Launched at the beginning of 2010 by SWIFT, the bank payment obligation (BPO) provides an alternative means of settlement in international trade. SWIFT, together with the International Chamber of Commerce (ICC) Banking Commission and a working group of banks and corporates, undertook an initiative to establish the BPO, most recently signing a co-operation agreement at the Sibos in September 2011, with the intention of encouraging industry-wide adoption.
BPO sets out to upgrade several current methods for settling international trade. While letters of credit (L/Cs) have been around for years, will be for many more and are trusted and used globally, the time and paperwork required means that there is certainly space for modernisation of the system, particularly when it comes to open account transactions not currently benefiting from L/Cs’ well-known risk mitigation advantages.
As is often the case, change involving new technologies and standards can be daunting, but in the case of BPO, there are a number of reasons not to be afraid. Its standards-based technology foundations in particular are merely following the same path of evolution undertaken by other areas such as cash management since the mid-2000s, and the transition to BPO is unlikely to be problematic on this front.
Beyond the clear benefits of the instrument itself from a financial and risk management perspective, complementary advantages are also expected in the increased granularity of the data the BPO exposes. Not only will it improve settlement of trade transactions, but its ability to read even more information and increase visibility should also mean banks are able to enhance their services too.
A BPO is an irrevocable undertaking given by a bank to another bank that payment will be made on a specified date after a successful electronic matching of data according to a defined set of rules. Therefore, a BPO offers:
- An assurance of payment.
- Risk mitigation for all parties.
- Possible use as collateral for finance.
Interest in BPO is fuelled by the fact that it seeks to bridge the gap between the current system of L/Cs, which, despite its value, is often blamed for being slow, inflexible, administration-intensive and costly in terms of both paper and processing, and open account transactions lacking the traditional L/C assurances provided by banks.
Trading parties use complementary techniques in the context of open account transactions to manage the risks of their transactions in lieu of L/Cs. For example, the risk of payment default for exporters can be mitigated through buying credit insurance, arranging standby L/Cs or various methods of selling their invoice portfolio at a discount. However, these methods tend to cover only a portion of the trade transaction and lack integration with the underlying end-to-end flow of information along the physical supply chain.
From a risk management perspective with open account, it is also incumbent on the parties to know their counterparties’ risk profile. For this reason, open account is mostly used for longstanding and trusted relationships, while L/Cs are preferred for new customers without a proven track record and where banks play a key role thanks to their extensive knowledge in managing risks.
BPO aims to mitigate open account risks and to accelerate the payment cycle. It enables banks to provide their trade finance customers with guarantees and other banking services on open account terms. Based on ISO 20022 messaging, it brings together the Trade Services Utility (TSU), SWIFT’s matching utility as a reference implementation, with a set of business rules that replace the reliance of L/Cs on actual documents (either on paper forms or electronic as authorised for many years by the eUCP rules of the ICC but with little success) with dynamic data sets that can be automatically streamed.
The Same, But Different
The use of electronic data exchange to support trade finance is not a fundamental change and the technology is ready. In many ways, it’s not that different to L/Cs, whose process is already largely electronic. Corporate e-banking systems offered by a large proportion of banks active in trade finance support the ability to issue, notify and monitor L/Cs and other instruments throughout their lifecycle including subsidiary events and copies of documents.
In addition to an interactive web-based user interface, some also include the ability to integrate directly with the corporates’ enterprise resource planning (ERP) or treasury systems. Statistics vary between different banks and regions, but a consensus among the financial institutions using customer portals today is that more than 80% of their total volumes of L/Cs will generally be exchanged and managed electronically with their customers.
The same level of dematerialisation is largely in place at most banks’ back office operations where integrated trade finance systems process transactions and manage the necessary electronic data interchange with the customer channels, other banks via SWIFT and payment gateways.
Therefore, we already have in principle both the channels and the back office systems to support the kind of facilities necessary to deploy BPO in the value chain. Much of the infrastructure needed to enable corporate customers to upload and action their purchase order or invoice data, and banks to automate the overall accounting, risk management and billing of transactions, is already in place.
