Time for a New Payment Guarantee to Automate Trade Finance

The new payment guarantee offered by SWIFT, in the form of the bank payment obligation (BPO) combined with SWIFT electronic invoicing ( e-invoicing), can be packaged as a valuable supply chain finance (SCF) solution with global acceptance and strong growth potential.

Declining Traditional Trade Finance Products

Less than 15% of current global cross-border trade is conducted on letter of credit (L/C) terms and the figure is just 5% for documentary collections. This year-on-year decline, shown in Figure 1, is largely due to the fact that both instruments are paper based, require extensive manual effort and so are slow to process. Consequently both corporates and banks regard them as expensive to operate, which results in high fees for corporates.

 Figure 1: Declining Importance of L/Cs
Declining importance of L/Cs
Source: SWIFT

Over recent years powerful corporate buyers have tended to pressurise suppliers to accept open account trade terms as a way to reduce their own costs by cutting out L/C charges – to the point that open account now represents over 80% of global cross-border trade. Traditionally, local banks in the exporters’ country have been willing to use export L/Cs as collateral to support pre-shipment and post-shipment finance, as well as a support for back-to-back L/Cs. With the reduced usage of L/Cs it is harder for suppliers to access working capital facilities, which is putting pressure on their cash flow.

A challenge from the banks’ perspective is that they have tended to be disintermediated. In many open account transactions the bank’s role is simply to execute a clean payment on behalf of the importer. As payments become increasingly commoditised, there is limited bank revenue in open account transactions. So the banks need to find a suitable means of re-intermediating themselves back into open account transactions by delivering added value. This situation sets the scene for a modern, more efficient SCF instrument.

The Impact of Basel III Regulations

The Basel III regulations redefine regulatory capital requirements and introduce a new liquidity regime. As a result, many banks will have to hold more capital and prove that they have greater liquidity to meet on-going business obligations. The current Basel III proposals for trade finance products are controversial enough to have caused lobbying, since they risk ending the historic special treatment of these instruments and applying a full 100% credit conversion factor. This will replace banks’ current general practice of applying a 20% weighting to L/Cs, given the short term and self-liquidating nature of these trade finance instruments and their very low historic default rate.

This could have a major negative impact on economic growth, since banks may be less inclined to support trade finance given the higher costs. For the same reason, corporates will be deterred from using such trade finance instruments.

Whatever the outcome of current lobbying, banks are taking a close look at their trade finance strategy. Given the high internal costs they face in supporting traditional trade finance business, now is an ideal moment for banks to develop alternative and lower cost instruments that will have broad appeal to corporates by mitigating risk and supporting various finance models. They have the potential to streamline global trade and become a viable alternative to L/Cs and, most importantly, to re-intermediate banks into open account trade.

SWIFT and ICC’s BPO Initiative

SWIFT and the International Chamber of Commerce (ICC) have joined forces to develop an industry-wide standard for a new trade finance instrument, BPO. The BPO has gathered momentum as a strong candidate that satisfies the criteria for a viable alternative to the L/C. Modern automation features enable it to be processed faster and at lower cost, making it attractive to all parties.

The ICC Banking Commission views the development of the BPO Rules and the related ISO 20022 messaging standards as strong foundations for banks to provide modern risk and financing services aligned with today’s technology evolution. SWIFT and the ICC are working to establish a set of BPO rules by the beginning of Q213.

The goal is to extend the benefits of the L/C to the open account world by re-using electronic data available from corporate customers. Using BPO, suppliers will benefit from the assurance of timely payments and will therefore find it easier to access pre-shipment and post-shipment finance.

The BPO effectively provides the benefits of an L/C in an automated and secure environment, without the drawbacks of slow paper-based processing. It will enable banks to offer flexible risk mitigation and financing services across their corporate customers’ supply chains.

Banks’ Branding of the BPO

One of the few potential barriers to adoption of the BPO by the corporate community actually lies in its name. The acronym BPO is already widely known in the corporate world as an abbreviation for business process outsourcing or optimisation. The similarity might cause confusion in the market place, especially during this delicate adoption phase.

While SWIFT, the ICC and the banking community have already settled on the name BPO, I would suggest that individual banks, as they start to educate their corporate customers on the potential of this new supply chain finance instrument, should carefully consider how they brand and package the BPO. In order to differentiate themselves, they will probably wish to create their own branding around a BPO product package, which is where you might see terms such as trade payment guarantee (TPG), payment guarantee or cash flow accelerator.

