Although Asia has a historic tradition for letter of credit-based trade, the region is moving into an era of change as new electronic solutions begin to make their mark. Liz Salecka reports.
The speed and efficiency of trade and trade finance transactions with – and within – Asia have often come under the spotlight given the region’s reliance on traditional trade finance instruments and paper-based processes. However, there are signs that this situation is changing as certain Asian countries embrace open account trade, and some electronic solutions become more readily acceptable.
Today, there is a greater movement to open account trade in developed markets such as Hong Kong, Singapore, Taiwan, Korea and Japan.“In some countries, the share of open account trade is now reaching 80%, and this is largely due to large buyers outside the region requesting that their suppliers switch to open account arrangements,” says George Fong, head of trade product management and financial institution trade advisory, Asia Pacific, JP Morgan Treasury Services.
“Letters of credit (LCs) remain important instruments, but as trade grows, there is also a higher rate of conversion to open account. Domestically too, more corporates are working on an open account basis.” In many instances, open account trade is also being encouraged by the longevity of trading relationships. “There was less trust between corporates when they just started to trade together, but as these relationships have become more established, the levels of trust and credibility have grown. These companies now want to move away from letters of credit to reduce time and costs,” says Connie Leung, director, payments and trade markets, Asia Pacific, Swift.
However, in spite of this, Asia’s use of LCs remains above the global average of 20% of all trade transactions, and these instruments have continued to play a huge role in intra-Asian trade.
According to Swift trade traffic statistics, about 45% of letter of credit-based transactions are intra-Asian. “Certain industries and sectors are pre-disposed to using traditional trade instruments like LCs and guarantees,” adds Venkatesh Somanathan, director and regional head of trade finance product management, Asia Pacific, global transaction banking at Deutsche Bank. “In sectors such as telecoms and oil exploration, the provision of a guarantee plays a very important role in facilitating trade transactions, and this is also the case in newer sectors such as media. For these industries, there is usually no alternative but to use the traditional trade instruments,” Somanathan adds.
There are also strong suggestions that any global decline in LCs has now stabilised, and that recent economic uncertainty has even led to their revival. Of the 229 banks in 110 countries worldwide that responded to the International Chamber of Commerce (ICC) global survey on trade finance (2012), 51% reported an increase in export LC volumes, and 56% an increase in import LC volumes.
This renewed popularity is also evident in Asia. “The eurozone debt crisis of the last two years has made many Asian corporates more aware of the need to remove risk from their trade transactions and they have actually gone back to using letters of credit and other guarantees,” says Louis Robinson, managing director, Emea trade and network origination head, GTS, RBS.
Much of the historic dependence on traditional trade instruments stems from local market regulations that encourage and endorse their use. “There are still a number of countries where restrictions on open account trade are applied, although it is not totally prohibited, including India, Sri Lanka and Pakistan,” says Fong. “China too has definitely been slower in the movement to open account.
Globally, there has been a movement to electronic trade, but in countries such as India, China and Pakistan, a number of third-party bodies (government bodies) insist on the use of paper trade documentation,” he adds.
“Regulatory requirements in many countries make it mandatory to use LCs for import and export business,” confirms Ashutosh Kumar, global head of corporate cash and trade banking, transaction banking, Standard Chartered, pointing out that such requirements have historic roots. “Regulators are more comfortable with LCs as it helps mitigate the risk of default.”
He adds that banks in Asia also find it easier to finance export business with an LC because “it is a legally valid contract, and an exporter’s bank often does not know the buyer involved in the transaction”.
Kumar explains that from a legal perspective, there is often a need to present the original documentation, such as the underlying invoice, although he notes that electronic documents can be used in more developed countries. “The challenges presented to electronic transmission are similar to those faced in moving away from LCs,” he says, pointing out that this applies to all trade documentation including invoices and shipping documentation. “If things go wrong and a claim needs to be made, it may not be possible to do this with an electronic version of a paper document in certain countries.”
