BPO press coverage Extracts from GTNews.com

Bank Payment Obligations: The Way ForwardTan Kah Chye, Barclays Corporate 19 Jan 2012

It is important that all banks involved in trade finance, irrespective of size or geographical coverage, work together to facilitate the introduction and successful implementation of the bank payment obligation (BPO), leveraging the initial groundwork of SWIFT and the work now underway within the International Chamber of Commerce (ICC).

The trade finance industry has come under criticism at times for using out-dated and cumbersome systems to facilitate trade transactions. Therefore the various industry initiatives to modernise and simplify trade coming on-stream in 2012 should certainly be welcomed by banks and corporates alike. One such initiative is the introduction of bank payment obligations (BPOs), which are set to foster significant efficiency improvements in trade in the coming year.

As a tool, the BPO is very similar to the definition of a documentary credit in that it is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after successful matching of data. The key difference with the BPO is that it is electronic and involves matching data fields as opposed to documents.

This is a major leap in efficiency in trade finance as it removes the physical presentation of shipping documents to a bank as would be the case with a documentary credit. Instead notification of the BPO obligation and the decision on whether the seller has complied with

the terms of the BPO is all based on electronic data. The efficiency gain is at least hours, but potentially days, for participants in the transaction.

Changes in GovernanceA landmark agreement, signed during 2011 between the International Chamber of Commerce (ICC) Banking Commission and SWIFT, has paved the way for the ICC to assume responsibility for the rules governing BPO. The importance of this change cannot be underestimated as it will mean that the BPO will benefit from the extensive experience the ICC has in managing successful industry rules and also provides the BPO with another critical component: an industry recognised dispute resolution capability, which will build on the foundations that have already been laid down in the SWIFT-led model.

Under the agreement the ICC will develop industry standard rules for the BPO. These rules will apply to any BPO transaction and will form the bedrock of the future standing of the BPO, potentially elevating the BPO over time to a position similar to the letter of credit (L/C).

The ICC rules will be platform agnostic, meaning that they will apply to a BPO transaction irrespective of the platform that has been used to create and transact the BPO, resulting in the obligor and recipient banks under a BPO no longer being limited to using the SWIFT Trade Services Utility (TSU) functionality. This should encourage other software companies and vendors, many of whom are already well advanced in offering BPO functionality, to enter the market and provide alternative competition.

Figure 1 shows the key stages of a BPO transaction, which can be summarised as:

— Buyer and seller exchange contracts.

— Buyer instructs their bank (obligor bank) to establish the BPO containing the data that the seller needs to provide to obtain payment.

— Obligor bank agrees to support the transaction and issues the BPO to the recipient bank.

— The recipient bank notifies the BPO to the seller.

— After shipment of goods the seller provides the data required under the BPO, which flows through the recipient and obligor banks where it is matched to the original BPO requirements.

Benefits of the BPOCorporates often quote that there are many benefits with the BPO over traditional documentary credits. Benefits are:

— Faster payment to the seller.

— Reduction in utilisation of banking lines and related fees due to later issuance of the BPO.

— Potential for different approaches to the provision of confirmations of obligor bank risks, particularly where the exporter/seller has some internal appetite on the obligor bank or where multiple banks are needed to cover a single transaction.

— Potential creation of new ‘events’ on which to base financing, particularly pre-shipment financing that can assist small and medium-size enterprise (SME) exporters.

Another major benefit of electronic trade finance programmes like the BPO is the massive improvement it can have cash flow forecasting. The presence of a committed payment due date is often worth the cost of participation, particularly if the BPO is used in longer standing trading relationships where bank involvement can be requested later in the process (resulting in lower bank line usage and bank fees).

Overall, there is significant corporate interest in BPOs, and when combined with other initiatives such as corporate SWIFT membership, BPO’s can provide a powerful platform for revolutionising trade.

BPO Progress to DateWhen reviewed in terms of actual transactions and participation, progress has been limited. SWIFT says that there currently 19 banks committed to participating in promoting the BPO and a slightly smaller number with the capability to enter into BPO transactions. Some are more active than others. Likewise, the number of live transactions entered into so far has been small with the majority of the transactions conducted within the Asian markets and most of those within the Chinese domestic market.

Notwithstanding, this limited progress interest continues to grow with a handful of large corporations and a growing number of banks actively pursuing the use of the BPO within their supply chain.

Where to from Here?The future of the BPO has been boosted significantly with transfer of governance to the ICC. Of course, this development in its own right will not embed the use of the BPO across the industry. BPO can only be as successful as the L/C if all participants in international trade commit to trying it and finding a place for it in their businesses.

In the early stages, education and communication of the benefits that the BPO can offer is also a key cornerstone of its future success. This education has to go across all the communities who may benefit from the BPO including buyers, sellers and banks. Ultimately, like any new development or initiative, the relative success will depend on how forcefully customers, in this case corporates, demand that their banks are able to provide them with BPO solutions. Banks

in their own right may decide to develop BPO solutions based on the benefits that they believe can be achieved, but a robust corporate demand is required for the BPO to enter the mainstream trade finance world.

