Last week, HSBC and ING Bank successfully executed a live trade-finance transaction for international food and agriculture conglomerate Cargill using R3’s Corda blockchain platform.
This was a bulk shipment of soybeans from Argentina, through Cargill’s Geneva trading arm to Malaysia, with Cargill’s Singapore subsidiary as the purchaser. A letter of credit (LC) was issued using Corda by HSBC to ING. The two banks were acting on behalf of the Cargill organizations.
But why should anyone care?
Banks have been touting such transactions for the best part of two years now. HSBC, Bank of America Merrill Lynch (BAML) and the Infocomm Development Authority of Singapore announced a breakthrough prototype in August 2016 for handling LCs on blockchain.
Then in January 2017, HSBC was one of seven bank founders of the Digital Trade Chain consortium. It was built for SMEs in Europe to use distributed ledger technology on the Hyperledger to bring new levels of simplicity, efficiency, security and transparency to the paper-heavy blizzard of often manual and insecure processes companies undertake after a buyer has agreed to purchase goods and a supplier to deliver them in open account trading.
That consortium has since rebranded as we.trade.
Are we going round in circles here, or are we threatening to get anywhere yet?
Vinay Mendonca, global head of product and propositions, trade and receivables finance at HSBC, agrees that there have been lots of test trade-finance transactions during proofs of concept for blockchain technology, but he claims this Cargill transaction – which focuses on trade using LCs rather than conducted on open account – is more significant.
“A lot of those earlier prototypes were testing the blockchain technology,” he says. “We have now built a production scale platform with scalable architecture. This is a live commercial use-case. It is not a dummy transaction. This is no longer something that it is being incubated in a laboratory. It is working technology that we can scale up in the months ahead, as we continue to enhance the platform.”
He suggests that the Cargill transaction is as significant an advance as the work done in partnership with BAML in 2016 and now brings blockchain much closer to the day-to-day way these transactions will be handled as a matter of course.
Mendonca says: “We have soaked up a lot of learnings from those earlier tests and we are now up and running with a scalable platform to support live transactions that we see as a utility that many banks are interested to join.
“The platform also offers different nodes for various users beyond buyers, sellers and banks. As an example, there is a node on Corda for Bolero [the company established by Swift and the global shipping and insurance industries to drive the digitization of global trade] to join to offer an electronic bill of lading title registry service. And Corda offers nodes for verification and certification.”
He adds: “We need to get the shipping companies and ideally the ports and customs authorities on the system as well.”
Conventional exchanges for paper-based documentation relating to LCs usually take between five to 10 days.
“You sometimes find that the ships move faster than the documents,” says Mendonca.
The soybean exchange was completed in 24 hours on a single shared application rather than the multiple systems of the buyer, the seller and each of their banks.
“You could crash those times even further,” Mendonca suggests. “It needn’t be 24 hours. It could be two hours.”
Rani Misra, regional treasurer, Apac, at Cargill, says: “Simply put, we took a highly manual, complex transaction and made it more secure and efficient.”
She adds: “We see the exciting potential of extending this technology into other areas of our financial ecosystem.”
Exchange of payments
That won’t, for now at least, reach as far as exchange of payments. The Corda trade-finance platform allows the various parties in a trade-finance transaction using LCs to view associated records in real time on a shared platform, rather than sequentially passing paper confirmations.
“We have had a lot of interest from clients, especially commodities companies, in solving the complexity of paper records around letters of credit, which are central to a significant portion of all trade, and also to reduce the time involved and provide better visibility,” says Mendonca.
“And banks need to respond to that. The associated exchange of payments works well on Swift and is not the immediate pressing problem there.”
And how long will it be, does he think, before the blockchain becomes the default method for handling trade-finance LCs?
“There’s still a long journey ahead,” he says. “It could be five to 10 years, but it reminds me of how standardized container boxes came to dominate shipping. When they first appeared, market participants in global trade weren’t immediately convinced, but over time they simply became the way goods move.”
Blockchain: the gentle slope from disillusionment to enlightenment
We.trade, the blockchain platform for open account trading among SMEs first pioneered by KBC last year, is also set to scale up in the coming months, underlining the responsibility for members of various consortia attempting to digitize different types of trade finance to ensure interoperability between their blockchain platforms.
Euromoney speaks to Anthony Woolley, head of UK innovation at Société Générale, about the pace of adoption of blockchain technology in wholesale finance and capital markets.
“Many people will know the Gartner hype cycle for emerging technologies and it may feel that blockchain has been in the trough of disillusionment recently,” Woolley tells Euromoney. “But we did a lot of research from early 2015 on how blockchain could be adapted for regulated financial services.
“At the time, people were making very unrealistic projections that blockchain would remove the need for exchanges, for central counterparties, even for the entire banking system. But banks are very pragmatic. We realized quickly that you couldn’t just plug in the bitcoin blockchain. However, we saw distributed ledger as one possible way to bring efficiency and reduced cost.”
Woolley says: “By the start of 2017, we decided at Société Générale that we would stop just experimenting and testing with blockchain and concentrate on the road to production in a handful of use cases. Financial supply chains that have a low technology footprint, often still operating on email and faxes, and with complex inter-relationships up and down the chain that leave participants wary of dependence on any central authority, are particularly interesting.
“And that manifests in trade finance. So, we have done big production test transactions such as soybeans from the US to China. And we.trade should go into full production this summer with a limited number of institutions at first using it every day for open account trade finance among SMEs. It will then scale up.”
Woolley suggest that scaling-up process will take some time.
“It requires a lot of rigour to ensure that thousands of companies can depend on it every day,” he says. “And that is the test for blockchain, as with any technology, in moving to full production at scale. You know it has fully emerged when you suddenly look round and realise you couldn’t do without it.”
Société Générale also expects a blockchain-based oil trading platform to be operational next year. It is part of a nine-strong consortium called VAKT – three oil majors (BP, Shell and Statoil), three commodity traders (Gunvor, Koch Supply & Trading and Mercuria) and three banks (SocGen plus ABN Amro and ING) – aiming to transform post-transaction management of physical energy commodities trading.
“This is now past being a use case,” says Woolley. “It is a business case that goes beyond letters of credit and automates processes up and down the oil trading supply chain, using smart contracts.”
Over time, the venture aims to lead the migration of all forms of energy transaction data to the blockchain, improving data quality, further strengthening security and increasing the speed of settlements, so reducing costs for industry participants.
The slow speed of adoption of blockchain in financial markets comes down to the need for collective action. It is not an emerging technology that a single commercial organization can bring to market.
Rather, participants with divergent commercial interests and market positions need to work together in consortia with appropriate governance over legal organizations that run these blockchain networks. Increased efficiency, of course, damages the position of those banks that profit from temporary loading of cash and other collateral security.
However, banks have another motive to press ahead with such blockchain consortia aside from the reassurance of moving from perimeter firewall database security towards embedded encryption.
“While you need a company to operate blockchain networks, maintain capacity and upgrade software, the users of the platform will retain ownership and control of their data at all times,” says Woolley. “You will not have central market infrastructure providers monetizing data, as we have seen in the financial markets historically.”
The banks have learned a hard lesson about allowing others to take their data, combine it with that of many market participants’, transform it and sell it back to them.
Meanwhile, for those not intimately familiar with the Gartner hype cycle, the banks seem to be saying that after the extraordinary peak of inflated expectations in 2016 and then the more recent trough of disillusionment, blockchain is now moving forward once again, along the gentler upward slope of enlightenment towards the eventual plateau of productivity.
Euromoney can barely wait.