In the years before the pandemic and the Ukraine War, much was made of the potential of digitalising trade finance including using blockchain. This task has turned out to be a marathon rather than a sprint, and there is no one-size-fitsall platform.
First off, how big is trade finance — of which commodity finance is the largest portion — to the local banks? Only DBS Group Holdings breaks it out in its results. As at end June, trade finance accounted for 11% to 12% of its loan book. United Overseas Bank (UOB) has hinted at the size of its trade finance book, revealing in its 1HFY2022 ended June results that it had $8.2 billion exposure to Chinese banks as at end June, which was mainly in trade loans. Of these, 98% had a tenor of less than a year, mostly for trade.
Based on replies in Parliament to questions by Member of Parliament Louis Chua, Singapore’s local banking groups had an aggregated commodities financing exposure of $109 billion as at end 2021, which is around 9% of their total credit exposures.
The importance of trade Singapore’s trade-to-GDP ratio in 2021 was reported at about 338%, a 6.58% increase from 2020. Meanwhile, Singapore’s trade-to-GDP ratio for 2020 was a 9.92% increase over the ratio in 2019. According to the World Bank, trade as a percentage of global GDP is only 52%.
Ninety-per-cent of global trade is seaborne. By volume, the top categories are crude oil, iron ore, refined oil products, industrial metals, and food and agriculture products, notes Jonathan Teo, digital & transformation office, global corporate banking, Oversea-Chinese Banking Corp (OCBC).
For local banks, commodity financing is the largest part of their trade finance business although it is not the fastest-growing. Still, Ng Chuey Peng, head, global commodities finance, global corporate banking, OCBC, says commodities and energy is a big part of OCBC’s trade finance book.
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Types of trade
Sriram Muthukrishnan, group head of product management, global transaction services, DBS Bank explains that DBS is involved in two types of trade finance — documentary trade finance and supply chain or open-account trade finance.
“We split trade finance into two areas, documentary trade like letters of credit, where you need messages to go back and forth, where two counterparties are involved. This is cumbersome and platforms like Komgo and Contour have tried to make these more digital,” Muthukrishnan explains. “It’s very heavy lifting because many companies are involved. The main reason why this hasn’t scaled [digitally] is because of the network density,” he elaborates.
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The second part of trade is open-account trade which is around supply chain finance and factoring. “This part is ripe for digitalisation and the takeup on digitalisation has been enormous,” Muthukrishnan says.
Commodity trading makes use of documentary trade. These are large volume commodity traders where the letter of credit or LC contains the key transactional elements. Traders and their counterparties can get financing off an LC, Muthukrishnan says.
“In FY2021, DBS’s documentary trade grew 7% whereas supply chain finance grew 40%,” Muthukrishnan reveals. Documentary trade has been around for more than a century but supply chain finance is only around two decades old, so it is coming off a lower base.
“In terms of book size, documentary trade is bigger but growing at a slower pace. Supply chain financing talks to digital and SME financing, and it’s a strategic business for us. We’ve digitised the process end to end and we can onboard even unknown suppliers in 30 mins – 45 mins.”
As Muthukrishnan tells it, 90% of DBS’s open-account (supply chain) finance is digital. “The customer can send information such as instructions through ‘host to host’ platforms (such as DBS’s own). There are a lot of platforms (Infor Nexus, CRX Markets, C2FO to name a few). It’s easy [for DBS] to link up with these platforms. You need fewer instructions, invoice details and counterparty details,” he continues.
UOB too has been able to digitalise documentary trade and supply chain-financing. “Our proprietary platform, UOB Infinity, is a single digital platform for cash management, trade and financial supply chain management solutions. The platform enables our clients to gain greater control over their financing as they grow their businesses. We offer our comprehensive trade services and financing products including documentary trade and open account financing through this platform as well,” says So Lay Hua, head of transaction banking, UOB.
DBS is moving to multi-tier supply chain financing which sounds complex. As an example, Muthukrishnan uses a hypothetical shoe manufacturer. The manufacturer has a supplier, who buys leather from, say, ‘123’, and buttons from ‘456’. To help finance the entire chain, distributed ledger technology or blockchain comes in handy.
