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Trade Finance is a key business area for commercial banks as it provides an
opportunity to earn interest income as well as non-interest income. Many banks,
both locally and overseas, target this market for a significant contribution to their
financial performance. As a result it has become a highly competitive market
segment. However the business environment is undergoing a radical change,
creating a new challenge for banks.
The traditional Receivable Trade Finance Instruments create significant value to
both the importers and exporters. To the exporter, they facilitate maintaining
ownership of goods; to the banks, guarantee of payments, greater predictability
of payment timing, provision of credit and outsourcing debt collection. To the
importer, they facilitate management of country risk, Exchange Control, provision
of credit, outsourcing of document checking, comfort on performance/ quality of
goods. In the past it was only the banks, which were able to exploit these
opportunities and create value to their import and export customers. Therefore
importers and exporters were highly dependant on the banks to provide them
the required services to enable them to continue their business operations.
During the recent years the business environment has undergone a major change
and become highly competitive. This current market situation has made not only
importers and exporters but all businessmen adopt a three-pronged business
strategy (refer Figure 1). The first strategy is Cost Reduction. During the last decade
it has been very common to eliminate waste and have strict control over costs,
especially by the management of the supply chain, for the purpose of increasing
the profits of any business. The savings made by firms by using this strategy has been,
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in some cases, quite significant. The
second strategy is to Increase Revenue.
Today organizations expand their scope
and venture into new areas well outside the
traditional boundaries of their industry in
order to increase their revenue. The third
strategy is the Management of Risk and
Liquidity. This is an area that has received
a high degree of attention in the more recent
times since stability and reliability are
considered extremely important for
continuing business relationships.
Therefore, it is desirable to examine the evolving market situation and the
developments that are taking place in the industry in order to adapt to this
changing environment. What would be the role of the banks in the new arena
and what would be the competition that they will be required to face are all
questions that need to be addressed.
The Trade Market
The changing market situation and this dynamic environment of the Trade Market
has become the most important factor that needs to be addressed by banks if they
are to survive and be successful in facing the competition. Therefore let us start
by examining the market conditions.
The Evolving Market Situation
When the importers and exporters who were all relying on services provided by
the banks for the servicing of their financial value chain are, today, looking at
ways and means of reducing costs whilst managing their risks in keeping with
their business strategy, they have a good understanding of the Corporate Risk
Spectrum (refer Figure 2) and they are no longer prepared to pay the banks for
handling their low or no risk transactions. The Corporate Risk Spectrum clearly
indicates the fact that lesser the involvement of the banks, the greater is the corporate risk they have
to take and vice versa.
Therefore, whenever the
corporate risk is low, it
does not make sense for
importers and exporters
to pay high fees to banks
to handle such transactions
and they are
bound to pursue cheaper
and more efficient
alternatives.
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Over the years there has been a rapid increase in the global trade being carried
out on Open Account basis. At the end of last year an estimated 81% of global
trade was being done on Open Account. This has led to a slow growth of the
traditional Trade Finance business. Since SWIFT is used extensively by banks for
transmission of messages relating to Documentary Credits and Collections, one
can estimate the volume of trade business handled by banks by examining their
growth rates. The growth in SWIFT’s Category 4 & 7 messages (which deal with
Collections and Documentary Credits) during the last five years is around 2.7%
whereas the growth in world trade has been around 10%. The bulk of the growth
in SWIFT message traffic in the category 4 and 7 messages has been due to the
growth rates in Asia with China leading the way.
The market drivers have increased the challenges in the banking industry. Let us
examine some of the market drivers and the challenges they create to the banks.
The first market driver is Geographic Volatility and the challenge, arising from it,
is managing of changing country risk profiles. The next is Investor Confidence
and the challenge that it creates, is protection of shareholder value. New Entrants
into the market is another and it leads to increasing competition, resulting in
erosion of margins. Another driver is Global Participation which makes the
constraints of operating costs and increasing IT burden on banks, a major
challenge. One of the most important market drivers is greater Customer Mobility.
This has been a highly critical factor for banks that have been enjoying customer
loyalty for many a decade. Risk Management has come into focus in recent times
and new initiatives like Basel II has been another market driver. This has brought
in the challenge of capital efficiency to banks.
In the light of the changing business environment, banks are reviewing aspects of
their Trade Finance business in order to remain competitive. Customer demand
is one aspect that needs to be reviewed. Banks have been forced to introduce new
functionalities and achieve a higher level of quality at a lower cost. Regulatory
changes also cause changes in some of the aspects. New directives have been
introduced on cross border payments, which will need to be adhered to.