ConclusionThese are exciting times for trade finance banks and to realise the full benefits that the BPO can offer both banks and their customers it is important that all banks involved in trade finance, irrespective of size or geographical coverage, work together to facilitate the introduction and successful implementation of the BPO, leveraging the initial groundwork of SWIFT and the work now underway within the ICC.

Improving Trade Finance Efficiency with Bank Payment ObligationPrathima Rajan, Celent - 20 Jan 2012

The newly developed bank payment obligation (BPO) will allow corporates to conduct more business, as their risk will be better managed and finance will be more readily available to the supply chain.

The banking industry has always been among the pioneers of computerisation and networking, which in turn have driven the adoption of worldwide standards. This is particularly true in the case of international trade finance, where financing often goes beyond boundaries making standardisation inevitable. In trade finance, open account and letter of credit (L/C) are the two dominant product categories.

Despite the financial crisis and the significant rise of counterparty risk concerns that have emerged, open account is still a dominant means of conducting international trade. Open account is a high risk option for trading partners, particularly exporters, and require a significant level of trust between the two counterparties. In addition, in industries where payment cycles are long, open account transactions curtail cash flow and increase cost for the exporters. Due to high competition in export markets, foreign buyers often press exporters for open account terms, and this will strain the exporter.

Although a rebound of L/C usage would have been expected during the past few

years due to increased concern about counterparty risk, the reality has been different. In some specific industries and countries L/C usage has seen growth, but for a majority of corporations the ‘cash trap’ nature of L/Cs has counterbalanced their concerns about the solvency of their trading partners. They were more concerned about cash availability to weather the difficult economic conditions. The revocable L/C is less popular as compared to the irrevocable L/Cs that adds the endorsement of a seller’s bank (the accepting bank) to that of the buyer’s bank (the issuing bank). This arrangement provides a level of protection to the seller because the L/C cannot be cancelled unilaterally by the buyer, and also both banks involved in the transaction guarantee its payment on maturity.

While the drawbacks in both these products resulted in high risk, increased costs and concerns about the solvency of their trading partners, an alternative means of settlement in international trade was much needed.

A Recent DevelopmentIn the year 2009, SWIFT’s Trade Service Utility (TSU), a matching and workflow engine for open account transaction data, started to offer bank payment obligation (BPO) as an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after a specified event has taken place. This ‘specified event’ is evidenced by a ‘match’ report that has been generated by SWIFT’s TSU.

The BPO was designed by banks to provide complementary services to corporates who are either trading on open account already or planning to move from L/C to open account. It allows corporates to make use of related banking services such as financing, payments, collections and account reconciliation.

The combination of international trade rules with that of technology ensures two key elements:

— BPO ensures the buyer will make the payment.

— BPO acts as collateral for financing.

The BPO brings the best of both the L/C and open account. In L/C banks will play the role of intermediaries, and in open account the paper-based exchange of documents remains within the corporate-to-corporate space without going into the

bank-to-bank space.

The BPO is more convenient than L/C in the sense that the BPO’s electronic presentation of data eliminates the physical documents in the process, and is thus more cost effective than L/C as it is linked to the automatic matching of data through the TSU matching application. It is also more flexible than L/C as it allows changes to be made anytime during the lifecycle of a transaction for any amount that can be different from the total value of the goods consigned.

Likewise, it is more secure than open account in terms of mitigating risk and providing assurance of payment to the exporter. It is also more adaptable than open account, as it acts as collateral for financing.

The flavour of BPO, apart from data matching exercise promised by TSU, is the conditional undertaking by the issuing bank in favour of the receiving bank. In the pre-shipment finance BPO acts the same way as an L/C. There is still a degree of performance risk; however this is heavily mitigated, as the data has been matched at the purchase order stage by both parties and independently verified under TSU. Thus, the success rate of such transactions is high from banks’ perspective.

At post-shipment stage, financing is made easy as the data match between the invoice and the purchase order has already been made. The performance risk at this stage is eliminated and therefore post-shipment finance can be readily

availed against the risk of the buyer.

At present, a majority of the banks worldwide are yet to realise the importance and advantage of such transaction. The existing banks using BPO are in the learning curve and are waiting to see how effective this alternative instrument can prove to be in the long run. Banks will have ample opportunity to integrate the BPO into their existing trade services portfolio in the years to come.

ConclusionThe BPO will allow corporates to conduct more business as their risk will be better managed and finance will be more readily available to the supply chain. A key element, however, is the level of comfort that counterparties feel with the legal underpinnings of the new instrument.

Sellers see cash flow optimisation and improved liquidity forecast due to releasing of cash trapped in the supply chain through automated data matching. With improved payment cycles sellers can reduce processing effort, cost and risk. Likewise, buyers benefit from extended payment terms that further enable the possibility to negotiate improved terms with the seller. Improved cash flow, increased competitiveness and optional ability to trigger payment are some of the added advantages to the buyer.

Keeping all the above analysis in mind, Celent expects BPO to become an effective alternative instrument that brings the best of both L/Cs and open account

Figure 1: L/C Versus BPO Versus Open Account

to the international trade finance scenario in the years to come.