One of the things that is crippling the industry and hindering the adoption of mass working capital financing techniques such as supply chain finance (SCF) is the lack of standardisation. But a key advantage of BPO is that it is standards-based – following the ISO 20022 standard – and therefore provides an unambiguous reference to its definition and mechanism. It is again here a strong analogy with the L/C and its uniform acceptance across the globe. This is in contrast with SCF and its variations, which do not rely on standards-based definition and practices today – in spite of initiatives such as the BAFT-IFSA glossary.
BPO is fundamentally aiming to tackle this – not only the standardisation from an ISO 20022 messaging perspective, but also in terms of business rules which the ICC is currently working on. Another important aspect of the ICC endorsement to help widen adoption is the decoupling of BPO from being exclusively run on the SWIFT TSU infrastructure, despite the SWIFT service being the obvious initial reference implementation.
Provided that all aspects of the upcoming ICC rules are fulfilled, it shall be possible for a party independent from SWIFT, such as a bank, a corporate, a solution provider or consortiums of the above, to implement platforms supporting the end-to-end deployment of BPO. Again much like L/Cs, which are independent of the network over which they are processed, even if most of them eventually take the form of MT700 messages transmitted over the SWIFT network.
Key points about standardisation are the guarantee of interoperability between participants (parties and systems), a larger pool of skilled resources and the de-risking of investment in proprietary technology. But the advantages do not stop there.
Even if exchanged electronically, L/C transactions transmitted over proprietary channels and SWIFT tend to contain large amounts of unstructured data such as free text. BPO, on the other hand, streamlines this data, making it more structured and granular with ISO 20022. This in turn facilitates usage, distribution and storage of the transaction data.
This development will provide corporates a finer control over their transactions and a deeper integration with the existing process of their physical supply chain. It will also enable banks to instantly access and identify specific trade activity, not only minimising risk, but also tailoring their services to match the customer’s needs.
For example, by capturing data from a purchase order, a bank can be alerted to a customer’s upcoming need for foreign currency in order to settle the underlying invoice at due date. Another example is the access to more detailed descriptions of goods and services allowing a tighter matching in order-to-pay (O2P) processes down to line item levels.
This more granular access to the data can therefore be seen as an interesting means by which banks can provide value-add features beyond commoditised payment services and ultimately remain relevant to their corporate clients. It can particularly be the case to those large international clients who have moved an increasing proportion of their trade business onto open account terms, rendering the bank’s involvement in the transaction unnecessary. The BPO can play a role in helping avoid this disintermediation of banks and create a new source of fee and commission-driven income for financial institutions.
Barriers to Adoption
The acceptance and expansion of BPO presents something of a chicken and egg situation – people will only start adopting it once enough people are doing it, but how do we get to that tipping point of critical mass? Creating a set of rules relies upon demonstrable evidence gathered from real, live transactions and this will take time to amass. In an effort to build this evidence, BPO is currently being tested by some of the corporates in the working group, which will help drive momentum in adoption.
Basel III is another potential obstacle to adoption. Confusion about how to calculate risk and how much capital to set aside for BPO transactions could hinder its acceptance. Traditionally, trade finance practitioners as a group tend to resist change. However, we are seeing clear interest in those ranks with an influx of commercial and logistics backgrounds and appetite to realise this evolution.
From the technology perspective, the analogy with the L/C processing and the similarities with the development of cash management are certainly contributing to lowering those barriers. Existing IT expertise within banks coupled with the ability to leverage infrastructure already in place for cash management and payments in support of ISO 20022 should facilitate the evolution.
Despite industry inertia to change, BPO is an opportunity for a positive evolution in the face of an increasingly online industry. L/Cs are still used faithfully by many corporates and banks alike and open account transactions are already the norm, but there is a need to streamline the flow of information so that it benefits both sides of the settlement.
The BPO can help achieve this. We are seeing beneficial change in many areas of trade finance, much like with cash management before. Reaching critical mass for any service is always a complex feat, but, in parallel with the ICC work on the subject, we believe the technology transition to BPO will be a relatively simple one where the benefits will quickly proven.
Many banks around the world, large and small, continue to experience major security failures. Biometric systems such as pay-by-selfie, iris scanners and vein pattern authentication can help.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
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.