Implementation of Basel II will bring in additional capital requirements on
operational risk. The Patriot Act, the Know Your Customer (KYC) requirements
and Asset and Liability Management (ALM) measures all need to be addressed
thereby increasing the operating cost.
Competitive pressure is affecting the home markets and is under severe threat
from new entrants. Many of these new entrants introduce solutions, which are
propelled by cutting edge technology. The revolution in the industry has created
a movement of the method of payment from Documentary Credits to Open
Account hybrid solutions. They have also forced the banks to have web-enabled
development of information exchange. Banks have also started looking at
outsourcing of the non–core activities so that they could concentrate better on
their core activities.
The Trade Market is therefore undergoing a major change and the following
characteristics have started emerging. Banks are coming under severe pressure
from both the local and global competitors; not only from other banks but also
from those outside the financial services industry. Furthermore, the banks are
being pressurized by their customers to improve on their capabilities while
reducing the costs.
Consolidation of trading partners, taking place in select industries result in the
movement towards integrated supply chain management solutions introducing
new needs and new products to the market. Technological enhancements are
seen in the supply chain management creating a paradigm shift from the
traditional Documentary Credits to hybrid Open Account methods for their trade
settlements.
Financing of international trade risk mitigation for importers and exporters and
settlement of payments by banks will continue to play a vital role in trade. However
the margins on both the processing and the risk components of the business are
shrinking. This has motivated a number of banks to move processing offshore
either directly or through alliances, in order to reduce their costs. Enhanced
imaging and web capabilities have also allowed more efficient processing in the
back offices and better reporting of information to clients.
Let us now look at the changing customer needs in order to find appropriate
solutions. Most Banks will continue to have an 80 – 20 rule. Since 80% of the
business comes from 20% of the customers they will need to handle those 20% of
the customers cost efficiently and with extreme care.
The provision of credit facilities will continue to drive the small and medium
enterprise customers dealing in trade. On the other hand Straight Through
Processing (STP) with lowered procurement costs will drive the Corporates.
Corporate customers will themselves be looking into making investments in their
supply chain in order to become cost efficient.
Vendor financing and Liquidity management will drive the need for the active
involvement of the banks. The customer usage and need for Documentary Credits
will continue. Banks will need to provide enhanced capabilities in order to continue
to support the customers requiring trade products.
A number of initiatives have been taken by the individual banks in response to
this changing business environment in order to create value and maintain customer
loyalty in order to improve their trade services business.
Trade Origination Processes, Trade Information Exchanges and Trade Partners
are all schemes designed by individual banks to assist their customers to increase
their trade business and thereby winning not only the ensuing business but also
customer loyalty.
Bank-to-Bank Reimbursement, Outsourcing of Global Treasury and FX Trades
are initiatives designed to add value to their correspondent banks and their
customers and for increasing revenue whilst managing costs.
Some of the other initiatives that the individual banks had to move into are
Consolidated Payment Capabilities, Integrated Treasury Workstation, Centralized
Disbursement, Pooling of Services, Payroll, Petty cash and Transportation pending
Some of the Information Technology initiatives that resulted in banks coming up
with e-Enabled Trade Data Warehouses, Electronic Commercial Trade
Documents, Online Integrated Reporting, Transaction Initiation Investments and
Inquiries, Electronic Invoice Presentation and Payment, Online Document Image
Archiving and Retrieval
Bolero was founded in 1998, with significant backing from the bank community
and from the global logistics industry. Bolero was created as a neutral, trusted
third party to develop a comprehensive set of standards that would remove the
barriers to global, cross-enterprise business.
Bolero implements and enforces these standards in an open platform to enable
paperless trading between buyers, sellers, logistics, banks, agencies and customs
anywhere in the world, delivering transaction visibility, predictability, speed,
accuracy and security.
Building on this platform, Bolero delivers applications that enable the merging of
the physical and Financial Supply Chains, allowing companies to fundamentally
re-engineer the way that business is done and take advantage of electronic trading.
Customers and their trade partners are rapidly deploying Bolero solutions
delivering significant reductions in cost and working capital, increased visibility
and improvements in operating efficiency.
Bolero, with the cross-industry representation and significant community expertise of founding shareholders were founded to build a platform, which
conformed to their fundamental pre-requisites, providing a unique and substantive
technology to underpin electronic trade. They primarily cater to corporate
Importers and Exporters and the integration of their trade activity with the two
communities on which their trade processes are dependant are highly interrelated.