Accelerating Global Trade FinanceAndré Casterman, SWIFT - 23 Jan 2012

The partnership between the International Chamber of Commerce (ICC) and SWIFT will revolutionise global trade finance practices by leveraging electronic transaction data available from dematerialised business-to-business (B2B) processes and by establishing paperless inter-bank practices.

In an opinion piece, entitled “Collaborative Supply Chain Finance: A Few More Steps to Go”, published in SWIFT’s Dialogue magazine on October 2010, I advocated that the time had come for “the ICC [International Chamber of Commerce] to embrace the BPO [bank payment obligation] rules and help the industry establish best practices in supply chain finance”. I also suggested that a set of ICC rules governing collaborative supply chain finance will be “a key milestone” for the trade banks, as such rules will offer a legally binding, valid and enforceable risk mitigation instrument for financing open account transactions.

One year on, at Sibos 2011 in Toronto, the ICC and SWIFT confirmed their joint ambition and action plan to provide the global trade industry with new rules and tools in support of the development of international trade in the 21st century.

The ICC was established in 1919 to facilitate the flow of international trade. It was in that spirit that the Uniform Customs and Practice for Documentary Credits

(UCP) were first introduced in 1933 to alleviate the confusion caused by individual countries’ promoting their own national rules on letter of credit practice. The objective was to create a set of contractual rules that would establish uniformity. The ICC rules on documentary credits - UCP 600 - are the most successful privately drafted rules for trade ever developed.

SWIFT is a member-owned co-operative through which the financial world conducts its business operations. SWIFT provides a worldwide communications platform, products and services that allow customers to connect and exchange financial information securely and reliably. SWIFT also acts as a catalyst to bring the financial community together to collaboratively shape market practices, define standards, such as the ISO 20022 financial messaging standards, and develop global technology solutions, such as SWIFTNet messaging and transaction matching services.

The recently signed partnership is now well underway with an ambitious timetable aiming to establish the new BPO rules by 2Q13. The goal of both industry-owned organisations is to enable banks to extend the benefits of the letter of credit (L/C) to the open account world by re-using electronic transaction data available from their corporate customers. Using the BPO, sellers will benefit from timely payments whereas buyers will be able to support pre-shipment finance of their strategic suppliers without conceding advance payments.

Figure 1: ICC BPO Rules and SWIFT’s TSU

Opportunity for the Trade Finance IndustryThe physical supply chain has significantly increased efficiency through the use of new technologies and business models. By doing so, trading counterparties have accelerated their industry-specific processes, reduced handling costs and inventories, increased visibility and improved forecasting and planning. Some industries have succeeded to shorten order and delivery processes from an average 20 plus days to same-day execution. However, on the banking side, most of the supporting global trade finance processes have not been optimised sufficiently due to paper-based practices slowing down key processes, such as discrepancies handling.

The time has now come for the trade finance industry to link the delivery of financial services to what is actually happening in the physical supply chain in a more efficient way: i.e. using electronic transaction data. The emergence of trading hubs (e.g. South Korea, Taiwan and Hong Kong) and business-to-business (B2B) e-commerce/e-invoicing platforms (e.g. Ariba, GXS, PayModeX, Peppol and Tradeshift) has significantly increased the dematerialisation of B2B processes, such as sourcing, negotiation, quotation, ordering, shipping, invoicing, etc.

Such new electronic B2B processes have created a new paperless world where efficiency gains and cost reduction are achieved to the benefits of both buyers and sellers. Buyers and sellers now expect their banking partners to follow suit.

ICC BPO Leverages Electronic Transaction DataThe dematerialised B2B processes offer banks the opportunity to extend today’s paper-based trade finance services to new services based on electronic transaction data.

The co-operation between the ICC and SWIFT is delivering a complete package made of new rules (the BPO), as well as new messaging standards (ISO 20022 standards) and a new SWIFT cloud application for supply chain finance (Trade Services Utility (TSU)). The new rules and messaging standards enable banks to leverage electronic transaction data available from the B2B world. Using data representing the purchase order, invoice, certificates and transport documents offers banks the ability to accelerate

global trade finance processes, as well as increase visibility on transaction details (e.g. line items) in order to better mitigate risk and finance transactions.

ICC BPO: A Modern InstrumentThere has never been an equivalent instrument to enable an exporter to trade on open account terms with the same degree of confidence that a payment will be executed in accordance with the terms of an L/C. The BPO is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date, after a specified event has taken place. This ‘specified event’ is evidenced by feeding the relevant data elements taken from a range of

associated open account documentation, such as purchase orders, commercial invoices, advanced shipment notices, bills of lading, etc, into a shared matching application that then generates a ‘match’ report to show that the description of goods shipped matches precisely the description of goods ordered.

The BPO places a legal obligation on the issuing bank to pay the recipient bank subject to the successful matching of compliant data. In short, the BPO delivers business benefits and security equivalent to those previously obtained through a commercial L/C, while at the same time eliminating the drawbacks of manual processing typically associated with traditional trade finance.

Figure 2: BPO Brings Benefits of L/C to Open Account Market

Figure 3: BPO Extends SCF Services to Higher Value Risk and Financing Services

Certainty of payment not only facilitates access to flexible forms of financing but also supports the more efficient management of working capital, enabling the release of substantial volumes of cash which might otherwise be trapped in the supply chain.

