Sofia Lotto Persio reports on why connecting trade finance to the internet of things will become a priority for the sector.
Imagine that your fridge is able to detect what products are running low and order them directly from the shop, with the money automatically transferred from your bank account and the groceries delivered straight to your car boot, while you observe the process on your phone without even lifting a finger. Welcome to the age of the internet of things (IoT).
If in the last 12 months blockchain was trade finance’s favourite buzzword, the future belongs to the IoT. For a concept that sounds so abstract, it is actually surprisingly concrete. The term refers to devices and sensors connected to one another and automatically communicating and sharing data – and it does not stop there.
While the most common image of the IoT is found in the retail industry and in physical goods, the step to industrial applications and trade finance is a small one. If a fridge can do it, certainly a similar process can be deployed for a warehouse or shipping containers, and onto invoices and receivables. If you can dream it, you can build it – in fact, a handful of innovators are already working on connecting trade finance (and the supply chain) to the IoT.
The physical and the immaterial
The most physical manifestation of the IoT is in sensors and devices connecting to one another, but it is the immaterial – ie the data that is transmitted – that truly gives meaning and value to what the IoT is all about. The data can relate to the physical status of a commodity or a good, such as its location, the lighting it is exposed to, the humidity and temperature of the environment where it is stored, and thereby the value it has at any particular point in time.
“The IoT in the form of sensors has an important role to play in realising the potential of smart contracts in trade and supply chain finance,” says Ranga Krishnan, Skuchain vice-president for technology. He tells GTR that Skuchain is working with two banks on a proof of concept for commodities where the sensors will indicate the location of the goods. The data would then be used, for instance, to determine whether the funds for the transaction should be released.
The value of this data is obvious to the insurance industry, which can benefit from the IoT by improving the monitoring of the goods insured and enabling real-time payment of claims. In the trade finance space, banks involved in commodity finance have also started to pay attention to the potential of the IoT for their business. “The commodities shipped in containers change value according to the conditions of the containers and the insurability of those [goods]. Exactly where they are in the lifecycle of the transaction is very [valuable] information for commodity finance banks,” says Stephen Atallah, trade finance advisor at R3 CEV and a former banker.
Just as with checking the status of shipping containers, monitoring the state of collaterals stored in warehouses – whether as inventory or about to be shipped – is an attractive proposition for those lenders involved in pre-shipment finance who are otherwise unable to verify the collateral independently. “A lender can be much more confident in the collateral of the pre-shipment finance, thereby creating greater liquidity and working capital opportunities for the buyer and the seller,” says Atallah.
This is where new platforms providing supply chain finance see opportunity for innovation. “When we think about the IoT in supply chain finance it starts right there, with the ability to access the data, read it, write it, take it and make it speak to systems that are very different. It’s about interconnectivity of all the systems across stakeholders,” explains Cedric Bru, CEO at Taulia, an invoice payment platform.
Taulia connects to the buyers’ and suppliers’ systems through its platform and transfers their data to the cloud. This data can then be used to find patterns of invoice payment and help conduct predictive analytics for the finance needs of the companies.
“For most people, [the] IoT means connecting your fridge to your phone […] and it has nothing to do with finance or supply chain finance,” says Bru. “Others understand that [it has to do with] leveraging and sharing data across multiple devices and systems. If you look at the value chain, it’s about connecting the data and system of buyers, suppliers and financial institutions and to do that in a harmonised fashion, with a common terminology and, more important than anything else, in real time: that is the internet of things for Taulia. Deep integration of systems is core to what we do,” he says.
When applied to invoice financing, some refer to the IoT as the “internet of intangible things”, involving the connection of documents that can transmit credit information. This information can then be transferred to the marketplace and, if the data is substantial enough, it can even define a credit rating for an invoice. “Rich data mobility is another way of looking into the future for the IoT in financial transactions,” says Atallah.
Enabling these transactions are the smart contracts, which are basically regular contracts, albeit written in computer code that can be executed automatically once a certain number of conditions are met. “Those conditions could be certain documents being received, approvals being done, or it could be a message from a sensor saying that something has happened. That’s how sensors fit into smart contracts, they are one trigger that can cause a smart contract to implement its actions,” explains Krishnan.
For those concerned about regulation around smart contracts, fear not: under current regulations, smart contracts are governed by e-signature laws. “For most lawyers, so long as there is a regular contract specifying what it is that the parties have agreed to, that serves as a paper definition. The fact that it is implemented and executed through a computer is auxiliary to that,” says Krishnan. Additional security in using smart contracts can be ensured by using blockchain technology as a means to exchange the contracts.
Enter the blockchain
Marrying the IoT to the blockchain is a way to infuse trust into the data exchange. Sharing data between devices isn’t a meaningful exercise if the quality of the data cannot be trusted by those engaging in the transaction and recognised by third parties as authentic.