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“We did a deal in China where we worked with a local platform, Caihuilian. You don’t need blockchain for basic supply chain finance,” says Muthukrishnan says although it is needed for multi-tier supply chain finance.
The promise of blockchain
Some five years ago, as blockchain was being used to facilitate cross-border transfers in pilot projects, much was made of its potential to revolutionise trade finance. What has progress around digitalising trade finance with blockchain been like?
“We observe that initiatives around blockchain are trending at a slower pace than the speed of adoption. The reason behind this is that for the pace of adoption to pick up, there is a dependency on the entire ecosystem. This includes banks, clients, fintech partners, industry partners and government agencies who need to come together and harmonise cross-border platforms for such trades. As a ‘community’, we will then be able to drive the success and pace for adoption,” notes So of UOB
Komgo, which OCBC invested in in the first quarter of this year, has some elements of blockchain in one of its solutions. “Digitalising the industry via a platform is inevitable as the manual processes are increasingly ineffective in countering the evolving risks and often cause operational inefficiency. It will also counter the increasing cost of doing business. When assessing the various platform options, Komgo checked off the majority of our criteria,” Ng of OCBC says.
Trade finance, which traditionally relies heavily on manual, paper-based processes that are susceptible to human error and fraud risks, is overdue for disruption, Ng adds. “Fraud has been near the top list of concerns of many banks in supply chain finance, resulting in over US$4.2 billion in losses in 2020. Hence, we are looking to materially reduce fraud risk,” she says.
Duplicate financing — using the same cargo or goods to obtain financing from more than one bank — has occasionally been an issue in commodity financing. In 2014, the same cargo of aluminium in a bonded warehouse in Qingdao was allegedly used to obtain financing from several different banks, including foreign banks.
Similarly, in Singapore in 2020, Hin Leong Trading was alleged to have obtained financing from banks through schemes that involved the sale of the same inventory to multiple parties, and the sale of non-existent inventory. While digitalising trade finance can reduce the risk of duplicate financing, it may not be able to eliminate it.
Still, Ng and her team say Komgo is gaining traction among both traders and banks. Some 6,000 secured instructions are exchanged on Komgo monthly, 1,000 LCs are processed and the platform facilitates US$20 billion ($27.98 billion) of trade flows monthly.
“Our equity stake in Komgo is mutually beneficial for both parties. OCBC gets to actively drive Komgo’s direction, and Komgo has a partner to drive adoption in Southeast Asia and Greater China markets, to strengthen its regional positioning,” Ng says, adding that her team will look at interoperability between Komgo and SGTraDex and the Trade Finance Registry.
Interoperability, common platforms, common laws
“We don’t want to sponsor one platform or the other and we have not invested in any of them. We can use APIs to get on different islands. Unfortunately, trade is a fragmented business while payments are homogenous. Trade is specific to corridors and counterparties. Countries have localised or regionalised, leading to pockets of digital islands. We have solutions in APIs because you can create channels of communication between digital islands,” Muthukrishnan explains.
UOB is also platform agnostic for its trade finance customers. “We remain open and ready to work with new platform providers or partners, both public and private-led, as long as the collaboration offers tangible value for our clients to future-proof their business model. The platforms should be able to streamline trade and financial supply chains for industries to result in higher productivity,” says So.
On a more positive note, trade finance has the potential of getting on to a common platform. The United Nations Commission on International Trade Law (UNCITRAL) adopted the Model Law on Electronic Transferable Records (MLETR) in 2017. MLETR enables the legal use of electronic transferable records both domestically and across borders. Electronic transferable records are a fundamental component of a paperless trade environment, and can be used to facilitate digitally-enabled trade finance.
“We need for the various players to think about using common standards and here I want to offer a ray of hope. Singapore has signed UNCITRAL’s MLETR into law. India, China, and the UK are looking at adopting it. If countries are adopting this law for electronic trade, this is the way the future will unravel. We can then leverage a single, common law. It will take some years for this to become reality but we are moving in the right direction,” concludes Muthukrishnan.