Robinson at RBS believes that the solution here is for banks and corporates to place greater pressure on local regulators for change. “What is needed in many of these countries is for banks to launch a lobby against central banks and put pressure on regulators,” he says, pointing out that this applies equally to requirements for the use of LCs. Other issues, such as the more limited application of trade insurance in Asia, have also hindered any movement to open account.
“Globally, trade transactions are taking greater advantage of insurance, and if an exporter takes out insurance, the bank can benefit from this too. However, this is not so much the case in Asia. In India, for instance, banks cannot take advantage of an insurance policy taken out by the exporter due to local regulations,” says Standard Chartered’s Kumar.
Is the BPO a solution?
For trade finance banks, Asia’s dependence on LCs and other paper-based documentation has hindered the efficiency and speed with which they can process transactions, thereby slowing down their release of funds.
One solution that has emerged is Swift’s Bank Payment Obligation (BPO), a new instrument which is electronically transmitted between an importer’s bank and exporter’s bank to guarantee payment for goods in much the same way as an LC. Already, the BPO has been used for trade finance transactions with Asia, most notably by the Bank of China. “The BPO does do a lot for banks because it fulfils the purposes of a LC by providing a payment guarantee and mitigating risk, and it also eliminates the need for them to receive and look at paper trade documents and check them manually,” says Leung from Swift.
She explains that with the BPO purchase order information, packing details for the goods, and shipping details are sent across electronically as data in real time, and then automatically matched against the corresponding data on the trade transaction held by the recipient’s bank, with no manual intervention.“This can really cut down the time that banks spend looking manually at papers and can help banks save on staffing costs,” she adds.
For Asian exporters, this promises faster bank processing of trade finance transactions, which could accelerate payments. “For corporate exporters, the BPO speeds up their receipt of trade financing, which can be just five days in intra-regional transactions, where physical goods can take less than one day to be shipped from one country to another,” says Leung. “An intra-Asia letter of credit is typically processed in 14 days.”
BP Chemicals recognises the benefits of the BPO and completed its first BPO transaction in May this year, and is looking to engage in further transactions, including a BPO with counterparty in India.
“The BPO can make a lot of difference to many exporting organisations,” says David Vermylen, global credit manager, petrochemicals, BP Chemicals, who believes that its use can speed up receipt of payment by five to 10 days on an ‘on-sight’ letter of credit. However, according to Deutsche Bank’s Somanathan, it will still take some time before the BPO has really made its mark. “The BPO is still a relatively new concept, and while there have been several pilots, it is too early to expect any mass migration to the BPO,” he says.
Corporates remain cautious but are keen to know more about how BPO will add material and profitable value to their businesses. In order to support the establishment of the BPO, most of them want to see consistent rules and frameworks put in place. They will also need to figure out how much they might need to invest in the required technology.
Paper is still needed too
Although the BPO removes the need for paper-based documentation to be exchanged between banks in a trade finance transaction, local market requirements in Asia mean that these paper documents still need to flow between other players in the supply chain.
“In certain Asian countries that require the use of paper originals, these paper documents will still need to be produced, and go through the physical supply chain, even when a BPO transaction takes place,” says Fong.
And Leung confirms: “Paper documentation will still need to be in place such as the insurance certificate and invoices for legal purposes, for example customs clearance. A shipping bill of lading will also be required for duty and tax purposes.”
Requirements for the use of LCs may also limit the BPO’s penetration of certain Asian markets. Fong believes that more time may be required for countries such as India to subscribe to the BPO, and it may take even longer in Pakistan and Sri Lanka. Robinson also raises a few doubts: “One of the issues that arise with the BPO is the willingness of some banks in Asia to do a BPO,” he says. “Global banks such as RBS support the BPO, but is this the case among local banks in countries such as Sri Lanka and Bangladesh, for example?”
Here, Leung says that certain Asian countries are expected to lead in the take-up of the BPO. “Asia is a diversified market, and we do not yet fully know the implications of how legal requirements to use letters of credit will affect the BPO,” she says.
