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BPO: The risks of faster trade finance

A faster way to pay suppliers marks a new era for international trade as it helps companies unlock working capital and improve cash flow. Bank Payment Obligations (BPOs) are one tool among many though, so companies should think carefully about when to use them.

Manoj Menon, Global head of trade services, innovation & customer proposition, RBS

BPOs are a clear sign of the overall direction international trade finance is taking – more automation leading to greater efficiency. The International Chamber of Commerce (ICC) and global financial messaging giant SWIFT believe they will play a key role in supporting the future development of international trade. They are a payment obligation between banks that involves exchanging data electronically. This enables faster, cheaper payments and better capital management, and they can be used to cover the underlying risk or finance the amount owed.

Businesses started looking at them more closely as an alternative means of trade settlement last year when they were endorsed by the ICC, which issued a set of rules on them – the Uniform Rules for Bank Payment Obligation (URBPO).

Companies and industries with advanced supply chains – strong links between buyer and seller and technology systems in place – have already started thinking carefully about BPOs. Early indicators show interest mounting in the energy and commodities sectors in particular.

BPOs are, however, just one trade payment mechanism or trade finance tool among many — including letters of credit (L/Cs) and guarantees. How useful they are depends heavily on the relationship between the buyer and seller.

Their main advantage is that they are based on the exchange of data rather than documents, which underpin the majority of today’s largely paper-based trade.

They therefore might be right when there is a long-standing relationship between trading partners – so they trust each other – and they want to move away from the time-consuming process of ploughing through documents. On the other hand, less documentation means more risk if anything goes wrong.

We’ve seen the consequences of ignoring such risks before. L/Cs and open account trade were the traditional tools for conducting international trade until about 10 years ago when companies moved towards a direct open account system. This involved buyers agreeing terms and paying when they received the goods, with no banks taken on to cover any shortfall if a problem arose.

Fiercely competitive export markets meant foreign buyers pressed exporters for this form of financing because it was so straightforward. But the financial crisis exposed the inherent risks involved when a payment could not be made. Corporates operating in the open account space moved back to more secure instruments such as L/Cs and guarantees.

SWIFT set up BPOs as a more secure form of open account trade that could still streamline the process.

When using a BPO, a buyer’s bank commits to paying a specific amount to the seller’s bank if the trade data they submit to a central platform successfully matches up.

That platform is the Transaction Matching Application (TMA) set up by SWIFT. Banks need to subscribe to this to offer BPO services.

It matches data between banks to the preagreed rules automatically. Consistency is ensured through the use of a ‘dictionary’ of common data. It is based on the XML ISO 20022 trade services management message type (TSMT).

The benefits of BPOs

For the seller:

  • Faster release of buyer’s funds once it’s shown that the seller has shipped the goods. This means faster payments, accelerated cash flow and lower Days Sales Outstanding

  • Less expensive than letters of credit thanks to reduced banking and handling fees

  • No presentation of physical documents required — it takes less time and resources

  • Provides collateral for accessing preshipment and post-shipment finance

  • Can extend credit terms to a buyer since their bank is now guaranteeing their payment obligation

  • Possibility of spreading the risk with multiple buyers

  • Improved customer offering with more flexible options — which could lead to winning additional business

For the buyer:

  • Better payment terms can be negotiated by providing a payment assurance to suppliers

  • Achieve early payment to the supplier to make use of discounts or rebates

  • Free up banking credit lines thanks to shorter, automated transaction cycles

  • Make payments on time and avoid physical supply disruption or judicial proceedings

  • Cut confirmation, vetting, presentation, and discrepancy fees

  • Increase business opportunities with suppliers

When to use a BPO

Companies might want to use a BPO for their domestic or international trade transactions when they:

  • Trade with long-term partners using letters of credit and want to switch to something more efficient

  • Conduct open account transactions today but want to cover the risk or arrange financing

  • Want to extend credit terms so they can try to create new business, or take better advantage of terms such as rebates or discounts

  • Deal with trading partners who are moving away from paper or proprietary systems

  • Work with new partners and therefore face a greater risk of non-payment – they can use the BPO to cover that risk if they don’t want to use a letter of credit

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