Whereas banks have attempted in part to plug the gap, for example through the issuance of conditional payment guarantees or standby L/Cs, the BPO acts as an electronic inter-bank conditional promise to pay offering a comprehensive and cost-effective risk mitigation and financing tool to all trading counterparties.

ICC BPO Extends the Scope of SCF Using Electronic DataAlthough data-driven supply chain finance (SCF) solutions are widely available from large banks and from some third-party vendors, most are limited to the last mile of the transaction - i.e. using the invoice approved by the buyer to finance the supplier’s receivables. Although addressing suppliers’ working capital issues, this type of offering only represents a small - yet relevant - step when considering the real potential of supply chain finance across the full transaction lifecycle.

With the BPO, banks are involved as from the very early stage of the trade transaction, i.e. the raising of the purchase order, and at every stage of the transaction lifecycle. This is a key difference for banks that wish to provide, for example, payment risk mitigation and/or pre-shipment finance in a secure, efficient and collaborative way. Such services represent much higher value for corporates.

Both large and mid-caps sellers will enjoy timely payments when dealing on open account terms, since payment will be done by their own bank independently of effective payment by the buyers. When needed, buyers with strong credit ratings will be able to facilitate pre-shipment finance to support their critical suppliers while not using their own capital as it is often the case today.

Contrary to today’s reverse factoring services which are driven by large buyers, the BPO is offering an industry-wide multi-bank instrument relevant to any type of corporate in any industry.

ConclusionBoth the ICC and SWIFT believe that by working together and leveraging their respective positions in the trade finance community, the BPO will have an important role to play in supporting the development of international trade in the 21st century by addressing cost pressures in the face of increased automation and changes in the regulatory environment. By using electronic transaction data, the banking industry is preparing itself to better respond to the desire of their corporate clients to accelerate financial processes and optimise working capital.

The time has now come for banks to prepare for this innovation and start extending their supply chain finance services from invoice-based processing services (e.g. e-invoicing, factoring and reverse factoring) to purchase order-based services, such as payment assurance, risk mitigation, pre-shipment and post-shipment finance. Banks will be able to better respond to key issues for sellers, such as delayed payments, whether dealing on L/Cs or open accounts. They will also be able to speed up processing and enable buyers to optimise credit lines and to reduce handling costs and inventories. Finally, buyers will be able to avoid supplier defaults by facilitating pre-shipment finance without using their own capital.

Some 19 banks have understood the opportunity offered by the BPO and last year confirmed their decision to adopt the BPO. As corporates will discover the benefits of the BPO in 2012/2013, they will be expecting their banking partners to react quickly. Waiting for the ICC publication of 2Q13 and missing the opportunity to get ready in 2012 is, in my view, a mistake banks ought to avoid making.

List of Banks Adopting the BPO (January 2012)— Banco do Brasil

— Bank of China

— Bank of Communications

— Bank of Tokyo-Mitsubishi

— BMO Capital Markets

— BNY Mellon

— China Citic Bank

— China Minsheng Bank

— Commercial Bank of Dubai

— Commerzbank

— Deutsche Bank

— First National Bank

— Hua Nan Bank

— JP Morgan

— Kasikornbank

— Korea Exchange Bank

— National Bank of Greece

— Standard Bank of South Africa

— Standard Chartered Bank

Mitigating Risk and Maximising Opportunity for International TradePravin Advani, JP Morgan - 24 Jan 2012

Bank payment obligation (BPO), which is available through SWIFT’s centralised automated data matching engine - Trade Services Utility (TSU), is a new financial instrument offering the opportunity to mitigate risks, while still capitalising on the advantage of open account trade.

Until the financial crisis of 2008, global trade was being conducted increasingly on an open account basis, with SWIFT estimating the figure to be around 80-85%. The rationales for open account trade are clear: it is convenient and helps lower cost. During and subsequent to the crisis, however, treasurers and finance managers increasingly recognised that despite its convenience, there are challenges associated with the open account model, both for buyers and sellers, particularly relating to liquidity and risk. There is now the opportunity to mitigate these risks while still capitalising on the advantages of open account trade. The answer comes in the form of a new financial instrument called bank payment obligation (BPO), which is available through SWIFT’s centralised automated data matching engine - Trade Services Utility (TSU).

Advantages of Conducting Trade Through Open AccountAn open account transaction means that goods are shipped and delivered to the buyer (importer) before payment. As the relationship between trading partners matures, conducting trade through open account can offer substantial benefits

to both the buyer and seller. First and foremost, buyers can reduce underlying costs associated with trade flows, specifically those relating to bank fees. Turnaround time also improves as a result of straight-through processing (STP), which in turn facilitates cash forecasting and liquidity management for both parties and reduces the need for external credit facilities. Moreover, both parties are also able to cut down operational requirements as a result of less trade-related documentation.

