Global Policies (Week 1) Synopsis

Trade finance and digital technologies: Facilitating access to international markets

TRADE POLICY BRIEFS

NO. 35

TRADE & AGRICULTURE INNOVATION

Authors: Mischa Tripoli

Introduction

Access to international agricultural markets depends on numerous
factors, including compliance with technical standards and
procedures in importing country, product quality and food safety
requirements, marketing, business relationships and access to
finance. I n i nternational t rade, t here i s s ubstantial r isk f or t raders
between product dispatch, delivery and payment. Exporters typically
want to receive payment when a purchase order is placed and before
they ship the goods to the importer; while an importer typically
wants to receive the goods before making payment. In order to win
sales in a competitive global marketplace, exporters are challenged
with providing attractive sales terms to their clients, while also
minimizing payment risk. Trade finance helps businesses fund their
operating costs and manage various payment related risks, whether
commercial, exchange rate, transportation, or political.

Different payment methods in international transactions carry
different risks for exporters and importers. Of the four main
payment methods, letters of credit1 or even cash-in-advance are
the most secure forms for exporters, while open account is most
secure for importers (figure 1 ). C ompetitive g lobal m arkets o ften
force exporters to accept the riskier open account payment method
in order to win sales, requiring the goods to be delivered before

1 A letter of credit is a guarantee of payment by the importer’s bank to the exporter once the
contractual conditions are met. It mitigates payment risk for exporters typically when they
do business with a new or unknown foreign buyer. One of the conditions is presenting the
buyer’s bank and buyer with a bill of lading (typically sent by courier and in paper form),
which is used to claim the shipment and release the payment.

TRADE FINANCE AND DIGITAL TECHNOLOGIES:
FACILITATING ACCESS TO INTERNATIONAL MARKETS

payment. Open account trade represents approximately 80 percent
of all trade (ICC, 2018). Trade finance is a key factor in facilitating
access to international markets; however, small and medium-sized
companies (SMEs) often lack the ability to obtain financing.

Figure 1: Payment risk

Source: United States Department of Commerce (USDC), 2008.

Challenges in trade finance
The demand for trade finance is persistently greater than supply,
leaving an annual global trade finance gap of about USD 1.4-1.6
trillion during the period of 2014-2018, which is equivalent to about
8-10 percent of world merchandise trade (Asian Development Bank
[ADB] and United Nations Economic and Social Commission for Asia
and the Pacific [ESCAP], 2019). The problem is that many SMEs,
particularly in developing countries, have trouble accessing trade
finance, affecting their ability to access international markets. SMEs
tend to have higher rejection rates of trade finance applications than
larger firms, since banks have higher transaction and information
costs when serving smaller companies (ADB & ESCAP, 2019). When

• Trade finance is an important determinant of international agri-food trade, and used to offset risk for exporters and
importers related to product dispatch, delivery and payment.

• The low availability and high costs of trade finance limit access to markets by small-scale agricultural producers and
traders, acting as a significant barrier to trade, economic growth and participation in global value chains.

• Digitalization and automation can reduce costs and better facilitate trade transactions by improving process
efficiency, risk mitigation and access to working capital management in trade finance, increasing access to financing
for small companies and the underbanked.K

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trade finance is available, its high costs make it unprofitable for SMEs
to use such instruments as letters of credit and even open account
arrangements. In effect, low availability and high costs limit access to
trade finance for small-scale agricultural producers, processors and
traders, acting as a significant barrier to trade, economic growth and
participation in global value chains.

High inefficiencies in trade finance contribute to the persistent gap
in financing. The use of paper documents and manual processes for
processing and handling documents in trade finance transactions
are major contributors to the high costs, lengthy-payment terms,
delays, human error and even fraud. The complexity of coordinating
a transaction through paper-based manual processes results in
duplicated information and redundant document examination. One
international trade transaction can include approximately 20 different
entities, 100 pages of documentation in 10-20 documents and 5,000
data field interactions (BCG, 2017). In addition, financial institutions
conduct significant due diligence to comply with regulatory
requirements2, which raise the costs of supplying trade finance.
Lastly, risk assessment requires lenders to have adequate knowledge
of their clients to mitigate information asymmetry. Information
asymmetry requirements can pose hurdles for SMEs to access finance
(ADB & ESCAP, 2019).