On one side the Freight Forwarders and the broader logistics service
providers; and on the other, Banks and other Financial Institutions. They deal in
the global world where there are a number of customs, industry and particularly
in Asia, regional trade community platforms, introducing aspects of paperless
trade to the global Physical and Financial Supply Chain. Bolero has been designed
to integrate with these emerging platforms as well as providing incremental steps
of value to these inter-related communities.
The bolero solutions consist of the Bolero Trusted Trade Platform, which is the
core investment and infrastructure underpinning all Bolero services, the Bolero
Open Account Suite and the Bolero Documentary Credit Suite. The entry-level
component of the credit Suite is Bolero-Advise, which provides multi-bank
electronic Letter of Credit Advise capability.
For many Banks, the traditional trade services business faces challenges while
significant new opportunities have begun to rise. Trade finance volumes are flat,
traditional paper-based processes offer no great economies of scale, and Banks
are faced with the continual need to improve their trade transaction margins. At
the same time, both Importer and Exporter Banks are seeing an increased risk of
disintermediation as some of their customers move towards Open Account
banking.
Clearly there’s an imperative for Banks to develop new credit, risk and transaction
revenue streams to address this challenge. However, the concerns and issues that
this causes, aren’t necessarily the same for different Bank functions. So it’s
important to look at how evolving International Trade pressures can impact them.
 For banking Relationship Managers, the goals are fairly clear – growing
business with current clients, winning new business and developing the
revenue potential from each corporate relationship. To date, open account
banking has left Banks only handling transactions and payments, and that’s
diluting the strength and value of many relationships.
In the Payment Services business, bankers are looking to differentiate their
services in a utility market, finding ways to increase margins in a commodity
sector, while also addressing the challenge of domestic/EU cross-border
payment charge alignment.
With Risk and Credit solutions, bankers are searching for ways to acquire
more ‘good’ business from its best customers at the expense of the competition.
At the same time the focus is on ways to deepen lending margins and reduce
the engagement costs associated with setting up and maintaining a loan
portfolio.
For Cash and Treasury Management, the focus is on ways of providing
enhanced working capital solutions, perhaps offering new information
services and developing greater cross-selling opportunities.
Trade Services are investigating ways to offer customers a trade solution
that provides the level of transparency and accuracy that their trading
customers need.
The Financial Supply Chain refers to the end-to-end processes and information
that drive a company’s cash, accounts and working capital. For the Exporter,
this covers the full order-to-cash cycle and is a source of significant trapped value
in the key areas of Working Capital, Cash Flow and Accounts Receivable
processing.
Bolero’s solutions are designed to unlock this value for companies that rely on
international export markets. Their Open Account and Documentary Credit
solutions provide a fully integrated order-to-cash solution that can be implemented
in a simple, phased approach, enabling you to achieve Financial Supply Chain
benefits rapidly. For Exporters, these include:
The ability to optimise working capital
Removing slack from the order-to-cash cycle
Improving discount offers
Ensuring better financing terms
Improved cash flow management
Reducing Accounts Receivable (AR) processing costs
The Financial Supply Chain is increasingly recognised as an area offering
significant potential for generating bottom-line improvements and creating
competitive advantage. However, many of the core processes underpinning
International Trade have hardly changed since trading began. At Bolero, they
believe there’s a huge opportunity to improve these processes and deliver
substantial financial and business returns for all parties involved in the trade
process.
Bolero works closely with corporate Importers to optimise the integration of their
trade activity with the two communities on which their trade processes are
dependent and highly inter-related – on one side the Global Trade Banks and
Financial Institutions, and, on the other, freight forwarders and broader logistics
service providers.
From an Importer’s perspective, the Financial Supply Chain involves the full
procurement-to-payment process and specifically the end-to-end trade processes
and information that drive a company’s cash, accounts and working capital.
Unlike the Physical Supply Chain – which has seen improvements ranging from
containerisation to fulfilment management/just-in-time inventory – there still
remain significant gaps in the Financial Supply Chain, particularly in the
optimisation of working capital efficiency, the development of vendor/client
relationships and overall financial performance.
For Importers the gaps between the Physical and Financial Supply Chain are
making it more difficult to manage daily reconciliation of invoices to purchase
orders, and the negotiation of financing and the precise management of payments.
Typical challenges include:
Reducing the time needed to create, transfer and process paper documentation.
Eliminating the cost and errors associated with the manual creation and reconciliation of documentation.
Lack of transparency in inventory and cash positions when goods are in the supply chain.
Disputes arising from inaccurate or missing data.
The physical disconnection between all the different parties in the Financial Supply Chain.
The spread of fragmented ‘point’ solutions that don’t address the complete end-to-end processes of the trade cycle.
