Two Russian companies, S7 Airlines, and Alfa-Bank, have successfully closed a deal using a smart contract to settle and record a Letter of Credit (LoC) on a blockchain. A Deloitte in Russia provided legal support to the project.
Siberia Airlines has been operating flights under the S7 brand since 2005. Headquartered in Novosibirsk Oblast, Russia, the company history dates back to 1957 when it was the first airline to connect Moscow to the Siberian hub of Novosibirsk, Russia’s third largest city. Dmitry Kudelkin, the Deputy General Director of the S7 Group calls S7 “the most technologically advanced airline on the Russian air transport market.” The airline was one of the first in the world to replace their ticketing system completely with e-ticket technology, in 2008.
The airlines banking partner in the recent deal, Alfa-Bank, is the largest private commercial bank in Russia, operating in most sectors of the financial market, including retail and corporate lending, investment banking, leasing, factoring and trade finance. Founded in 1990, the bank serves around 277,000 corporate and 14 million retail customers, while the branch network consists of 723 offices across Russia and abroad, including a subsidiary bank in the Netherlands and financial subsidiaries in the United Kingdom and Cyprus.
“Currently, many innovative companies are engaged in blockchain technology research and development. However, today we witnessed a practical application of the technology for letter of credit settlements. Only a few similar transactions have been completed globally and this is the first one in Russia.”
- Deloitte CIS
The two participants used a smart contract to open and execute a letter of credit, a document guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met. Only the people with information about the original parameters of the deal can view the status of the letter of credit in the blockchain record. “In this transaction, in addition to Alfa-Bank and S7 Airlines, the information is available to a service company that receives money under the letter of credit,” Deloitte revealed.
In a traditional trade finance system, each party involved such as the importer, exporter, shipper, and banks, must all maintain their own database for all the documents related to a transaction. Phillip Silitschanu, founder of Lightship Strategies Consulting, explains that LoCs, bills of lading, and invoices are among documents that must be constantly reconciled against each other and corrected if there is an error. “A single blockchain can embody all of the necessary information in one digital document,” he claims, adding that it is “updated nearly instantly, and viewable by all members on the network at the same time.”
Commercial letters of credit are guarantees from banks that a buyer will pay a seller on time and for the correct amount. A Standby Letter of Credit, on the other hand, is not a primary payment method but are created as a proof of a buyer's credit quality and repayment abilities. Legally, this transaction meets all the requirements for a letter of credit as a form of bank settlement, and demonstrates the potential of smart contract application in the framework of Russian legislation”, Artem Tolkachev, Director, Legal Services for Technology Projects, Deloitte CIS.
A Global Survey on Trade Finance, conducted by The International Chamber of Commerce (ICC), found that commercial LoCs make up the majority of both the export and import trade finance product mix. The Board of Governors of the US Federal Reserve System states that LoCs “are special in their ability to reduce risk in international trade.”
Kris Wielens, Senior Consultant with Orchard Finance Consultants states that current LoCs are “costly and cumbersome,” In addition to costs ranging between 2 and 4 percent on an annual basis, LoCs are “prone to error and involves a financial intermediary to process the transaction.” A blockchain based process can minimize transaction costs, he claims, stating that “It can be compared to physical mail (e.g. € 1 per letter) vs e-mail (negligible costs per e-mail).”
Bain & Company echoes the sentiment, while adding that about 50 percent of the cost for a bank to process a LoC is due to manual document handling. “Trade ﬁnance is particularly suited to distributed ledger solutions because it involves commitments from unrelated parties subject to very different legal regimes and cultural norms,” the firm wrote.
“The transaction enabled us to test the capabilities of smart contracts and understand how the technology helps to improve business processes and document flow efficiency. We are planning to continue cooperating with Alfa-Bank in this area.”
- Dmitry Kudelkin, Deputy General Director, S7 Group
While S7 and Alfa-Bank are attempting the first LoC transaction in Russia, there have been a handful of other blockchain technology projects in Russia this year.
In October, S7’s Russian competitor Aeroflot airlines was among a Central-Bank-led team to trial blockchain technology, specifically made to store and share immutable contracts. The project was called the ‘Digital Ecosystem for Exchanging Documents.’ While no mention was made of LoCs nor smart contracts, the project was run by the Federal Antimonopoly Service and included participants from many different sectors including energy and finance.
During the same month, the Bank of Russia conducted the first transactions between major banks, based on the Ethereum-based masterchain technology. The transactions were carried out using Cinimex’s prototype, a service for exchanging data about clients of various banks. The prototype allowed the development of the platform in the interests of financial market participants, which will enable the creation of new services in the future. Major financial organizations, including Qiwi, Sberbank, Alfa-Bank, Otkritie Bank, and Tinkoff Bank, contributed to the creation of the platform.
Outside of Russia, blockchain projects for LoCs and smart contracts for trade finance have also been forthcoming. In August, Bank of America Merrill Lynch (BofAML), HSBC, and the Infocomm Development Authority of Singapore (iDA) announced that they have jointly developed a blockchain prototype for trade finance. The application mirrors a paper-intensive letter of credit transaction “by sharing information between exporters, importers and their respective banks on a private distributed ledger,” the three announced at the time. “This then enables them to execute a trade deal automatically through a series of digital smart contracts.”
In September, French multinational bank BNP Paribas started working with a client’s company that uses blockchain technology to enable faster, simpler and more secure processing of LoCs, called ‘Smart LC.’ The aim of the project, the bank wrote on its website, is to optimize the Trade Finance and Cash Management activities of BNP Paribas Group clients.
In the same month, Barclays and its accelerator graduate Wave announced the claim that they were the first to complete a trade finance transaction. A LoC transaction between the Irish Dairy Board and a Seychelles Trading Company was the first to trade documentation on the Wave platform, while funds were transferred via Swift.
Wave's blockchain-based system allows all parties to see, transfer titles, and transmit shipping and other trade documentation through their decentralized network. Barclays announced that it eliminated “many of the current inefficiencies in international trade,” citing faster trade transactions, lower costs for companies and lower risk of documentary fraud. The bank also identified “substantial direct cost savings” from using the platform, such as savings on courier costs.
However, in April, EdgeVerve Systems, a wholly owned subsidiary of the Indian outsourcing services Infosys Limited, created a Blockchain Framework for financial services that offered a trade finance solution that can be used for LoCs. In its brochure, the company wrote that, for the LoC process, it offers “significant cost savings” with respect to messaging and settlement systems, Lifting Fees and Correspondent Banking Fees.
Most recently, the Commonwealth Bank of Australia, Wells Fargo and Brighann Cotton pioneered a trade finance transaction in October using blockchain technology, smart contracts and the Internet of Things. The transaction involved a shipment of cotton from the Texas, US, to Qingdao, China. The trade mirrored a LoC between the Brighann Cotton (the seller) and Brighann Cotton Marketing Australia (the buyer) as well as their perspective banks, Wells Fargo and Commonwealth Bank. A private blockchain, the Skuchain Brackets system, was used for the project.