As enticing as it sounds, there is a variety of challenges associated with open account transactions. To begin, while the buyer stands to benefit from improved cash flow and cost savings, the seller faces the risk of payment delay or default after the shipment of goods. As such, it is not easy for the buyer to convince the seller to trade on open account terms based on their own credit rating. In some instances, the buyer may need to provide a standby letter of credit (L/C) as security, which increases overall cost. Some sellers may also require buyers to assist with financing the trade flow as a form of risk mitigation. Operationally, there could also be additional administrative requirements such as reconciliation of payment information with purchase orders.

Likewise, the seller also faces a variety of open account trade-related issues besides those associated with risk management and payment. At the top of the list are securing financing and identifying ways to remove receivables from its balance sheet.

The Case for TSU and BPOIn response to the trend of open account trade, SWIFT launched a bank-to-bank platform called TSU through which pre-defined data extracted from trade-related documentation, namely the purchase order, commercial invoice, insurance and transport documents, can be automatically exchanged and matched. Essentially, TSU is a centralised matching engine aimed at providing automated data matching in a timely and accurate manner.

In 2009, this initiative was given a boost with the introduction of a new financial instrument called BPO, which is an irrevocable undertaking by the obligor bank (buyer’s bank) to pay a recipient bank upon successful matching of agreed data within TSU.

TSU, paired up with BPO, hasimmense potential in today’s operating environment as a risk mitigation tool offering cost and operating efficiencies to trading partners. This is possibly best epitomised in the signing of a ‘declaration of co-operation’ between SWIFT and the banking commission of the International Chamber of Commerce (ICC). In effect, the declaration paves the way for the acceptance of BPO as an alternative means of settlement in international trade, providing the benefits of a L/C in an automated environment.

While the benefits offered by a BPO and a L/C are similar, there are fundamental differences between the two. The key difference is that whereas the L/C relies upon the physical checking of complete sets of documents, BPO uses automated matching of selected data elements in accordance with the agreed baseline.

Figure 4 provides an illustration of the TSU-BPO process compared with a traditional L/C arrangement.

A Differentiated Service that Benefits Buyers and SellersFor buyers (importers), the TSU-BPO solution provides the opportunity for securing more favourable payment terms capitalising on the presence of an irrevocable payment obligation. As the TSU process is handled, buyers do not need to invest in additional technology or resources to use the solution. Cost of a TSU-BPO transaction is lower than that of a L/C transaction. Documentation is handled more efficiently, with

discrepancies identified and resolved promptly, accelerating the exchange of cash and goods. Finally, buyers also do not need to provide sellers with a standby L/C as the BPO can be issued per purchase order or per shipment, and is paid only against compliant transaction data.

Likewise, sellers also reap similar benefits in terms of risk mitigation, greater cost and operating efficiencies from using the TSU-BPO solution.

Moreover, in instances where the bank acts for the buyer and the seller, the firm can offer further value-add services such as providing the buyer with electronic copies of documentation for more accurate data matching and the seller with document preparation services.

Growing Interest in TSU-BPO SolutionsThe TSU-BPO’s promise of risk mitigation, greater cost and operating efficiency is drawing traction globally over the past year. So far, early adopters come mainly from the communications and energy sectors.

Looking ahead we expect to see a gradual but steady climb in take-up across a wide variety of industries. In addition, we also expect more banks to join the TSU initiative, which will help accelerate the adoption of BPO globally as an alternative payment means.

With volatile economic conditions expected to persist and pressure on working capital management optimisation

Figure 4: Trade Services Utility (TSU) Bank Payment Obligation (BPO) Compared with L/Cs. Source: JP Morgan

to mount, the role of TSU-BPO in trade finance is poised to gain further momentum in 2012 and beyond.

The ‘Trade Tilt’ HypothesisNigel Taylor, GXS - David Hennah, SWIFT 24 Jan 2012

Much has been said about the potential of the bank payment obligation (BPO) as an electronic equivalent to documentary trade processes and an automated alternative to open account. With the financial turmoil of the past few years, it is difficult to pinpoint exactly what impact this new instrument may eventually have on global trade, but with an accelerated emergence of the Brazil, Russia, India and China (BRIC) economies, the business case for electronic cross-border trade is increasingly compelling.

As the banking and treasury communities know, globalisation has seen open account trade dominate cross-border transactions. In its 2010 report ‘Re-Thinking Trade Finance’, the International Chamber of Commerce (ICC) generally acknowledged that at least 80%-85% of all global trade is settled on open account terms, with traditional trade products such as the letter of credit (L/C) representing the remainder. But an examination of how the dynamics of globalisation are ‘tilting’ suggests that the bank payment obligation (BPO), a new electronic alternative to the L/C and an enhancement to open account, will be an increasingly viable trade instrument.

The developed economies currently face multiple economic challenges and are experiencing slow rates of growth. According to the World Trade Organisation (WTO), in 2009 global trade contracted by approximately 12% and global GDP declined by 2.2%. In contrast, the Asian Development Bank (ADB) estimates Asia expanded by 9.6% in 2011 against a predicted 2.5% expansion in the US and further stagnation in the eurozone.

