Bank Payment Obligation: A New Instrument in Supply Chain Finance

The open commercial invoice is gaining in importance in global trade, with at least 90% of international trade flows now transacted by open account. The settlement of open account trading is, of course, easy and straightforward. Yet on the flipside, pure open account trading offers little in the way of risk protection or financing opportunities. At the same time, the market trend indicates a growing tendency towards electronic transfer and processing of trade data through appropriate platforms.

In this respect, a bank payment obligation (BPO) may be the answer for corporate treasurers and finance directors. A BPO is a new payment assurance instrument which, for the first time, offers the possibility of confirming an open account payment obligation between banks – thus ensuring the viability of settlement. As such, a BPO provides the risk mitigation benefits of a letter of credit (LC) in an automated environment and enables companies to employ flexible risk mitigation and financing tools across the supply chain.

Certainly, the demand for liquidity, management of risk and working capital along the supply chain is increasing. By processing trading data on an electronic basis, BPOs allow treasurers to use scheduled payment inflows for improved cash and working capital management. They can also attain financing and manage risk across their entire value chain. The BPO is therefore not simply a new instrument for trade finance, but also a useful supplement to supply chain finance (SCF).

Explaining the BPO in More Detail

The BPO is an irrevocable payment undertaking issued by one bank to another bank to effect payment on the due date following successful electronic matching of agreed trade data. It is therefore a type of payment assurance, which for the first time offers the possibility of confirming an open account payment obligation between banks and thus making it financeable.

The electronic matching of trade data is carried out by the respective banks of the buyer and seller. These banks have access to a special platform for electronic data matching called trade matching application (TMA). For this purpose SWIFT provides the trade service utility (TSU), a platform to which banks throughout the world can obtain access.

The special feature of the BPO is its status as a hybrid between the documentary credit and the open invoice (see figure 1 below). While there are many parallels with the documentary credit in terms of processing, it is worth stressing that the BPO is not an electronic documentary credit. It cannot replace the scope of risk protection of a documentary credit, as no trade documents are presented and examined by banks. Instead, settlement takes place on the basis of electronic trade data, which requires a solid basis of trust between the trading partners.

Instead, the BPO should be viewed as an additional instrument in the trade finance market. Looking ahead, the BPO is likely to make the open commercial invoice ’trade-finance-capable’ by providing opportunities for risk protection and financeability. Indeed, in addition to the payment assurance the seller has the option of obtaining financing on the term of payment under the BPO.

Figure 1: The difference between a BPO, documentary credit and open account

Commerzbank SCF fig 1

Supply Chain Finance Benefits

Besides being a payment assurance, settlement by BPO and the accompanying electronic data matching offers a wide range of advantages, in particular coming from the open invoice business. As the payment is undertaken on a fixed due date, the seller can use his scheduled payment inflows for improved cash management and, in addition, reduce the time and money spent on debtor management.

Furthermore, the electronic matching of trade data increases the processing speed, and changes in the transaction can be communicated and adjusted at short notice with higher flexibility. As the trade data to be matched are co-ordinated in advance between buyer and seller, shipment and contract performance risk is reduced. Thanks to efficient and accelerated work flows, costs can therefore be reduced.

In order to improve the respective cash flow of the business partners, the buyer has the option of extending his payment terms and at the same time of offering the seller financing under his credit rating, without additional risk or having to establish new credit lines. This corresponds to the financing model of approved payables finance (also known as reverse factoring)in supply chain finance (SCF). Elsewhere, the established baseline includes data of the agreed purchase order and could therefore serve as collateral for finance before shipment. Similar to pre-shipment finance under a documentary credit, this finance contains some risk, particularly shipment or performance risk.

Essentially, the BPO offers optimisation of working capital, risk and processes management and, at the same time, possible provision of liquidity – the key factors for effective management along the value chain.

What does Does the Future Hold for BPO?

Successful adoption of BPO will rely on both the acceptance of the industrial and banking world.

In this respect, the industry is already making significant strides forward. In July 2013 the ’Uniform Rules for the Bank Payment Obligation’ (URBPO) came into force, this being a legal framework developed by the International Chamber of Commerce (ICC) together with representatives of SWIFT, international banks and industry. The URBPO contractual rules will establish uniformity of practice in the market adoption of the BPO and the related ISO 20022 messaging standards.

The commitment of the ICC in developing these rules, together with its support at international conferences and events, hints to a bright future for the BPO. Indeed, at the end of November 2013, SWIFT announced that 56 banking groups in 42 countries now have access to the TSU matching platform in order to prepare for the BPO. In addition, the SCF working group of the European Banking Association (EBA) is discussing the BPO in connection with SCF.

However, it is also clear that international companies will be crucial to the BPO becoming successfully established in the market. Only if exporters and importers recognise the practicability and profitability of the BPO, and make use of the new instrument for their trade transactions, will it gain in importance in the long term. Progress on this front has so far been promising, with the BPO being widely praised by trading companies, especially in Asia where it is receiving great interest.

It is clear that this new instrument will not replace documentary credit business, which maintains a higher risk protection especially necessary when entering into new business relationships or volatile markets. We therefore see the BPO being used an alternative to open account transactions. The BPO is at this point in time still in its pilot phase, with initial transactions being carried out between international companies and banks. These tests will continue to contribute to greater confidence in using the BPO and drive forward the establishment of the tool in the market.


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