As Bolero has been designed to act as a platform that brings together all the
constituent parties involved in International Trade, it can provide importers with
a powerful framework to help address many of the key challenges they face.
Bolero’s Trusted Trade Platform is bank-neutral and scalable to all settlement
types, documents and parties. It also has cross-industry applicability, so makes
an ideal platform to help importers address some of the key issues that can cause
friction in the vendor/client relationship.
SWIFT, which is a cooperative owned by the member banks, has been one of the
biggest service providers to banks in recent times and any impact on the business
of banks will also have a direct influence on its operation as well. Therefore SWIFT
appointed a sub-committee of The SWIFT Board as the Trade Services Advisory
Group (TSAG) to recommend the strategy that SWIFT should adopt to be successful
in the evolving business environment. SWIFT’s Trade Services Advisory Group
(TSAG) was formed in early 2003, as a sub-committee of SWIFT’s Banking and
Payments Committee to:
Define and clarify community needs
Advise the SWIFT Board of Directors in formulating SWIFT strategy and tactics
This review was timely in the light of:
- Bolero, TradeCard etc
- New bank service offerings and cost reduction strategies
- Evolving market trends
The twelve member banks which took the initiative to embark on this venture were:
ABN Amro Bank, Bank Tokyo Mitshubishi, BNP Paribas, Citigroup, Deutsche Bank, HSBC, KBC, JPMorgan Chase, OCBC, Royal Bank of Scotland, Standard Bank of South Africa, and UFJ Bank.
The TSAG studied the current situation in the market and the emerging market
scenarios and came up with the following recommendations::
SWIFT’s Strategic approach:
Expand SWIFT’s focus from traditional trade instruments to supporting bank services across the entire corporate supply chain.
SWIFT’s two-part tactical approach:
Continue to maintain the current FIN Category 4 and 7 Message Types,
with appropriate enhancements, eg, to reflect ICC’s UCP requirements.
Develop a central Trade Services Utility (TSU) to enable banks to provide new and enhanced services in the trade area.
SWIFT was at this time in the process of upgrading their system and moving into
a private Network using IP technology called SWIFTNet. Since the member banks
have already incurred the overhead, it made good business sense to make optimum use of the SWIFTNet system as a platform for the TSU in order to be more cost efficient and to have better risk management.
The Trade Services (TSU) is a SWIFT service using SWIFTNet and XML messages to access a Central Data Matching and Work flow engine to support bank services in the Trade Supply Chain.
Since banks are in competition with each other, one may wonder whether a
collective effort by banks will undermine their competitive advantages and hence
have an adverse impact on their performance. There are certain areas where
banks can work together for their mutual advantage and this area is called the
Collaborative Space (refer Figure 3). The recommendation of the TSAG is to work together only
in the Collaborative
Space so that banks
can collectively
enjoy huge cost
savings whilst they
continue to compete
with each
other in providing
the Bank’s services.
The overview of the TSU be as follows:
There will be 4 Data Sets
Commercial, Transport, Legal and Certificates, Insurance
There will be 3 Ways of Initiating a Transaction
Push Through – where the initiator pushes it through the system to the recipient.
Lodging – where the initiator will lodge and the recipient is expected to get it from the system.
Blind Dating – Lodging is done by both parties and the system does the matching.
For the purpose of Reporting there will be:
Discrepancy Reports
Status and History
Notifications
Storage of data will be up to 180 Days
Messaging will be via SWIFTNet InterAct, SWIFTNet FileAct and / or Browse
TSU is being designed in such a manner that it will support a portfolio financing instruments of banks (refer Figure 4)
The potential services that banks could provide utilizing the TSU will be as follows:
Financial Services such as PO finance, Invoice finance, Pre / post-shipment finance,
‘Lite’ Letter of Credits, Rebate schemes, Forfaiting, Structured trade finance,
Asset securitisation, With / without recourse finance.
Risk Management / Mitigation Services including Risk insurance, Credit insurance,
Collections, Automated Letter of Credits process, Improved operational risk,
Conditional payment, Country risk management, Currency exposure
management.
Insourcing Services such as TSU Services to Correspondent Banks,
Confirmed Payment Collection, and
Accounts Payable / Accounts Receivable
Information and Other Services including PO confirmation, Reconciliation,
Netting, Documents creation, Document imaging, Market intelligence, Event
tracking, Data mining
The key concepts in offering these services will be a central matching and workflow
engine, accessed only by financial institutions, supporting new/enhanced services
to corporates, comprising of message services, standards and a business
application.
Following the success of the Prototype and market validation SWIFT Board
approved the going ahead with the development of the TSU commercial offering.
