FINANCE

The Evolving World Of Trade Finance: Optimize Working Capital With Distributed Ledgers

The Evolving World Of Trade Finance: Optimize Working Capital With Distributed Ledgers

By Geraldine Balaj, Senior Director, FinTech: Global Blockchain & Distributed Ledger Tech Lead, Capgemini Financial Services Business Unit

Geraldine Balaj

Geraldine Balaj

Trade finance still operates much as it did 100 years ago, as a largely manual, paper-based process. From order through payment, it is exceedingly difficult to manage and optimize working capital given the slow document exchange process, need for manual verifications, lack of transparency and complexities of back-office administration. That’s about to change. Distributed ledger technology (DLT) offers a promising solution to these challenges—one that may very well transform global trade across the myriad participants of the global supply chain.

Barriers to working capital optimization

One of the reasons it is currently so difficult to optimize working capital is that the landscape is disparate and complex, with multiple participants (buyers, sellers, banks, distributors, inspectors, miners, and more) in different industries struggling to navigate an elaborate supply chain process, from manufacturing to warehousing to delivery and finally—payment.

Traditional trade finance processes often lack straight-through processing capability—or even a standardized nomenclature or set of conventions—by which agreements can be initiated, negotiated and bound.Instead, data of different types manually reside across disparate spreadsheets causing latency and expensive errors. This lack of interoperability locks up working capital needed to keep the supply chain moving.Although standalone platforms exist that offer some degree of automation and straight-through processing, they are large, expensive and integration intensive. This can be cost prohibitive for the smaller or specialized (miners or inspectors, for example) participants of the end-to-end supply chain.

DLT, on the other hand, is being recognized, rightly, as a galvanizingsolution—connecting supply chains at a transactional level, streamlining processes and lowering costs. Ledger data is persistent and pervasive. This traceable transaction history is irreversible, serving as a single source of truth to streamline auditing, and detecting fraud or other anomalies. With a DLT transactional framework, everyone in the supply chain can access their transaction data on a shared and distributed repository secured by public and private keys.

Specialized smart contracts strengthen data privacy further.Smart contracts are programmed workflows specific to each type of supply chain operation and their respective events, from origination to final delivery and payment. The participants of each transaction event are privy only to their respective transaction data. This enables common source of truth, with controlled access to view the data. Only legal, regulatory or auditory entities are permissioned to see full audit trails (i.e. all data).

In that connected, real-time world, it’s possible to dynamically predict payment default situations, create approximations and projections, and make informed decisions without delay. In other words, DLT creates a more liquid marketplace, in which treasurers and capital managers can make dynamic decisions in real time to optimize working capital. Even smarter smart contracts that use inputs from the Internet of Things (IoT) parsed through an artificial intelligence mechanism are being explored and tested on a large scale. This multifaceted capability with DLT augurs a new marketplace that is not just dynamic and reactive to real-time events, but preemptive.

Despite the compelling business case, certain legacy behaviors challenge mainstream DLT adoption. Corporations and financial services firms must avoid deep silos that lead to repeating the same discordance seen in today’s traditional trade finance processes. The key is to adopt a standardized language and set of standards, which can then be applied across different agreements, geographies, jurisdictions and customs rules. Compartmentalization is essential to progress. Corporate buyers/sellers, their correspondent banks and respective members of their supply chains must take the lead in establishing this common language and framework.

Three steps to creating a standardized global ledger

Already we’re seeing large-scale financial institutions, pressed by their corporate clients, leading or at least participating in various consortia focused on digitizing global trade. These seminal efforts are important, but should be carefully managed to avoid creating one-off supply chain systems around individual products and industries. Corporate buyers/sellers worry about their specific supply chains. Banks and specialized logistics providers (i.e. shippers, miners, distributors) service all buyers and sellers. A common language and framework is crucial.

Understanding this fundamental point, DLT can be seen as the global highway and standardized APIs and data models as the rules of the road. Collaborative development between financial institutions and respective industry participants is paramount to realizing the full benefit of DLT. In general, the following three rules should be considered across the global supply chain community:

  1. Engage standards bodies and organizations. The International Organization for Standardization (ISO) and other standards bodies are allies in establishing a standard transactional language or taxonomy that builds on existing standards such as ISO 20022. Banks working across multiple physical economies, supply chains and industries are already leading the push for a global data taxonomy to eliminate the duplication and discordance that exists today at the transaction level.
  2. Engage intermediaries like SWIFT. As a nonprofit financial industry cooperative that serves as the largest intermediary on multiple supply chains, SWIFT is a leading influence in the move toward a more distributed, digital supply chain. At a minimum, understanding SWIFT ‘s current innovation roadmap to inform decisions is required. SWIFT could also be the lead orchestrator to bolster DLT-related activities across supply chains,and bring their findings back to the ISO to push forward on standardization.
  3. Share integration methodologies or APIs. Corporations, banks and other service providers must publicize not only APIs but also integration theories, findings, and methodologies.For example, in the capital markets and securities industry, it is a common practice publish and collaboratively certify APIs with market participants. Engaging consulting and system integrators who work closely with the securities operating model can help devise a sensible and scalable integration and API strategy. A comprehensive API strategy is critical to interoperability across supply chains to achieve a single source of truth and an immutable audit trail—the ultimate benefit of a DLT approach.

Capitalize on the opportunities

While all three steps mentioned above are essential, the success of DLT integration will require extensive collaboration—including “coop-etition” among competitive financial institutions that agree to publish their APIs. Only when the practice of publishing and sharing APIs is implemented in trade finance will standardization at all levels occur and guarantee the straight-through processing, interoperability and backward compatibility that make DLT attractive in the first place.

However promising, the adoption of DLT remains a daunting task. Orchestrating business development, communications, training, and collaboration among suppliers, vendors, competitors will not be easy. Compartmentalization is key. Additional challenges come from the numerous large-scale firms that are inventing new product opportunities with DLT, and the fear of intellectual property leakage that stymies the collaboration of theories and APIs. Finding the delicate balance between safeguarding IP and sharing integration methods to needed subscribers is essential.

Cautious optimism should guide the supply chain industry so that everyone wins. There is industry precedent in the regulated securities markets where competitors share information, APIs and integration strategies to build a secure, dynamic market structure to benefit the economy as a whole. Industry consortia, system integrators and other mutually trusted third parties can help govern these interactions, manage trust between the supply chain participants, and provide collaborative prototyping, testing and analysis. In the end, it is the firms that realize this today that will be leading the industry tomorrow.

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