Bank of America Merrill Lynch, HSBC, and IDA develop a blockchain prototype solution for trade finance

Bank of America Merrill Lynch (BofAML), HSBC, and the Infocomm Development Authority of Singapore (iDA) recently announced that they have jointly developed “a prototype solution built on Blockchain technology that could change the way businesses around the world trade with each other.”

The Hyperledger project’s open source blockchain was chosen to be the backbone of the small consortium. Supported by IBM and created by the Linux Foundation, Hyperledger is a commercial-grade blockchain already used by various consortia.

"The proof of concept shows potential to streamline the manual processing of import/export documentation, improve security by reducing errors, increase convenience for all parties through mobile interaction and make companies’ working capital more predictable.”
— – BofAML, HSBC, and iDA

Trade finance involves a range of activities; lending, issuing letters of credit (LCs), factoring, export credit issuance, and insurance. The processes are typically time and labor intensive, involving many parties; importers and exporters, banks and financiers, insurers and export credit agencies, and other service providers. Multiple documents must be checked to reduce risk and provide assurance to sellers, buyers, and their banks.

An LC or Documentary Credit represents a guarantee by a bank that a seller will receive payment from a buyer once certain conditions are met. Using blockchains, all parties involved in an LC transaction can view all actions in real-time, such as when the seller has shipped the buyer’s goods. “Each action in the workflow is captured in a permissioned distributed ledger, giving transparency to authorised participants whilst encrypting confidential data,” states the project press release.

“The application mirrors a paper-intensive Letter of Credit (LC) transaction by sharing information between exporters, importers and their respective banks on a private distributed ledger. This then enables them to execute a trade deal automatically through a series of digital smart contracts.”
— – BofAML, HSBC, iDA press release

The trio’s proof of concept has seven steps, starting with an importer creating an LC application. The importer’s bank is then notified to review the LC and, if approved, data is stored on a blockchain and access provided automatically to the exporter’s bank for approval. If the exporter’s bank approves the LC, the exporter is then prompted to view the LC requirements.

The exporter will then ship the goods as well as add invoice and export document. Once the documents are validated, they are stored on a blockchain for the exporter’s bank to approve or reject. Then the importer’s bank will check the documents against the LC requirements. If everything checks out, the importer can then check and make payments.

Many organizations have identified trade finance as one of the key areas where blockchain technology can improve on existing systems. Most recently, the World Economic Forum (WEF) published a report on how blockchain technology can ‘reshape financial services.’ Among the nine use cases highlighted was trade finance.

The report suggested that blockchains or distributed ledger technology (DLT) can be used to store financial details, facilitate the real-time approval of financial documents, create new financing structures, reduce counterparty risk and enable faster settlement.

“Multiple parties within a trade finance arrangement (e.g. importer, exporter, issuing bank, receiving bank, correspondent banks and customs) that do not “trust” each other and, therefore, institute layers of verification and impose collateral requirements.”
— – World Economic Forum

The WEF cited a World Trade Organization report, published in 2015, stating that US$18 trillion of annual trade transactions involve some form of finance – credit, insurance or guarantee – and the trade finance market has grown to more than US$10 trillion annually.

Since trade finance is such a large market and critical to many banks’ operations, many of them have individually explored how to use blockchains. The corporate and investment banking division of Bank of America, BofAML, started exploring the use of blockchain technology for trade finance transactions in March.

“The success of this proof of concept is a significant development towards digitizing trade transactions, potentially resulting in considerable benefits to the supply chain process.”
— – Ather Williams, Bank of America Merrill Lynch Head of Global Transaction Services

Bank of America has approximately 47 million consumer and small business relationships with approximately 4,700 retail financial centers. The bank has approximately 16,000 ATMs, approximately 33 million active online banking accounts and more than 20 million mobile active users. Bank of America is the second-largest U.S. bank, by assets, after JPMorgan Chase Bank, according to Accuity’s 2016 Bankers Almanac.

“We are continuously looking for ways to simplify and improve transaction processing for our clients,” Ather Williams, head of Global Transaction Services at Bank of America Merrill Lynch, said. “Blockchain has reshaped our thinking on how to make transaction processes more efficient and transparent for all parties.”

Bank of America reportedly prepared to file for 20 blockchain-related patents in January, having filed 15 patents relating to blockchain technology. In March, the bank successfully tested blockchain and smart contracts for post-trade lifecycle events, in collaboration with Citi, Credit Suisse, DTCC, JP Morgan, Markit, and Axoni.

“Many people are talking about the theory of Blockchain, but for the first time we can start to see how this technology might be used to solve the real world challenges our customers face.”
— – Vivek Ramachandran, HSBC Trade and Receivables Finance Global Head of Product and Propositions

HSBC, founded in 1865 and headquartered in London, is one of the world’s largest banking and financial services organizations serving approximately 46 million customers. With 4,400 offices in 71 countries and territories worldwide, the Group reported total asset of US$2,608 billion as of June 2016. Accuity’s 2016 Bankers Almanac ranks HSBC Bank as the fourth largest British bank by assets.

Trade finance is a big part of the company’s commercial banking division (CMB). “CMB is at the centre of business synergies within the Group, enabling nearly $6bn of business synergy revenue in 2015,” the company states in its Strategic Report.

Earlier this year, TFR Excellence in Trade Awards 2016 named HSBC as the “Best Trade Bank in the World.” Independently, GTR Asia Leaders named the bank the “Best Supply Chain Finance Provider,” as well as the “Best export finance bank” in Asia Pacific. The company was also awarded the Best Overall Global Trade Finance Bank, in the Trade Finance Awards for Excellence in 2016. Also in 2016, Global Finance awarded HSBC for the Best Trade Document Management.

“It’s really exciting to have a valid proof of concept. Letters of Credit are an important part of the trade system, but they are based on 20 th century technology, not 21 st . Our challenge is to take this from concept to commercial use; making it quicker and easier for businesses to connect with new suppliers and customers at home and abroad.”
— – Ramachandran

Both Bank of America and HSBC are part of the R3 Consortium which has been working on a framework for using blockchain technology in financial markets. While BofAML, HSBC, and iDA announced their proof of concept, R3 announced its own prototypes for trade finance on the same day.

R3 and over 15 of its consortium member banks have completed two prototypes for trade finance using R3’s Corda distributed ledger platform. However, neither HSBC nor Bank of America were involved in R3’s trials.

“Leveraging distributed ledger technology, the initiative will reduce risk around duplicate invoice financing for banks while preserving client confidentiality.”
— – iDA

iDA is a statutory board of the Singapore government, under the Ministry of Communications and Information (MCI). The board was formed in 1999 by a merger of two governmental entities; the government merged the National Computer Board (NCB) and Telecommunication Authority of Singapore (TAS). Its mission is to develop information technology and telecommunications within Singapore.

The idea of applying blockchain technology to trade finance is not new to iDA either. In December 2015, iDA announced that it has successfully completed a proof of concept using blockchain technology for trade finance invoicing. The project was in collaboration with Standard Chartered Bank and DBS Bank.

“A letter of credit or LC conducted on Blockchain enables greater efficiencies and visibility in trade finance processes, benefitting multiple parties across its value chain. With participation of more members, greater impactful benefits will be realised by the trade ecosystem.”
— – Khoong Hock Yun, iDA Singapore’s Development Group Assistant Chief Executive

The next step for the consortium is to conduct further testing on commercialized applications based on this concept.