Fintech: Blockchain landmarks point to transformation of trade finance
First international test; regs and compliance must catch up.
There will be many steps in the process of making blockchain technologies widespread in trade finance, but a crucial one was taken in October by Commonwealth Bank of Australia, Wells Fargo and a shipment of fine Texan cotton.
The transaction – delivering the cotton from Texas to Qingdao using Skuchain’s Brackets distributed ledger system – was important for three reasons.
First, it is believed to be the first global trade transaction between two unrelated banks. Previous blockchain trades may well have been done between two banks that are technically separate entities but actually part of the same group. CBA and Wells think this is the first cross-border trade finance involving two different banks to use blockchain.
Second, it uses blockchain technology in combination with two other emerging technologies – smart contracts and the so-called internet of things. And third, it involved an international physical
The model is designed to replace the standard letter of credit method underpinning trade finance.
“Trade finance is one of the areas of banking that is most ripe for disruption, with all the paperwork that comes with it,” says Michael Eidel, executive general manager of Commonwealth Bank’s cashflow and transaction services division.
It involved an open account transaction on a private distributed ledger between Brighann Cotton, a Texas-based cotton merchant, and the two banks. It used a physical supply-chain trigger, with the goods being tracked through GPS to confirm their geographic location before sending the necessary notifications to allow the release of payment. All the bill of lading information was digitized, scanned and put onto the blockchain system.
It didn’t, though, involve the payment taking place on blockchain, but rather a trigger to release the funds across traditional payment rails.
“We could envisage that for the future,” says Eidel. "What’s really important is that we make it a scalable situation for the industry in the future, and that needs collaboration.”
Such collaboration is under way. Both banks are members of the R3 CEV consortium that combines over 60 large financial institutions to develop applications and agree on common standards for wholesale finance on blockchain, joined most recently by ABN Amro and the China Foreign Exchange Trade System in November.
“We are developing a joint language for what blockchain could be and building trust with participants,” Eidel says.
The deal follows another trade finance trial by Barclays in September through which two partners, agriculture co-operative Ornua and a food product distributor in the Seychelles, transferred trade finance documentation through a blockchain platform created by Wave.
Wave is an Israel-based start-up that came from a Barclays-based accelerator programme.
Bank of America and HSBC are also understood to have conducted trade finance trials together with the InfoComm Development Authority of Singapore.
There is plenty to recommend greater use of blockchain technologies in the trade finance world. Although cost benefits won’t kick in until the operating model is mature and widely used, “when it becomes more scalable I would see huge benefits for banks to reduce admin and paperwork,” Eidel says. “We can reduce a lot of costs by putting all of this on a blockchain solution.”
There are knock-on effects to cost too: if systems like this make it easier to track goods and to identify with precision exactly who legally owns what at any point in time – including the moment of any problem – then risks ought to drop, and with them, insurance premia.
With cotton, for example, whose quality can be affected by temperature and humidity, the combination of blockchain, GPS and internet of things technologies should allow both a buyer and an insurer to identify at exactly what moment something damages the goods.
There is also, in theory, less risk of fraud by duplicated invoices from unauthorized parties, though clearly distributed ledgers bring with them their own potential for abuse.
If there’s a holdup, it seems to be more in regulation and compliance.
Chris Lewis, head of international trade finance services for Wells Fargo, while a big fan of the opportunities, says that “significant regulatory, legal and other concerns remain to be address with the technology”.
Eidel says one of the principal challenges is “coming up with a more comprehensive, straightforward solution for know-your-client and transaction monitoring. One of the challenges R3 is working on is to develop solutions that comply with rules and regulations in the financial services industry. KYC is a major aspect besides the scalability.”
Separately, CBA has also announced a memorandum of understanding with Alipay, the online payment platform operated by Ant Financial, owned by Alibaba. The plan is to make it easier for Australian customers to pay for purchases through Alibaba’s e-commerce websites, and to create a payment solution for Chinese tourists and students to use Alipay in-store systems through CBA’s smart payment tablets in Australian retailers.
About 19,000 Chinese tourists visit Australia a week and spend almost A$8,000 ($6,165) each, according to a joint statement from Alipay and the CBA; the same statement says China is expected to process $6.3 trillion in mobile payments by 2020.
Alipay tends to scare the daylights out of many bankers, but Eidel says that’s the wrong way of looking at it.
“Being scared is not the right answer,” he says. “We’re impressed with what they do. If you want to be a customer’s provider of choice, you have to welcome any innovation that leads to a better experience for your customers.”