Tech report: innovation
Technology and new tools are quickly reshaping how trade finance transactions are carried out
By Lucien Chauvin
Last June, international trade between Latin America and Europe took a major step forward when the Mercosur countries of Argentina, Brazil, Paraguay and Uruguay signed an agreement with the European Union (EU). The pact, 20 years in the making, could eliminate 90% of tariffs on goods once ratified, wiping away $4.5 billion in duties.
The long-delayed free trade agreement still faces challenges as France and Ireland threaten to veto the pact unless Brazil demonstrates more environmental concern about preserving the Amazon. It was welcomed through by proponents of free trade who have seen their influence wane in the face of the US-China trade war.
But it also highlighted a troubling obstacle to increased trade in Latin America: importers and exporters are struggling to secure sufficient trade financing. Even though trade volumes have increased exponentially over the past two decades, the trade finance gap globally is estimated at $1.5 trillion.
International trade in merchandise was $34.7 trillion in 2017, according to the most recent annual report from the World Trade Organization (WTO). Latin America accounted for approximately $2 trillion of that trade in 2017 and preliminary numbers put the amount around $2.2 trillion last year. Some estimates calculate the regional trade finance gap at 5% of the total.
“The banks find it difficult to update their antiquated systems and develop products and delivery methods that are modernâ€
—Alex Fenton, founder and CEO, GapCap
“In Latin America we perceive a continued pace of increase in trade,†says Susanne Kavelaar, regional lead in Latin America for trade and commodity finance for the International Finance Corporation (IFC). “But more importantly, a continued gap between supply and demand of trade finance.â€
That gap has spawned a wave of innovation and competition not usually found in the prosaic world of trade finance. Long dominated by traditional banks and multilateral agencies, the industry is witnessing the emergence of small fintech challengers, much like the broader banking sector. At the same time, lenders, big and small, are turning to such high-tech solutions as blockchains to speed service and lower costs.
Among the biggest beneficiaries are small and medium-sized companies (SMEs) that account for a growing share of global trade, but who have often been overlooked by lenders who generally do business with companies that have extensive track records.
While the volume of trade has started to slow this year in response to the US-China trade dispute, shifting patterns are creating new challenges and opportunities in trade finance. For starters, trade with Latin American was traditionally confined to the north-south corridor, with the region focused on trade with the US. That’s no longer true.
“The majority of exported goods could be going in the direction of China, where a big part of the global middle class will be living by 2030. This will influence the market strategy on a global level,†says Kavelarr.
The nature of trade is also changing. Apart from merchandise, trade flows of services and knowledge are increasing. Trade in commercial services, such as financial and business services, increased by 8% in 2017 and by 10% for intellectual property-related services, according to the WTO. Brazil placed sixth among developing economies with 19% growth in the intellectual property segment between 2000 and 2017. Singapore was first at 36%.
Banks continue to provide the bulk of financing. The IFC works with banks to help facilitate trade finance, originating more than $1.5 billion in commitments for trade financing in Latin America during its most recent fiscal year. The agency’s Global Trade Finance Program includes nearly 60 banks in 21 countries in Latin America and the Caribbean. Transactions average around $1.2 million for pre-export and import financing and are generally in the agriculture sector.
“We tend to look at the whole of trade flow and see where we can add funded for unfunded solutions,†says Kavelaar.
Another important multilateral player is the Banco Latinoamericano de Comercio Exterior (Bladex) that began operations in 1979 to facilitate trade. It has around $15 billion in commitments annually.
Bladex Chief Executive Officer Gabriel Tolchinsky says that banks, both local and international, will remain the major sources of financing for the foreseeable future, and there are new opportunities for them.
Tolchinsky says there’s more opportunities these days in financing imports, but this would require different financing models than those currently used in the region today. “The potential for growth is in financing imports, but the fact that the potential exists does not mean it can be done with the existing model,†he says.
“The potential for growth is in financing imports, but the fact the potential exists does not mean it can be done with the existing modelâ€
Gabriel Tolchinsky, CEO, Bladex
He estimates that demand for trade financing will increase 2.5% this year, down from close to 10% growth last year. He says the drop is directly related to trade disputes and protectionist policies from the world’s largest economies.
But new entrants say traditional lenders have been slow to adapt to the changing global trade environment and deploying new technology. “The banks find it difficult to update their antiquated systems and develop products and delivery methods that are modern and in keeping with the dynamic business they are designed to help,†says Alex Fenton, founder and CEO of GapCap, a London-based start-up that provides invoice financing and discounting.