While some experts suspect the developed nations of considering protectionist policies to safeguard their domestic markets, the world recently saw an increased number of trade agreements signed between Brazil, Russia, India and China (BRIC). These BRIC economies already represent 40% of the world’s population and a quarter of the globe’s land mass. The recent BRIC summits in Brasilia and Sanya also demonstrated

that, while the alliance may lack political cohesion, there is nevertheless a clear appetite between developing nations to increase trade with one another.

Changing DynamicsPerhaps a subtle indicator for a coming change in trade dynamics is the recent article in The Times of India where the Associated Chambers of Commerce and Industry of India (Assocham) assert that trade between China and India will increase from its existing level of US$63bn to the agreed 2010 bi-lateral target of US$100bn by 2015. With both countries established since 1984 as each other’s ‘most favoured trading nation’, there is little doubt that this objective is easily achievable.

Even though some emerging economies experienced short-term contraction followed by talk of ‘over-heating’, the long-term predictions remain optimistic. This view is endorsed by the 2011 predictions made first by PricewaterhouseCoopers (PwC) that China will eclipse the US as the largest global economy by 2030, and then by Standard Chartered Bank who gave their prediction as 2020. These predictions may be combined with those of Goldman Sachs which suggests the BRIC countries will represent 41% of the world’s market capitalisation by 2030, and will become four of the six largest economies by 2050.

Impact of the ‘Trade Tilt’So what does the accelerated emergence of the BRIC economies mean for the developed nations? ‘Trade shift’ is an over-used, over-hyped idiom and is perhaps an emboldened prediction for the result of unfolding events. It is imprudent to underestimate the fall-out of the current economic climate but a prospective, discrete suggestion is that a ‘trade tilt’ is beginning to occur right now. Initially, the tilt is expected to see a marginal return to the low-risk letter of credit. To date, many BRIC suppliers to developed countries were obliged to accept open account terms as the de facto standard when doing business with their overseas customers. However, a combination of factors is emerging now that may eventually see an accumulative rejection of open account and a consequent move towards other trade instruments such as the BPO.

Under open account terms, the importer takes on the supply risk and is obliged to ‘match’ a purchase order, shipping or warehouse data to the supplier invoice. This is seen as very low risk for the importer as they can reject goods on inspection for various reasons, and payment will only be made if a full match occurs and at conclusion of payment terms. Open account places all credit risk on the exporter and bases the cost of goods on the exporter’s credit rating and their ability to acquire working capital.

With an increasing emphasis on BRIC domestic markets, rising cross-border trade volumes between the BRIC economies, and perceived foreign exchange (FX) risk due to reduced faith in the US dollar and euro, the anticipated trade tilt will see BRIC suppliers prioritise those buyers who are able to offer improved terms of trade. But as L/Cs continue to be associated with increasingly expensive and paper-bound business processes, importers will for the most part resist any demand from overseas suppliers to revert back to documentary trade.

According to the ICC, the pricing of documentary trade finance is in fact substantially higher now than it was pre-crisis, further accentuating the problem of affordability. This increase in pricing is said to reflect higher funding costs, increased capital constraints and greater counterparty risk. Furthermore, the banking industry appears to believe that the prevailing higher fee structures are justifiable, given the additional security that L/Cs offer to trading counterparties.

New Rules and ToolsEnter the BPO as an alternative to the L/C and an enhancement to open account. The BPO is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date, after a specified event has taken place. This ‘specified event’ is evidenced by feeding the relevant data elements taken from a range of associated open account documentation (purchase orders, commercial invoices, advanced shipment notices, bills of lading, etc) into a shared matching application, which then generates a ‘match’ report to show that the description of goods shipped matches precisely the description of goods ordered.

The BPO places a legal obligation on the issuing bank to pay the recipient bank, subject to successful matching of compliant data. In short, the BPO delivers business benefits and guarantees equivalent to those previously obtained through a commercial L/C, while eliminating the drawbacks of manual processing typically associated with traditional trade finance. Certainty of payment not only facilitates access to flexible forms of financing, but also supports the more efficient management of working capital, enabling the release of substantial volumes of cash which might otherwise be trapped in the supply chain.

When you consider that a supplier’s order-to-cash lifecycle can sometimes exceed 120 days with inherent FX risk, it is not difficult to understand an exporter’s desire to move away from the relatively high-risk open account scenario.

André Casterman, head of trade and supply chain, SWIFT, argues “there has been never been an equivalent instrument to enable an exporter to trade on open account with the same degree of confidence that payment will be executed in accordance with the terms of a L/C.” Where banks attempt to plug the gap through issuance of conditional payment guarantees or standby L/Cs, the BPO acts as an electronic inter-bank conditional promise-to-pay, offering a comprehensive and cost-effective risk mitigation and financing tool to all trading counterparties.

Of course, the BPO does face significant challenges in terms of market acceptance. The modern version of the documentary L/C became established as an accepted market practice thanks largely to the publication and maintenance by the ICC of a set of rules - the Uniform Customs and Practice (UCP). For the BPO to become as widely accepted as the L/C, it will benefit from the backing of a similar set of rules published and maintained by the ICC. SWIFT is currently collaborating with the ICC and its membership to publish ICC rules for the BPO in early 2013. In the meantime, those buyers and sellers keen to take advantage of this new instrument today, can do so by making use of the existing infrastructure, standards and rules developed by SWIFT.