The potential role of digital technology
in trade finance
Digitalization and automation can address these core problems and
facilitate more efficient and accessible trade finance. By eliminating
paper-based manual processes, digital technologies can help reduce
costs through digital trade documents and automated processes.
Distributed ledger technology (DLT) provides a single ledger for all
parties in a trade transaction to exchange trade information digitally
and record an immutable transaction history. Smart contracts can
be used with DLT to auto-execute contracts and the settlement of
payments in real-time. This allows all parties to facilitate international
trade in a single, simple and secure platform, enabling faster
transactions with less error. For example, ‘we.trade’ is a “one-stop-
shop” open account trading platform, built on IBM’s Hyperledger
Fabric blockchain, which offers exporters and importers a simple
user-interface to easily create trade orders online, manage the
entire trade process from order to payment and select banking
products, settlement conditions and payment terms. The platform
is fully automated and guarantees payments when all contractual
agreements are met (we.trade, 2019).

DLT is also used for digitalizing the process for letters of credit. For
example, Project Voltron’s blockchain platform for letters of credit,
built on R3 Corda, was utilized by HSBC and ING to facilitate a live
trade finance transaction for Cargill to send a cargo of soybeans
from Argentina to Malaysia, reducing the processing time for issuing
a letter of credit from 5-10 days to 24 hours (Berminham, 2018).
The improvements in process efficiency not only reduce costs, but
also can shorten the length of payment-terms, which can reduce
counterparty risk, increase cash flow and free up working capital for
farmers and traders. DLT has been estimated to reduce the operating

2 Regulatory compliance for banks is related to preventing clients or counterparties from fraud
and losses under Know-Your-Customer regulations, Anti-Money-Laundering and financing of
terrorism (ADB & ESCAP, 2019).

costs in trade finance by 60-80 percent (Olsen et al., 2018).

In addition to process efficiency and managing working capital,
DLT and artificial intelligence provide advantages for risk mitigation.
DLT provides real-time visibility to verified trade data and enables
the convergence of data throughout the supply chain (R3, 2019),
which increases the data available to assess risk. In addition, artificial
intelligence and machine learning can transform nonfinancial
transaction records into useful information to help determine
whether to approve loans, reducing risk management costs (ADB
& ESCAP, 2019). Machine learning can also be used for screening
digital documents for consistency and compliance, thereby auto-
detecting and auto-correcting errors in trade documents such as
bills of lading and packing lists (ADB & ESCAP, 2019). By building
a verifiable track record to assess risks and through advanced data
analytics, lenders may have a greater ability to provide financing to
SMEs in a more cost-effective manner. These digital technologies can
reduce risks and compliance costs, enabling lenders to better assess
risks based on the accumulated digital information on SMEs.

What needs to be done:
• Strengthen the knowledge base of the private sector, in

particular SMEs and other underbanked companies, on the
available methods and digital tools that can be utilized to
mitigate payment risk in international trade.

• Promote stakeholder coordination to develop infrastructure,
regulation and standards for the adoption and implementation
of digital technologies in trade finance.

• Establish an enabling environment that reduces barriers for
SMEs to access trade finance and promote the adoption of
digital technologies.

References
ADB. 2019. Trade Gaps, Growth, and Jobs Survey. Manila,
Philippines.

ADB & ESCAP. 2019. Asia-Pacific Trade Facilitation Report
2019: Bridging Trade Gaps through Technology.
Asian Development Bank. United Nations Economic and Social
Commission for Asia and the Pacific.

Bermingham, F. 2018. HSBC and ING Complete Live Trade
Transaction on Blockchain. Global Trade Review, 14 May.
https://www.gtreview.com/news/fintech/hsbc-and-ing-in-live-trade-
finance-transaction-on-blockchain/

Boston Consulting Group (BCG). 2017. Digital Innovation in
Trade : Have We Reached a Tipping Point? BCG.
https://www.swift.com/news-events/news/digital-innovation-in-
trade-finance-have-we-reached-a-tipping-point_

ICC. 2018. Global Trade-Securing Future Growth. ICC Global Survey
on Trade .

Olsen, T., Di Marzo, A., Ganesg, S. & M. Baxter. 2018. Wolf in
Sheep’s Clothing: Disruption Ahead for Transaction Banking. Bain &
Company.

R3. 2019. Trade Market Report.
https://www.r3.com/reports/trade-finance-market-report/

United States Department of Commerce (USDC). 2018. Trade
Guide: A Quick Reference for U.S. Exporters.

we.trade. 2019. The platform we.trade. https://we-trade.com/

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HSBC and ING complete live trade finance transaction on blockchain

HSBC and ING complete live trade finance transaction on blockchain

https://www.swift.com/news-events/news/digital-innovation-in-trade-finance-have-we-reached-a-tipping-point_

https://www.swift.com/news-events/news/digital-innovation-in-trade-finance-have-we-reached-a-tipping-point_

https://www.r3.com/reports/trade-finance-market-report/

https://we-trade.com/