GapCap is among a growing number of fintechs that are taking on different aspects of trade finance, such as invoice financing for SMEs, a critical link in the chain, because it allows companies to receive payments faster by offloading invoices to a third party.
Invoice financing helps fill the gap a company faces between filling its orders and receiving payments. Fenton says that the gap between filling an order and getting paid is generally between six and nine months, an impossibly long timeframe for small companies.
GapCap’s operation is straightforward. Merchants upload invoices they would like the company to take over and GapCap responds within 24 hours. If it agrees to work with a vendor, it pays up to 85% of the invoice on the spot. It pays off the remaining amount, minus a fee, when the client pays.
“SMEs are hugely constricted by the financial aspect of the trade cycle, especially if factories require payment up front or on shorter terms than the customers will pay one. We free up cash to the suppliers so that they can service order appropriately,†says Fenton.
Other fintechs are tackling additional trade finance needs for SMEs and even corporations. Stockholm-based Mitigram is a networking platform that centralizes pricing for different components in trade finance, from letters of credit to accounts receivable, providing data for funding and risk review.
Using artificial intelligence, London’s Traydstream focuses on letters of credit, using its platform to clear them in under one minute, while Tradeteq works with banks to allow them to interact seamlessly with non-bank institutions to provide credit scores that enable trade finance for SMEs.
US-based CreateTrade Capital focuses on a wide range of services, using its platform to bridge sales orders by providing financing to vendors.
Traditional lenders aren’t sitting by idly. Like fintechs, many have started employing artificial intelligence for risk assessment and credit analysis, dramatically boosting efficiency and reducing the time it takes to secure financing approval.
For example, Citibank announced in April that it was working with EY to develop an artificial intelligence risk analysis program that will change the way transactions are vetted. Citi processes approximately $9 million in trade finance transactions annually.
Other banks, such as Lloyd’s are partnering with startups to design artificial intelligence solutions for trade finance, as are insurance companies and shipping companies. All are looking for ways to cut time, reduce risk and expand options that would allow them to fill that $1.5-trillion trade finance gap.
In late 2018, Lloyd’s acquired a 10% share in Thought Machine, a start-up that uses its cloud technology for data streaming. The key feature allows for contracts to be digitally signed and stored, giving banks rapid access to data.
GapCap’s Feton says that traditional trade financing avenues are being disrupted by technology and banks will either incorporate changes or slowly be phased out of the game. “New platforms are not only providing financing, but reducing risks, which is essential,†he says.
Participants in trade finance have also been expanding their use of blockchain technology over the past few years.
Blockchain, an electronic ledge, allows people along the chain to communicate directly. Information can be added and followed sequentially with the goal of increasing the speed of transactions while simultaneously ensuring traceability and trust. According to an August report from Fitch Ratings, “blockchain technology for banks involving trust counterparties, as seen with trade invoices, letter of credit and syndication platforms, has greater potential upside.â€
The technology is also being deployed through the industry to create more seamless trade finance platforms that include letters of credit, bills of lading and bills of exchange, key components that keep banks from providing funding for small or little-known firms.
Banks are already using blockchain technology platforms, such as we.trade and Voltron, the latter focused on greater efficiency in letter of credit transactions. HSBC reported in August that it conducted its first transaction on we.trade, a project launched by the financial sector in 2017 that now has 12 shareholders, including CaixaBank, Erste Group, Deutsche Bank, KBC, Natixis, Nordea, Rabobank, Santander, Société Générale, UBS and UniCredit, in addition to HSBC.
HSBC, in announcing the transaction, described it as an “online equivalent of a letter of credit†that allowed buyer and seller to create and accept a purchase order online.
Another multi-bank initiative, with includes some of the banks involved in we.trade, is Fnality. It’s developing a utility settlement coin that uses blockchain technology for trade transactions.
One of the larger blockchain platforms today is TradeLens, launched in 2018 by IBM and Maersk, a global logistics firm, to radically change the existing ecosystem by providing traceability in supply chains. In a nutshell. TradeLens lets participants track shipments and improve data sharing.
Maersk announced in early July that two new shipping lines, Hapag-Lloyd and Ocean Network Express, had joined the TradeLens network. With them, more than half of the world’s container cargo is part of the platform.
Tolchinsky said that while fintech and other players are entering the market, this doesn’t mean the end of traditional formats for proving trade finance. He says that traditional sources can and are incorporating technological changes.
“We need to continue improving operations and using technological platforms, making them more efficient to guarantee physical and virtual channels with our clients,†he says.
