The corporate and investment banking division of Bank of America, Bank of America Merrill Lynch (BofAML), is reportedly developing a blockchain-based experiment for trade finance transactions. The pilot is being developed with another, unnamed bank for possible testing later this year, according to the head of BofAML innovation for global transaction services, Jason Tiede.
“As trade finance often relies on manual, paper-based processes, it serves as an interesting use case of the value of digitising an asset on a distributed ledger."
- Jason Tiede, the Bank of America Head of Innovation for Global Transaction Services
Generally, trade finance concerns both domestic and international transactions, where typical activities include lending, issuing letters of credit, factoring, export credit and insurance. When commonly used, the term “trade finance” is generally reserved for bank products that are specifically linked to underlying international trade transactions.
The World Trade Organization (WTO) estimates that approximately 80 to 90 percent of world trade relies on trade finance, mostly of a short-term nature. In addition, private banks account for approximately 80 percent of the trade finance market. Banks play a critical role in international trade by providing trade finance products that reduce risk.
“International trade exposes exporters and importers to substantial risks, especially when the trading partner is far away or in a country where contracts are hard to enforce. Firms can mitigate these risks through specialized trade finance products offered by financial intermediaries.”
- Federal Reserve Bank of New York
An independent report by the Boston Consulting Group shows that trade finance revenue for banks totalled about $45 billion globally in 2014. The United States Department of Commerce estimates that the direct and indirect costs of trade financing that a U.S. company would have to pay to import goods valued at $1 million from overseas - on a cost, insurance, and freight basis - is $43,568.
A separate report by Accenture explained that trade finance has proven to be a recurrent and interest rate independent source of revenue for banks, with the added benefit of low default rates, “up to 10 times lower than for traditional corporate lending.” An example given in the report shows that $1 in trade finance fees can bring an additional $1.70 in foreign exchange and cross border payment fees, and another $2.25 in other transactional banking revenue. Not only is trade finance lucrative, but it also help banks build lasting and profitable relationships with their corporate clients.
However, the global trade finance market has suffered since the financial crisis of 2008. The World Trade Organization states that leading trade finance banks have been “shedding” assets in order to to comply with new capital adequacy regulations, scaling down the size of their balance sheets. Subsequently, banks have become more risk-averse, and only offer trade finance services to "quality" customers.
“Corporates are getting more selective in the use of trade finance instruments due to the relatively high fees of trade finance instruments and the complexity and time delays connected to their reliance on paper documents.”
To reduce costs and increase efficiency, corporates are increasingly replacing paper document flows with digital data flows. Bank Payment Obligation (BPO), a collaboration between SWIFT and the International Chamber of Commerce (ICC) aiming to enhance rules and tools for trade finance is, for example, one improvement in supply chain finance. BPO provides an alternative means of settlement in international trade, in a fully digital way, therefore improving speed, flexibility and reduced complexity.
SWIFT claims that market adoption of BPO is growing steadily. However, according to Boston Consulting Group only 20 banks were offering BPO as of October 2015, including just six of the top 15 trade banks.
Bank of America is one of the three banks in the North America testing BPO on the SWIFTNet Trade Services Utility (TSU) platform, although the Director and senior product manager in Global Trade and Supply Chain Finance, Paul Johnson, has stated that the bank's adoption of BPO has been slow: “That’s the case with any new development that involves a fundamental shift in the way business is done.”
Other potential technologies that can drive change in trade finance are SWIFT MT798 messaging and electronic bills of lading, all of which have been adopted slowly by the trade finance community, according to Boston Consulting Group. However, the landscape of trade finance is changing.
“What one banker we surveyed called the ‘arrogant assumption with BPO that only we can do the document-checking process,’ may soon be undermined. Distributed ledgers built on blockchain technology can validate ownership, certify documents and make payments. This could ultimately restrict banks’ role in the trade ecosystem to nothing more than providing financing.”
- Boston Consulting Group
SWIFT is also responding to the change, exploring the use of blockchain technology for a similar purpose, to solve the correspondent banking problem. Boston Consulting Group states that infrastructural players such as SWIFT may be better positioned to take advantage of blockchain technology, when compared to third party entities.
Large banks are increasingly exploring the use of the blockchain technology as well. Accenture highlighted that global banks account for a quarter to a third of global bank-intermediated trade finance. However, they are facing heightened competition from local and regional banks as well as non-bank players.
“It is likely that the nimble start-ups will be the first to leverage blockchain technology for trade finance, further adding to the threat for traditional banks.”
In addition to starting this trade finance blockchain project, Bank of America is also part of the R3 CEV consortium. In January, R3 announced that eleven of its 40+ member banks, including Barclays, HSBC, Credit Suisse and UBS, had simulated trading assets with each other and R3 on a blockchain-based system. Tiede clarified that the new BofAML trade finance project is not related to their involvement with R3.
In addition to hands-on blockchain initiatives, Bank of America has also been filing patents relating to cryptocurrency. The company already filed 15 cryptocurrency-related patents, and was reportedly drafting 20 in January.
Meanwhile, other banks such as UBS, JPMorgan Chase, Deutsche Bank and Barclays are exploring the benefit of blockchain technologies for financial and capital markets. Nasdaq is ahead of the game and has already issued securities on a blockchain using their proprietary platform, Linq, in addition to testing blockchain-based proxy voting in Estonia.
JPMorgan Chase has also started testing a blockchain platform, moving US dollars for about 2,200 clients between London and Tokyo. Despite all of the activity in the space, there are still no instant solutions.
“The general consensus amongst banks and non-banks, however, is that mainstream blockchain applications in trade finance are at 5+ years away.”
- Boston Consulting Group
The BofAML Global Trade and Supply Chain division has advised over 5,000 corporations and 10,000 middle-market companies. With a presence in 44 countries, the company serves institutions and individuals across 200 countries and more than 140 currencies. The company launched its flagship trade and supply chain portal, TradePro, in 2012. The portal allows clients to automate, manage, import and export trade and supply chain activity between buyers and sellers efficiently, therefore saving time and resources.
If BofAML is successful at testing trade finance transactions using the blockchain technology, the company will have a way to reduce cost and complexities associated with trade finance. “A lot of the benefits of blockchain are still being conceived. As we move into live prototyping, we will aim to prove out the business case," Tiede said.