The payment mechanisms of trade finance may finally be catching up with the logistical mechanics of trade shipments. Documentation remains crucial: sales and purchase contracts, proof of shipment and receipt in good order. Card payments, online and telephone banking may work for retail and small value transactions but high volume and big ticket sales require working capital, bank finance and security.
For all those reasons the backbone of trade finance has been the documentary letter of credit. It has the force of law in different jurisdictions and so is generally enforceable. It also enjoys the advantages of practice, codified since 1933 by the International Chamber of Commerce (ICC) in Paris and through its constantly updated Uniform Customs and Practice (UCP) guidance.
But the fact remains that documents are paper, they must be sent securely and, in the end, they must be checked to ensure conformity. This laborious process may soon be replaced by an electronic matching system, the Bank Payment Obligation (BPO), a joint initiative between the ICC and Swift, the banks’ standardisation cooperative body. The outlines were published in 2012 and Uniform Rules for Bank Payment Obligation (URBPO) were adopted by the ICC in April 2013 and became effective in July 2013. The URBPO brings together traditional practice (including legal precedents) and electronic flows.
Meeting an old friend
In essence, the BPO is an old friend, the electronic letter of credit, whose time has been coming for many years. But unlike proprietary systems, offered by software vendors and individual banks, the BPO promises to be universal by bringing together the UCP and the Swift network of some 10,000 banks and corporates in more than 200 countries around the world.
André Casterman, head of corporate and supply chain markets at Swift and a member of the ICC’s Banking Executive Committee, thinks that this time it’s different because “we are moving from paper to electronic only in the bank to bank space to start with so we are introducing rules based solely on the interchange of electronic data and we are dematerialising that space.”
David Vermylen, global credit manager at BP Chemicals, sees the BPO as an important tool for making the sales process easier for customers. “It could quite easily be used as an electronic letter of credit but it goes beyond that,” he says. “The traditional documentary letter of credit is a very linear process,” he notes. “There is the presentation of documents, then the checking and finally the payment.” Paper means post, couriers and laborious checking by eye and execution by hand.
Modern electronic tracking methods of shipments have now overtaken the cash and payments tracking. “All the presenting and checking make for a very slow process in the current trade environment,” he adds, “so the goods are moving quicker than the paper.”
Vermylen was an early convert but not an immediate adopter. “It took me a while to understand the BPO, but then the more I understood, the more I saw the opportunities.” The company can ship immediately to customers and the customers can have security of supply and do not have to tie down their working capital capacity as much. “Slow processing can choke our customers.”
Gary Slawther is treasurer of OCTAL Petrochemicals in Oman, one of the world’s major manufacturers of Polyethylene terephthalate (PET) in resin and sheet form, which is a plastic used extensively in packaging, in particular for soft drinks bottles. BP Chemicals is a major supplier but OCTAL supplies into over 60 countries across the world with the principal markets being North America, Europe, Middle East and Africa.
“First, it takes the paper and the delay out of the system. Second, it’s principal to principal.” Those are the reasons which should appeal to any corporate treasurer. But the wider adoption of the BPO will depend on building up enough users. That’s why, Slawther adds, “Third, for us at Octal, BP is our biggest supplier.”
This gradual approach means that most participants, even the early enthusiasts, think that it will take five years or a decade before there is a BPO culture. “We are not requesting the carriers to change their way of working,” says Casterman. “We are only imposing data matching onto the banks and all the rest can continue to work as it is today.” Vermylen thinks that it will take five or more years to achieve widespread adoption. “There will still be very limited use of the BPO because there are very few banks so far,” he notes, adding that there are so many small customers attached to small bank relationships and those are critical.
But there could be swifter progress with big implications for the banks and businesses. Vermylen is realistic about speed of the take up of the BPO but Casterman points out that 15 out of the biggest 20 world trade banks are already signed up – and he also expects around 100 corporates in the system by the middle of 2015.
This constraint may change as small banks start to outsource more of their work beyond relationships and credit management to the big banks with huge technological infrastructures. But BPOs are a mechanism, a facilitator, not a source of working capital. “It’s unclear to banks how they will keep the revenue streams in a BPO environment at the same levels as in an LC environment,” Vermylen says, “although this shouldn’t be a problem as the real chunk of the business should always be the credit undertaking not the documentation and processing.”