Benefits of the BPO

The benefits of the BPO or TPG include:

  • Mitigating risks for buyers and suppliers.
  • Speed, reliability and convenience.
  • Reduced cost and improved accuracy.
  • Enhanced risk management.
  • Assurance of payment.
  • Access to flexible financing options, both pre-shipment and post-shipment.

The BPO can be used in various situations by banks to support corporate customers, for example to guarantee against payment default or delayed payment, or as collateral to support finance.

Although it should be assumed that Basel III rules on L/Cs will be applied equally to the BPO and that both will have a 100% credit conversion factor, the BPO is a far lower cost product for a bank to process, given the superior level of processing automation available. In this respect, the profit margins they can achieve on BPOs will be far higher than the margin on L/Cs. Alternatively, banks will be better placed to be competitive on pricing, given BPO’s lower processing costs.

Alongside quicker processing times and lower costs, additional key benefits of a payment guarantee in the form of a BPO for suppliers include:

  • Cutting the risk of payment delay or default by providing assured payment on a specified date, subject to fulfilment of pre-determined conditions represented by data matching.
  • Covering the full value of the transaction, unlike credit insurance.
  • Ability to apply automated data matching reduces complexity and increases reliability, minimising the risk of dispute and delay. This, in turn, enables improved visibility and cash flow forecasting.
  • Credit risk is transferred from the buyer to the buyer’s bank.
  • Foreign exchange (FX) risk can be eliminated with local currency payment guarantees.

Collateral for accessing pre-shipment finance and post-shipment finance, enabling accelerated cash flow and improved days sales outstanding (DSO).

Benefits for buyers include:

  • Strengthening supplier relationships by facilitating access to finance and mitigating risk.
  • Protecting the buyer against paying for unwanted goods, since the bank only pays when the seller complies with the specific terms of the contract and provides the required data.
  • Safer than pre-payments.
  • Safeguards can be built into the contract, for example by requiring data from goods inspection certificates.
  • Opportunity to extend commercial payment terms, by making it easier for suppliers to accelerate cash flow.
  • Lower utilisation of bank credit lines and fees due to shorter transaction lifecycle, thanks to later issuance of the Payment Guarantee and faster matching.
  • More efficient and thus lower processing costs than L/Cs or documentary collections.

Both the buyer’s and supplier’s banks also benefit from a payment guarantee – it generates higher profit margins than L/Cs since it has significantly lower processing costs and allows re-intermediation into open account transactions alongside cross selling opportunities regarding FX, payments and reconciliation. The BPO opens the door to new bank business opportunities, thanks to the innovative and automated nature of the product.

Using SWIFT E-invoicing to Maximise BPO STP

The highest degree of automation can be achieved by combining SWIFT e-invoicing with the new BPO. This enables straight-through processing (STP) of data flows on an end to end basis between buyers’ and suppliers’ ERP systems and their respective banks. This STP is viable because SWIFT e-invoicing and BPO both use ISO 20022 standards, underlining the growing importance of this relatively new messaging format. Data from corporate enterprise resource planning systems (ERPs) can be readily reformatted using software to transform it into the appropriate ISO 20022 format. It is noteworthy that the new single euro payments area (SEPA) messages for credit transfers and direct debits also use this XML format, showing how formats are converging on a common standard, a move that is long overdue.


The TPG offered by the SWIFT BPO has the potential to be a transformational new SCF instrument. It provides the ‘best of both worlds’, combining the risk mitigation and financing benefits of L/Cs with the efficiency of open account and all on an automated basis.

A payment guarantee gives banks a modern and robust SCF instrument, and provides a timely opportunity to extend SCF services from invoice-based processing services (e.g. e-invoicing, factoring and reverse factoring) to purchase order-based services such as payment assurance, risk mitigation, pre-shipment and post-shipment finance.

It is anticipated that the BPO will enable banks to create new value added services for their clients in open account, but also provide a highly cost-effective alternative to the L/C and documentary collection. While not expected to replace the L/C, payment guarantees present banks with an opportunity to automate the processing and cut the cost of some of the more basic L/C models, while also making significant inroads into the larger open account market.

All of these activities will enable corporates to manage their trade activities more efficiently and improve working capital management. In the current economic climate, anything that gives corporates the ability to trade with confidence and minimise financial risk is to be strongly encouraged.


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