Digital trade ecosystem has obstacles — Are S2P networks part of the answer?

There has been a significant amount of resources invested over the last 10+ years in attempts to digitize trade finance. Earlier digital efforts even go back to the Bolero days in the mid-1990s when Bolero stood for Bill of Lading Electronic Registry Organization.

The whole idea is to digitize a process that’s highly dependent on paper, legacy infrastructure, legal rulings spanning centuries and settlement instruments such as the letters of credit. The goal is to digitize trade documents and track the goods to create a new way of trade and verify ownership and to enable finance and payment. Documents may include purchase orders, shipment notices, bills of lading, customs notices, inspection certificates, invoices and warehouse receipts.

These past few years have seen much hope placed on blockchain and distributed ledger technologies (DLT). Banks formed consortia with technology players such as IBM and Marco Polo to be part of this new future (see chart below). It makes perfect sense to replace the costly, paper-laden legacy trade system with technology that’s more cost-effective.

Sample DLT and Blockchain Initiatives

Banks were seeing how technology could be deployed along the global physical supply chain for tracking and transparency. Visibility and transparency are driving the narrative to make investments in this space.

But the biggest pitch that has made many venture capitalists wake up and get their check book ready is the unmet demand for trade finance.

According to the Asian Development Bank, the current trade finance gap, or the amount of requested trade finance that is rejected, is estimated at $1.5 trillion globally. The International Finance Corporation, part of the World Bank, estimates a $4.7 trillion finance gap for small and medium enterprises (SMEs) in emerging markets. There is a persistent message in the market by key industry bodies (or what I would call Missionaries) that a large trade finance gap exists for small businesses.

I would add to that argument these examples of fraud and significant trade losses — Qingdao commodity warehouse fraud, Hitachi Capital Factoring (China) invoice fraud, Singapore $3 billion oil scandal, etc.

So why not use blockchain or DLT to solve the above problems? If it were only that easy (see Blockchain and Digital Invoice Finance — What’s Missing?).

Many of these DLT and blockchain networks, such as we.trade and Marco Polo, are focused on what they call open account trade finance (open account basically implies outside of banks, meaning not using letters of credit or documentary collections to facilitate and settle a trade). We have been down this path before when the banks tried to do this themselves through the Bank Payment Obligation (but without the DLT). That didn’t end well.

Many of these solutions are struggling to find any real traction as they rely on their bank consortia to pitch the value proposition to their customers. This has proved challenging beyond getting some pilots up and running. Banks do not have a culture of innovation and value creation, or marketing. We.trade recently announced layoffs. Others are rumored to have cash issues and may be challenged to raise funds.

Too many of these propositions are trying to boil the ocean. While it certainly would be nice to have a truly digital process flow on both the buy and sell side, one could argue this is not just a technology problem.

Any solution must be corporate-centric when it comes to digital connectivity. Everyone knows the coronavirus pandemic is pushing us more toward digital. I believe source-to-pay (S2P) networks already have a step up because they have digitized the buy process and enable the invoicing to be electronic as well. They are corporate-centric because they solve specific problems for clients. Advanced ones are sophisticated using smart APIs, so tapping into those networks for data extraction is possible. This has always been a tolling issue combined with solving real problems. In a world where multiple partners connect to create economic value, who gets what? Sure, you can have tokens, smart contracts, encryption and all of that, but figuring out the economic value part is not trivial.

When there are fat margins, it’s easier to come in with substitutes — think card interchange, or charging suppliers APR rates of 20% or more. But when there is competition, those margins are squeezed and eroded. Look, we can all trade stocks and options for free today. So where is the economic value? In the case of stocks — it’s you, your information, played by more sophisticated players.

Before we get too enamored of all the blockchain payments and open account trade finance solutions, being operationally viable is not the same as being commercially viable with a chance for sustainable profits.

I am thinking how S2P platforms can play a role with trade digitization initiatives. I believe it has to start with specific company pain points, not pitch decks showing trillion-dollar gaps. We’ve been down that road before many times.

What do you think?

David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital. He can be reached at dgustin (at) globalbanking.com.