The TSU, a collaborated centralized matching utility, will allow banks to increase
revenues and share the costs when engaging in the provision of services such as:
In sourcing of payables and receivables
Finance and risk mitigation
In sourcing of trade data checking
Management information
Banks will build on the core functionality of the TSU to individually offer competitive services complementary to their existing offerings to their corporates.
The first release of the TSU will support bank solutions based on purchase order
services.
SWIFT will pilot the TSU from December 2005 and the launch is expected to be
around the middle of 2006 by which date banks will be geared to offer supply
chain services.
SWIFT has chosen Bolero as a supplier of technology for the TSU. The TSU is
based on SURF (Settlement Utility for managing Risk and Finance) technology and conforms to the specifications defined by SWIFT and its community of banks.
The TSU is an independent, complementary and non competitive service to SURF.
The TSU is a bank-centric solution with no direct corporate access. Bolero operates
entirely in the corporate-centric space, where one or more corporates would always
be part of the Bolero based services. Where the TSU provides matching of subsets
of data from trading documents, submitted by one or more bank, Bolero offers
applications designed to support the full compliance process.
“The need for banks to develop new services is compelling,” said Arthur Vonchek,
Bolero CEO, at the Bolero session at Sibos 2004. “Financial supply chain
management has not evolved anything like as far and fast as physical supply
chain management. Given that in the complex, paper-based world where even
the simplest international trade transaction can involve a dozen different parties,
the TSU will introduce one standard element. It will encourage wider use of
standards and push towards community-based rather than individual solutions.”
SWIFT is a founder shareholder in Bolero, with representation on the Bolero Board
of Directors. SWIFT is also a supplier of services to Bolero and is the operator of
Bolero’s services.
The need to make provisions in the UCP to cater to electronic paperless documents
was first discussed during the drafting of the 1974 revision (UCP400). The drafting
group of the 1983 revision (UCP500) modified some of the clauses in the UCP in
order to make it more acceptable for electronic transactions. However, the
provisions made were still found to be inadequate and ICC had to debate as to
whether they should have another revision that facilitates the handling of
electronic transactions using the evolving e-business technology or to come up
with a separate set of rules applicable only to e-business transactions.
ICC finally decided on the latter option and they drafted the eUCP as supplement
for UCP500 for electronic presentations (version 01), which enables the new articles
(eUCP) to be revised at shorter intervals than the UCP, if the technological
advancements during that time warrants the same.
Meanwhile the UCP500 itself is presently being revised and the drafting group is
nearing completion of the UCP600, which is expected to come into force either
from 01 July 2006 or 01 October 2006 depending on when they will be able to
finalise and submit the final document to the Board Meeting of the ICC.
The focus on the physical chain management and the financial chain management
has become a pre-requisite for any global business. Banks can no longer enjoy the
comfort of Importers and Exporters coming to their doorstep. Even Freight
Forwarders are said to be coming up with supply chain management solutions
and if the banks are to compete in this area of business they will have to make the
first move so that they can get the other players to join their system instead of the
opposite.
“‘Trade Finance’ - I can think of no other discipline where investment bankers,
commercial bankers, credit insurers, political risk insurers, guarantors, boutique
advisers, specialist financiers (e.g. forfaiters and factorers), trading companies
and even software houses can all choose to operate under the same generic title,”
says Reinhard-E. Uhl, Head of Global Trade Finance, Deutsche Bank, in his
foreward for the Global Trade Review Directory 2004-5.
Therefore the Trade Services Utility is an initiative, which the banks are bound to
adopt in order to remain competitive. Even for the banks in Sri Lanka, it will not
be different other than probably a timing difference when it is introduced. This
will become the new challenge for the Sri Lankan banks thriving on Trade Services
business.
www.swift.com
www.bolero.net
Parama Ranjana Dharmawardene is a Management
Consultant, Postgraduate Institute of Management and a
former Deputy General Manager, Sampath Bank, having joined
that Bank at its incepetion. Prior to that, he had served at Bank
of Ceylon for almost 20 years, having commenced his banking
career there. A Fellow of the Chartered Institute of Bankers, London, he has a MBA from University of Sri Jayewardenepura. A Certified
Documentary Credit Specialist awarded by the Chartered Institute of Bankers,
London in association with International Chamber of Commerce, Paris. He is
the only member from Sri Lanka serving in the DOCDEX panel of experts
appointed by ICC, Paris. Parama is the Chief Examiner for International Trade
Finance paper, Institute of Bankers of Sri Lanka, He has served in a large number
of wide ranging committees and is presently the Convener, Banking Committee,
ICC Sri Lanka and Assistant, Treasurer, Bankers’ Club.
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