Banks traditionally perceive documentary L/Cs as low risk business and there is no reason to believe they will disappear completely, nor should there be. It is

important for the market to support choice, so that those who favour open account can choose open account, and those who favour L/C can choose L/C. For those looking for a hybrid solution which balances the best of both worlds, there is now another option on the menu. As the anticipated tilt materially alters trade dynamics, so we foresee that importers and exporters alike will look to alternative methods of trade finance. Fully electronic trade automates business process and data matching. Apart from the obvious efficiency of removing paper that benefits all counterparties, there are also clear pre- and post-shipment trade finance opportunities that can be supported across the entire transaction lifecycle.

With the BPO offering an assurance of payment upon matching a confirmed purchase order, suppliers can potentially leverage the BPO as collateral for pre-shipment finance. In this scenario, credit risk is transferred to the obligor bank, thus mitigating counterparty risk. The supplier can also issue a BPO in their local currency, mitigating any perceived FX risk from the once stable currencies of the dollar, the euro and sterling.

Goldilocks and the BPOThis ‘Goldilocks scenario’, where L/C are too hard, open account is too soft and BPOs are just right, offers an exciting opportunity for existing global open account networks.

Complex data matching solutions bring together the required electronic data elements consistent with ISO 20022 messaging standards with the ICC BPO rules to provide a solid platform for BPO issuance, acceptance and financing.

Whether importers wish to reduce fees, enhance process efficiency or provide improved terms of trade to their overseas suppliers, existing global electronic networks such as SWIFT and GXS, currently processing billions of transactions and trillions in spend, are ideally placed to propel the BPO forward as the emerging standard for cross-border trade finance and working capital management.

BPO and ISO 20022: A Technology PerspectiveOlivier Berthier, Misys - 25 Jan 2012

Despite industry inertia to change, bank payment obligation (BPO) is an opportunity for a positive evolution in the face of an increasingly online industry.

Launched at the beginning of 2010 by SWIFT, the bank payment obligation (BPO) provides an alternative means of settlement in international trade. SWIFT, together with the International Chamber of Commerce (ICC) Banking Commission and a working group of banks and corporates, undertook an initiative to establish the BPO, most recently signing a co-operation agreement at the Sibos in September 2011, with the intention of encouraging industry-wide adoption.

BPO sets out to upgrade several current methods for settling international trade. While letters of credit (L/Cs) have been around for years, will be for many more and are trusted and used globally, the time and paperwork required means that there is certainly space for modernisation of the system, particularly when it comes to open account transactions not currently benefiting from L/Cs’ well-known risk mitigation advantages.

As is often the case, change involving new technologies and standards can be daunting, but in the case of BPO, there are a number of reasons not to be afraid. Its standards-based technology foundations in particular are merely following the same path of evolution undertaken by other areas such as cash management since the mid-2000s, and the transition to BPO is unlikely to be problematic on this front.

Beyond the clear benefits of the instrument itself from a financial and risk management perspective, complementary advantages are also expected in the increased granularity of the data the BPO exposes. Not only will it improve settlement of trade transactions, but its ability to read even more information and increase visibility should also mean banks are able to enhance their services too.

BPOA BPO is an irrevocable undertaking given by a bank to another bank that payment will be made on a specified date after a successful electronic matching of data according to a defined set of rules.

Therefore, a BPO offers:

– An assurance of payment.– Risk mitigation for all parties.– Possible use as collateral for finance. Interest in BPO is fuelled by the fact that it seeks to bridge the gap between the current system of L/Cs, which, despite its value, is often blamed for being slow, inflexible, administration-intensive and costly in terms of both paper and processing, and open account transactions lacking the traditional L/C assurances provided by banks.

Trading parties use complementary techniques in the context of open account transactions to manage the risks of their transactions in lieu of L/Cs. For example, the risk of payment default for exporters can be mitigated through buying credit insurance, arranging standby L/Cs or various methods of selling their invoice portfolio at a discount. However, these methods tend to cover only a portion of the trade transaction and lack integration with the underlying end-to-end flow of information along the physical supply chain.

From a risk management perspective with open account, it is also incumbent on the parties to know their counterparties’ risk profile. For this reason, open account is mostly used for longstanding and trusted relationships, while L/Cs are preferred for new customers without a proven track record and where banks play a key role thanks to their extensive knowledge in managing risks.

BPO aims to mitigate open account risks and to accelerate the payment cycle. It enables banks to provide their trade finance customers with guarantees and other banking services on open account terms. Based on ISO 20022 messaging, it brings together the Trade Services Utility (TSU), SWIFT’s matching utility as a reference implementation, with a set of business rules that replace the reliance of L/Cs on actual documents (either on paper forms or electronic as authorised for many years by the eUCP rules of the ICC but with little success) with dynamic data sets that can be automatically streamed.

The Same, But DifferentThe use of electronic data exchange to support trade finance is not a fundamental change and the technology

is ready. In many ways, it’s not that different to L/Cs, whose process is already largely electronic. Corporate e-banking systems offered by a large proportion of banks active in trade finance support the ability to issue, notify and monitor L/Cs and other instruments throughout their lifecycle including subsidiary events and copies of documents.