The credit challenge could also mean a bigger role outside the banking chain for the trade credit insurers. Susan Ross, director trade credit at Aon Risk Solutions, an insurance broker, is cautious. She thinks that the uptake of BPO will be gradual. “It seems the BPO is not going to challenge open account trade/transfers just yet,” she says. Rather she’s waiting to hear from exporters about their experiences. By the end of 2013, she hopes, there will be more people with experience of BPO transactions.
Slawther is more enthusiastic. He uses the BPO with credit insurance because “the insurers have more reliable credit appetite.” His observation is supported by the 2012 figures published by the International Credit Insurance & Surety Association (ICISA). The industry body’s members insured €1.92 trillion, up 4.4% on 2011’s €1.84 trillion.
Jim Davidson, ICISA’s president, thinks that this shows that more companies are valuing trade credit insurance as part of their risk control procedures. “It has a positive effect on cashflow management and business continuity,” he says, “in an environment concerned with an increasing number of bankruptcies.”
The BPO’s security is also important in controlling risk. “Customer relationships depend on mutual trust,” says Vermylen, “but open account trading means risk.” The electronic matching of documents can be done within an hour or so but always in the context of the commercial contract between buyer and seller. This means that one of the big problems for trade credit insurers – retention and passage of title – can be dealt with in the contract in case of a claim but the payment process is streamlined.
Slawther goes further. He wonders what the point of the banks will be in the future. “The logical next step is to convert world trade wholesale to electronic documentation.” He acknowledges that such a move could only be accepted in all jurisdictions if it is driven by (or at least with the very firm support of ) the ICC.
He puts a controversial question: “Again, we stay outside the banking system – we start to integrate the offerings of trade credit insurers, Swift, ICC and eDocs and pretty soon, who needs banks?” In his view they will just become the repository for the funds. “Even then, with the funds existing merely in electronic form, maybe Swift could start to be provider of the most basic of account services – it’s a logical step!”
Casterman has a more nuanced view. After all, Swift is owned by banks and they have no intention of putting themselves out of business. “Corporates are not looking at BPO to reduce their banking fees,” he says. “The main objective is to increase corporate to corporate efficiency thanks to accelerated bank to bank processing. Most of the benefits are for the buyers and sellers, the exporters and importers, to improve efficiency in the physical space.”
He wants to take a bigger view of supply chain finance and how this can help in preshipment and post-shipment finance. He is also keen to bring in the smaller banks so that they in turn can help Small and Medium- sized Enterprises (SMEs) have access to trade and working capital.
Getting SMEs on board
“The real supply chain does not start when the goods are accepted. It starts when goods are ordered and this is where financing is needed. Financing the supply chain should start at the purchase order level. To extend financing for SMEs to buy materials to produce goods, we need to involve the local banks to give pre-shipment finance and the large banks need to involve the local banks.
“Pre-shipment finance involves taking a risk on the SME. To take on that risk the large banks need a relationship and usually the large banks do not have that sort of relationship in emerging markets. By involving the local banks they can facilitate the provision of pre-shipment on the back of a BPO issued by the large buyer’s bank.”
The second extension is to post-shipment finance before the approval of the invoice. The BPO is a defined risk, a bank risk, and so the local bank can finance the invoice on the back of the BPO rather than waiting for the buyer to approve the invoices. Invoice issuance comes before invoice approval and there is thus no need to await approval of invoice.
Negative impacts of LCs
Casterman makes again the crucial point about the nature of electronic flows. “The documentary letter of credit has a negative impact on the physical supply chain because the line must be opened very early in the process and therefore the goods may be delivered late.”
This is perhaps the most important point for SMEs. “We are not looking at those extreme cases where the buyer is so dominant, paying very late for instance, imposing their terms, advance payments,” says Casterman. “The BPO fits into the middle segment.” He cites the example of Ito- Yokado, a big Japanese superstore. It has 12 SME suppliers where fast settlement is critical for working capital and so the company can act as a good buyer and also negotiate better commercial terms.
It’s win-win,” Casterman says, “for buyers and sellers.” But it could be lose for the banks. Slawther’s experience inclines him to think outside the box where many smaller banks are already thinking. “The banks that understand and realise that, to use a cliché, unless they’re part of the solution they are part of the problem (and in trade at the moment they’re not part of the problem – they are the whole problem!) will flourish, those that don’t will start to whither over the coming years.”