“Blockchain is the cornerstone of improving transactions and the cornerstone of distributed ledgers is the security and authenticity of the information and the fact you can tell what’s happened to it,” says Atallah. “Adding security and real-time data integrity is going to launch several important transformations in trade finance and other industries and if it’s applied well to the IoT you can have a lot more credibility and a high level of security for the information.”
Another way in which blockchain can enhance IoT applications to trade finance is by ensuring authenticity of the goods, particularly if these are precious goods or commodities at risk of illegal trafficking. Similarly, it can be used to tag invoices to avoid fraud, or exchange information about certain transactions. According to Atallah, improvements in data collection allows the blockchain-based IoT to become useful for both banks and other financial services providers, such as insurers, who can then better understand policy coverage, know the state of an invoice and have constant real-time credit reporting.
More and better data on the status of the trade executed will enhance the transparency and speed of the transaction for the parties involved. Smart contracts can automatically verify the conditions required to execute a transaction, releasing the funds in a secure way through the blockchain. Banks are therefore assured they have performed the necessary checks without needing to delay the release of funds, and speedier transaction times can allow greater efficiency in handling trade.
This system also provides an audit trail.
The blockchain provides an immutable ledger containing a historical record of the transactions performed on it, which can be valuable information for a bank for regulatory purposes and for all the other parties participating in the transaction, facilitating the resolution of disputes that may arise much more efficiently.
According to Skuchain’s Krishnan, despite the fact that we are still in a proof of concept stage, there is enough understanding of the benefits of the technology to encourage a relatively smooth process of adoption. “There is a lot of interest, not just in the tech community but among banks too. This is an early-adopter stage for the technology, but given the express need I am fairly confident these things will be implemented,” he says.
Atallah also thinks that R3 is making better progress than expected. The projects carried out by the consortium so far have produced solid data on which to build more solutions in the future, and the intention is to work on validating product ideas, testing thoroughly, and putting something to market even sooner than planned. “It is becoming more concrete each month,” he says.
While R3 mainly focuses on developing blockchain-based solutions, Atallah tells GTR that the consortium is looking to integrate IoT applications and that his Asia-based R3 colleagues have already made progress with Commonwealth Bank of Australia on a proof of concept related to sensors tracking humidity inside cotton containers and their location.
But wider adoption and implementation at industry level does not rely only on the interest in proof of concepts, but also in the quality of co-operation among banks and technology providers.
The co-operation imperative
For data-rich companies like banks and insurers, co-operation with tech or fintech companies can happen on different levels. One of them is at the data level, to untangle the mass of legacy data and that which is collected on a day-to-day basis. “No one knows what to do with data, it is just a fact. Some people admit it, some don’t, but they know in their heart of hearts they are not using it to the full advantage,” says Bru. “Most people rely on third-party technology partners to take advantage of this because they have a hard time doing it themselves.”
Fintech companies can then also provide the bridge to connect the data to the actual operational needs of the company. According to Bru, financial institutions and banks will primarily be needed to provide the capital into the schemes and frameworks developed.
Whether banks will be comfortable with the role of disbursing capital towards developing the IoT and other tech solutions remains to be seen. For now, it seems that they are getting their heads around the idea that a co-operative environment in the technological development field works better than competition. “All of our members [know] that the power of this technology is based upon network effect. To really unlock the power of the technology and its implications for the IoT, you require a broad and deep network of financial services providers and other types of corporations that are interested in the technology and see it as a benefit to them,” says R3 managing director Charley Cooper.
According to him, these market players all need to work together to achieve the best results that the technology can offer because, if they built their own platforms and tried to convince the others to use it, they would find themselves in the same inefficient position in which they are already: with systems unable to interact with one another.
A partial solution to the issue of connecting different ledger platforms already exists in the form of the interledger protocol, a piece of code which allows transactions to reach their beneficiary regardless of the route they need to travel to get there. With such a system, smart contracts happening on different kinds of blockchain can be valid on any kind of blockchain: once the sensorial input from IoT devices is transformed into a transaction on a ledger, it is able to reach whichever ledger it needs to.
The biggest challenge facing the IoT and blockchain enthusiasts is a more fundamental one than getting market participants to join a distributed ledger: it is getting them to go digital at all. “Going digital is huge, but it has to be made affordable, simple, easy and safe,” says Atallah, who thinks that blockchain can be instrumental in driving digital engagement, by helping to make the data transfers secure.
Those resisting the idea of a trade finance world that seems bound to become ever more digital and automated should take comfort in the fact that there is still plenty of room left for human input and intermediation: technology simply tries to reduce human error. The technological advancement in creating smarter and more efficient data collection is merely an aid to those working in these processes, allowing them to focus their time and energy on making good decisions, finding new business and liaising with clients.
“There will always be a need for human intervention, and these systems need to be set up so that humans can intervene if someone has a problem or a dispute,” says Atallah. “It’s not complete automation that we’re seeking, it’s smarter automation.”