This weekly four-part series serves as a guide to blockchain for trade finance. Fluent Network’s founders Lamar Wilson and Casey Lawlor provide GTR readers an overview of how blockchain technology provides transparency, streamlines asset transfer and lowers the operating costs of global trade finance programmes for all relevant parties. Follow the links for Part 2, Part 3 and Part 4.
Part 1: Building a network
Trade finance programmes have played an integral part in supporting the increase in global commerce since the financial crisis of 2008. Their usage has led to increased output, directly correlated with lowered supplier insolvency risk. Increasingly, the focus of the industry has moved towards improving the inefficiencies of trade finance in a push towards mass adoption. Blockchain technology continues to show the greatest potential to streamline trade finance and maximise the value it delivers to business and financial institutions alike.
Today the most important metric to gauge the financial health of a large business is predictable, well-managed working capital. Currently, there are three different ways to improve working capital: getting paid earlier (reducing days sales outstanding or DSO), managing inventory better (improving days inventory outstanding or DIO), or paying your suppliers later (increasing days payable outstanding or DPO). While all are viable options, increasing DPO by way of extended payment terms has proven to be the most permanent and in most cases, the most practical. Studies show that over the past 10 years, nearly every industry has increased payment terms by 0.5 to 2.5 days each year. This has led to almost all companies pushing payment terms to 90, 120, and even as far as 585 days.
Unfortunately, this adds a tremendous amount of risk to the supply chains – the life-blood of many of these institutions. Suppliers with high DSO must inevitably look to strenuous, rigid and sometimes expensive working capital solutions outside the buyer-supplier relationship or take early payments at a discount equivalent to extremely high annual percentage rates (APR) to continue operations.
Trade financing services for smaller international suppliers, such as factoring, inventory financing, purchase order financing and short-term business loans, can include rates of up to 50% APR. These high rates lead to higher prices, an inability to expand operations to satisfy other customers and increase supplier insolvency risk. Are the benefits of increased cashflow worth the risks associated with a fragile supply chain?
Blockchain and distributed ledger technology increases the speed, transparency and verifiability of digital asset transfer and ownership.
When viewing supply chains holistically as collaborative entities striving for an efficient end-to-end transfer of value from raw materials to the final consumer, DPO, while extremely popular, can’t be your only consideration. In recent years this perspective has led to a holistic approach to management of the global supply chain via trade finance. Lower cost of capital for even tier-3 suppliers can increase throughput, prevent disruptions and lower the cost of a supplier doing business with said buyer.
Unfortunately, procurement and merchandising teams continue to rely heavily on personal relationships, paper-based processes, manual co-ordination of remittance advice and opaque, siloed systems. The collection of information, documents, and the eventual perfection of interest in the underlying asset necessary to provide financing is extremely time-consuming and costly for financial institutions.
Suppliers and their enterprise counterparts must soon incorporate technical innovations to increase efficiency and lower risk, allowing them dependable access to cheaper working capital. Often those deemed too risky (primarily small international suppliers) are excluded despite having razor-thin margins, zero negotiating leverage and, thus, the highest need for these solutions.
One of the most recent innovations to gain the spotlight of the trade finance industry is blockchain and distributed ledger technology that increases the speed, transparency and verifiability of digital asset transfer and ownership. Recently, Citibank highlighted blockchain in its US Digital Banking Research Report as having massive potential to improve both supply chain logistics, management and supply chain finance.
A blockchain-based distributed ledger contains a multitude of properties, some of which lend themselves extremely well to trade finance programmes, such as:
- Immutability and timestamping
- Provenance of goods
- Streamlining settlement
- P2P transfer of ownership of digital assets
- Smart contracts and automation
- Secure distribution of ‘single source of truth’
The ability to securely connect previously siloed trade finance participants across both supply chains and financial institutions allows for transparency and a massive reduction of risk, manual processes and co-ordination between institutions.
Over this four-part series we will discuss the benefits of a distributed ledger with the above properties to buyers, suppliers and financial institutions participating in trade finance programmes.