid as soon as it ships; the buyer wants to pay only when goods arrive in the condition requested.
“For centuries the trade finance banks have developed products – documentary credit, guarantees – to bridge that gap. But they all require lots of documentation and high levels of human intervention. Blockchain technology can now bring huge efficiency and new levels of trust between counterparties that don’t know each other.”
Mancone stresses that the seven large banks building the DTC platform will ensure that it is modular, so that additional participants can join easily if it builds a desirable network and that the network will be scalable.
“The partners will ensure that the technology stack on which this platform is built allows inter-operability so that it is easily extendible to other partners,” he says.
The speed of building that network of SMEs remains unknown.
To the outsider it would seem that SMEs used to dealing with a few known regular buyers and sellers might have less motivation to engage than those whose business plans envisage rapid expansion. No doubt each of the seven banks will have quietly committed to encourage on-boarding of a set quota of SME clients. However, these will have to be convinced that the platform is both efficient and secure.
There’s obviously the potential for eBay-style points scoring between SME businesses on how well they behave towards other buyers and sellers.
If the seven banks get this platform right, then their customers will start to sell it for them.