The trade finance industry has come under criticism at times for using out-dated and cumbersome systems to facilitate trade transactions. Therefore the various industry initiatives to modernise and simplify trade coming on-stream in 2012 should certainly be welcomed by banks and corporates alike. One such initiative is the introduction of bank payment obligations (BPOs), which are set to foster significant efficiency improvements in trade in the coming year.
As a tool, the BPO is very similar to the definition of a documentary credit in that it is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after successful matching of data. The key difference with the BPO is that it is electronic and involves matching data fields as opposed to documents.
This is a major leap in efficiency in trade finance as it removes the physical presentation of shipping documents to a bank as would be the case with a documentary credit. Instead notification of the BPO obligation and the decision on whether the seller has complied with the terms of the BPO is all based on electronic data. The efficiency gain is at least hours, but potentially days, for participants in the transaction.
Changes in Governance
A landmark agreement, signed during 2011 between the International Chamber of Commerce (ICC) Banking Commission and SWIFT, has paved the way for the ICC to assume responsibility for the rules governing BPO. The importance of this change cannot be underestimated as it will mean that the BPO will benefit from the extensive experience the ICC has in managing successful industry rules and also provides the BPO with another critical component: an industry recognised dispute resolution capability, which will build on the foundations that have already been laid down in the SWIFT-led model.
Under the agreement the ICC will develop industry standard rules for the BPO. These rules will apply to any BPO transaction and will form the bedrock of the future standing of the BPO, potentially elevating the BPO over time to a position similar to the letter of credit (L/C).
The ICC rules will be platform agnostic, meaning that they will apply to a BPO transaction irrespective of the platform that has been used to create and transact the BPO, resulting in the obligor and recipient banks under a BPO no longer being limited to using the SWIFT Trade Services Utility (TSU) functionality. This should encourage other software companies and vendors, many of whom are already well advanced in offering BPO functionality, to enter the market and provide alternative competition.
Figure 1 shows the key stages of a BPO transaction, which can be summarised as:
- Buyer and seller exchange contracts.
- Buyer instructs their bank (obligor bank) to establish the BPO containing the data that the seller needs to provide to obtain payment.
- Obligor bank agrees to support the transaction and issues the BPO to the recipient bank.
- The recipient bank notifies the BPO to the seller.
- After shipment of goods the seller provides the data required under the BPO, which flows through the recipient and obligor banks where it is matched to the original BPO requirements.
Source: Barclays Corporate
Benefits of the BPO
Corporates often quote that there are many benefits with the BPO over traditional documentary credits. Benefits are:
- Faster payment to the seller.
- Reduction in utilisation of banking lines and related fees due to later issuance of the BPO.
- Potential for different approaches to the provision of confirmations of obligor bank risks, particularly where the exporter/seller has some internal appetite on the obligor bank or where multiple banks are needed to cover a single transaction.
- Potential creation of new ‘events’ on which to base financing, particularly pre-shipment financing that can assist small and medium-size enterprise (SME) exporters.
Another major benefit of electronic trade finance programmes like the BPO is the massive improvement it can have cash flow forecasting. The presence of a committed payment due date is often worth the cost of participation, particularly if the BPO is used in longer standing trading relationships where bank involvement can be requested later in the process (resulting in lower bank line usage and bank fees).
Overall, there is significant corporate interest in BPOs, and when combined with other initiatives such as corporate SWIFT membership, BPO’s can provide a powerful platform for revolutionising trade.
BPO Progress to Date
When reviewed in terms of actual transactions and participation, progress has been limited. SWIFT says that there currently 19 banks committed to participating in promoting the BPO and a slightly smaller number with the capability to enter into BPO transactions. Some are more active than others. Likewise, the number of live transactions entered into so far has been small with the majority of the transactions conducted within the Asian markets and most of those within the Chinese domestic market.
Notwithstanding, this limited progress interest continues to grow with a handful of large corporations and a growing number of banks actively pursuing the use of the BPO within their supply chain.
Where to from Here?
The future of the BPO has been boosted significantly with transfer of governance to the ICC. Of course, this development in its own right will not embed the use of the BPO across the industry. BPO can only be as successful as the L/C if all participants in international trade commit to trying it and finding a place for it in their businesses.
In the early stages, education and communication of the benefits that the BPO can offer is also a key cornerstone of its future success. This education has to go across all the communities who may benefit from the BPO including buyers, sellers and banks. Ultimately, like any new development or initiative, the relative success will depend on how forcefully customers, in this case corporates, demand that their banks are able to provide them with BPO solutions. Banks in their own right may decide to develop BPO solutions based on the benefits that they believe can be achieved, but a robust corporate demand is required for the BPO to enter the mainstream trade finance world.
These are exciting times for trade finance banks and to realise the full benefits that the BPO can offer both banks and their customers it is important that all banks involved in trade finance, irrespective of size or geographical coverage, work together to facilitate the introduction and successful implementation of the BPO, leveraging the initial groundwork of SWIFT and the work now underway within the ICC.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.
Politicians have united in urging the Reserve Bank of Australia to lend its backing to the digital currency by officially recognising it.
In order to survive, banks must get ready for an open application programming interface-led economy and develop superior value propositions for their customers.
The banking industry will meet the challenge of the new era introduced by Europe’s Payment Services Directive, but it is up to its individual members to determine whether they sink or swim.