21.07.2022

Digitization in the Trade Finance Space

It’s fairly obvious that in today’s digital world, many industries have transformed the way they do business, adopting new technologies to improve efficiencies and eliminate redundancies. The trade finance space is no different and has undergone significant change over the last decade as events like the Global Financial Crisis and the COVID-19 Pandemic made it apparent that a once opaque industry needed to adapt. The trade finance gap makes this evident.

According to a 2021 study by the Asian Development Bank, “the global trade finance gap grew to an all time high of $1.7 trillion in 2020, a 15% increase from two years earlier, as the pandemic heightened economic and financial uncertainties and devasted global trade”. Some estimates however are significantly higher – up to $6.5 trillion. As of the pandemic, data shows that SMEs seem to have been hit the hardest, with a significant volume of trade finance requests being rejected or delayed.

But all participants in the trade finance ecosystem – banks, importers and exporters, export credit agencies, brokers and insurers – need new ways to stay competitive in an age of risings costs and operational risks. This need has fostered the rise of fintech and insurtech companies that have strategically positioned themselves to help plug the trade gap and set up digital infrastructure to allow market participants to engage in global trade in new ways.

From a banking perspective, although the pandemic didn’t drive digitization or the creation of new trade finance platforms, it did accelerate the opportunity to test new platforms or evolutions of older ones. Unlike during the Global Financial Crisis when liquidity was at a premium, what’s now key is that financial institutions find ways to make sure their liquidity is deployed efficiently and to where its most needed. Multilateral development banks can step-in commercial banks shoes in times when funding is scarce but commercial banks and other non-sovereign lenders need ways to finance and develop their own trade books.

So, tech solutions like those using Blockchain and Smart Contracts have become attractive for participants and important tools in allowing banks to analyse and aggregate large amounts of data as well as transact more securely. Switching from paper to distributed ledger technology can accelerate a bank’s ability to enhance goods traceability as well as rapidly implement payment automation solutions. This ties in with ESG initiatives. For example, if consumers are concerned that their goods are made by wood that originates from protected areas of the Amazon, blockchain technology can help banks quickly trace the origin of goods in the supply chain and ultimately help that make more informed decisions on which clients to support.

One might look at the work that a software company like R3 has done with banks to understand the processes that are being digitized. Larger commercial banks like Citi and BNY have signed up for R3’s Corda blockchain platform, which can provide a fully digital alternative to paper-heavy letter of credit transactions. According to Citi, the platform “reduced the average time it takes to execute from five to ten days (for paper LCs) to under 24 hours in most cases.”

During a 2021 forum that was led by R3 and BAFT, discussion on the merits of adopting blockchain technology made it clear that cases like what happened with Greensill could have potentially been avoided had blockchain tech been implemented by those involved – to reconcile quickly what was being financed and whether shipment and acceptance of goods actually took place. The security than an electronic trade ledger provides can’t be overlooked.

More broadly, the use of artificial intelligence in trade finance has decreased the burden typically borne by AML and KYC officers at banks. Quick machine learning has increased the speed at which trade documents can be reviewed for anomalies, sanctions violations, or evidence of fraud and lessen the likelihood of human error in compliance processes.

However, all of this is not to say that there haven’t been growing pains when it comes to the development of fintech solutions for trade finance. In 2019, we.trade, a start-up that employed the use of blockchain technology to facilitate open account trade finance business began operating, creating digital trade ledgers and allowing its users to apply for payment guarantees or pre-financing. Despite the company’s technology being licensed by 16 large commercial banks of which 12 are shareholders, the company had trouble getting a wider cross-section of users to adopt is technology which led to issues raising money and it ultimately shutdown in June 2022.

On the insurance side, a number of products have been developed by brokers, fintechs, and insurance carriers to tie into the digital development of the trade finance space. Insurance policy procurement and management can be an arduous task, so technical innovation is key to free up time for all stakeholders involved. The Texel Group has collaborated with Tradeteq to develop a non-payment insurance module to their Connect platform which facilitates faster and more efficient placement of trade finance deals. The platform allows banks with trade finance assets to distribute and insurers with pre-established limits on issuing bank counterparties to digitally connect and quickly establish contracts of insurance, creating efficiency and cost savings. Another platform, LiquidX, can digitize an insurance policy and the contracts it covers, turning it into lines of code and smart contracts (self-executing computerized transaction protocols that carry out a series of transactions which have been pre-agreed between parties and translated into code.

This product amongst others demonstrate that innovation in the trade credit insurance space matches that of the trade finance marketplace. Both markets are inherently complex but this is a time when reducing complexities and the amount of process inefficiencies in the trade finance ecosystem is vital in order to maintain trade flows. Further improvements are necessary but on the insurance side, the target of this innovation should be reducing frictional costs of obtaining credit insurance coverage and increasing the accessibility of credit insurance products for prospective buyers.