The extent to which the electronic transmission of trade finance documentation takes off in Asia is difficult to foresee given local market requirements for LCs and original paper-based documents. However, there is growing recognition that the transmission of trade documents in a digitised format could play a key role in addressing the time-lags caused by the use of couriers to deliver paper documents.
“One of the driving forces for change is that the documentary-driven process is very cumbersome, and even in countries where this is a requirement, there is acknowledgment that alternatives are available,” says Deutsche Bank’s Somanathan. “In many Asian countries, regulations require the checking of original documents in physical form, but there is also an increasing recognition that this process can be facilitated through the use of document digitisation.
For example, South Korea already has a framework in place, and in the countries that still tend to use paper-based trade processes, such as India and China, there is increasing focus on digitisation.” One solution that has already proved its merits here is solutions provider Bolero International’s electronic presentation of documents under an LC, which was deployed by Australian mining company BHP Billiton in 2010 in the first-ever electronic transfer of trade documents to the Korea Exchange Bank for approval and subsequent payment to the applicant. Since then, the same counterparties have participated in further transactions, including the first-ever e-presentation that included an electronic bill of lading in July 2011.
“Asia is a very paper-based region, and one of the biggest problems caused by this relates to the amount of time it can take to arrange an end-to-end trade financing,” says Arthur Vonchek, CEO of Bolero, pointing out that it is not uncommon for goods to arrive at their destination before the required trade documentation. “As a result these markets are looking at solutions like Bolero’s e-presentation platform as it represents a robust way of solving this problem.”
Vonchek believes that Bolero’s e-presentation platform provides a viable alternative to paper-based documentation in Asia because its legal infrastructure does not require the local jurisdiction concerned to accept e-documentation as a standard practice. Importantly for Asia, the legal infrastructure used by Bolero also ensures that electronic documents presented over its platform preserve the same legal meaning as the paper documents they replace, including documents of title such as the bill of lading.
“Our platform can make electronic transmissions legal. Transactions are secure globally regardless of the jurisdiction,” says Vonchek. “Another reason for our strong market acceptance in Asia is that this is combined with the capability to send electronic trade documents across as originals.”
He adds that aside from speeding up the settlement process, and guarding against time losses due to errors – such as paper documents being dispatched to the wrong location, Bolero’s multi-bank platform also enables companies to streamline their management of their trade documentation and improve efficiency, thereby reducing risks.
Asia’s traditional reliance on paper documentation for trade finance transactions has given rise to questions over whether local companies can take full advantage of converged electronic cash and trade solutions.
According to Venkatesh Somanathan, regional trade finance product manager, Asia Pacific, global transaction banking, Deutsche Bank, convergence will pick up pace in those markets that have already adopted electronic channels. “Asia is already taking full advantage of electronic solutions in developed markets such as Singapore, Hong Kong and Japan, so that their trade transactions with Europe and the US can be conducted as a complete, end-to-end straight-through process. “However, there have been delays in the take-up of electronic channels for intra-regional trade where there is a traditional reliance on LCs. As a result, we will probably see more countries trying to find ways of encouraging the use of technology to facilitate the growth of trade within Asia.”
Similarly, Ashutosh Kumar, global head of corporate cash and trade banking, transaction banking, at Standard Chartered points out that that converged cash and trade solutions have a real role to play in open account transactions, where the supplier wants to secure early financing.
“In such situations, the buyer, who has to make the regular payments, will look to simplify the payment process and this creates a real need for a converged cash and trade solution,” he says. “The buyer simply submits the payment file (cash) to its bank earlier, which then sorts out the provision of finance as part of the supply chain finance facility (trade). ”However, George Fong, head of trade product management and financial institution trade advisory, Asia Pacific, JP Morgan Treasury Services, firmly believes that the convergence of cash and trade is happening in Asia – driven by corporates who recognise that it can help them manage their working capital cycles and their management of payables and receivables.
“The reliance on paper is not hindering this process. All it means is that additional work is required outside the use of an electronic converged solution to provide third parties with the required paper documentation,” he says.“As the movement to open account trade develops in Asia, there will be less need to use paper in the financial supply chain, and this will further support the use of electronic, converged cash and trade solutions.”