In addition to an interactive web-based user interface, some also include the ability to integrate directly with the corporates’ enterprise resource planning (ERP) or treasury systems. Statistics vary between different banks and regions, but a consensus among the financial institutions using customer portals today is that more than 80% of their total volumes of L/Cs will generally be exchanged and managed electronically with their customers.

The same level of dematerialisation is largely in place at most banks’ back office operations where integrated trade finance systems process transactions and manage the necessary electronic data interchange with the customer channels, other banks via SWIFT and payment gateways.

Therefore, we already have in principle both the channels and the back office systems to support the kind of facilities necessary to deploy BPO in the value chain. Much of the infrastructure needed to enable corporate customers to upload and action their purchase order or invoice data, and banks to automate the overall

accounting, risk management and billing of transactions, is already in place.

One of the things that is crippling the industry and hindering the adoption of mass working capital financing techniques such as supply chain finance (SCF) is the lack of standardisation. But a key advantage of BPO is that it is standards-based - following the ISO 20022 standard - and therefore provides an unambiguous reference to its definition and mechanism. It is again here a strong analogy with the L/C and its uniform acceptance across the globe. This is in contrast with SCF and its variations, which do not rely on standards-based definition and practices today - in spite of initiatives such as the BAFT-IFSA glossary.

BPO is fundamentally aiming to tackle this - not only the standardisation from an ISO 20022 messaging perspective, but also in terms of business rules which the ICC is currently working on. Another important aspect of the ICC endorsement to help widen adoption is the decoupling of BPO from being exclusively run on the SWIFT TSU infrastructure, despite the SWIFT service being the obvious initial reference implementation.

Provided that all aspects of the upcoming ICC rules are fulfilled, it shall be possible for a party independent from SWIFT, such as a bank, a corporate, a solution provider or consortiums of the above, to implement platforms supporting the end-to-end deployment of BPO. Again much like L/Cs, which are independent of the

Figure 5: The Benefits of Richer Structured ISO 20022 Data Sets. Source: Misys

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network over which they are processed, even if most of them eventually take the form of MT700 messages transmitted over the SWIFT network.

AdvantagesKey points about standardisation are the guarantee of interoperability between participants (parties and systems), a larger pool of skilled resources and the de-risking of investment in proprietary technology. But the advantages do not stop there.

Even if exchanged electronically, L/C transactions transmitted over proprietary channels and SWIFT tend to contain large amounts of unstructured data such as free text. BPO, on the other hand, streamlines this data, making it more structured and granular with ISO 20022. This in turn facilitates usage, distribution and storage of the transaction data.

This development will provide corporates a finer control over their transactions and a deeper integration with the existing process of their physical supply chain. It will also enable banks to instantly access and identify specific trade activity, not only minimising risk, but also tailoring their services to match the customer’s needs.

For example, by capturing data from a purchase order, a bank can be alerted to a customer’s upcoming need for foreign currency in order to settle the underlying invoice at due date. Another example is the access to more detailed descriptions of goods and services allowing a tighter matching in order-to-pay (O2P) processes down to line item levels.

This more granular access to the data can therefore be seen as an interesting means by which banks can provide value-add features beyond commoditised payment services and ultimately remain relevant to their corporate clients. It can particularly be the case to those large international clients who have moved an increasing proportion of their trade business onto open account terms, rendering the bank’s involvement in the transaction unnecessary. The BPO can play a role in helping avoid this disintermediation of banks and create a new source of fee and commission-driven income for financial institutions.

Barriers to AdoptionThe acceptance and expansion of BPO presents something of a chicken and egg situation - people will only start adopting it once enough people are doing it, but how do we get to that tipping point of critical mass? Creating a set of rules relies upon demonstrable evidence gathered from real, live transactions and this will take time to amass. In an effort to build this evidence, BPO is currently being tested by some of the corporates in the working group, which will help drive momentum in adoption.

Basel III is another potential obstacle to adoption. Confusion about how to calculate risk and how much capital to set aside for BPO transactions could hinder its acceptance. Traditionally, trade finance practitioners as a group tend to resist change. However, we are seeing clear interest in those ranks with an influx of commercial and logistics backgrounds and appetite to realise this evolution.

From the technology perspective, the analogy with the L/C processing and the similarities with the development of cash management are certainly contributing to lowering those barriers. Existing IT expertise within banks coupled with the ability to leverage infrastructure already in place for cash management and payments in support of ISO 20022 should facilitate the evolution.

ConclusionDespite industry inertia to change, BPO is an opportunity for a positive evolution in the face of an increasingly online industry. L/Cs are still used faithfully by many corporates and banks alike and open account transactions are already the norm, but there is a need to streamline the flow of information so that it benefits both sides of the settlement.

The BPO can help achieve this. We are seeing beneficial change in many areas of trade finance, much like with cash management before. Reaching critical mass for any service is always a complex feat, but, in parallel with the ICC work on the subject, we believe the technology transition to BPO will be a relatively simple one where the benefits will quickly proven.

Figure 6: ISO 20022 for Cash Management, Trade and SCF. Source: Misys