Post by Sven Mueller on Jun 21, 2012 8:54:38 GMT 4
Trade Finance 2.0: The Future of the Documentary and Guarantee Business
Sven Müller, Commerzbank - Michael Starke, Commerzbank - 22 Dec 2011
These days everybody is talking about financial supply chain management (FSCM). But what does it mean, how does it affect traditional trade and what in particular has changed?
The guarantee and letter of credit (L/C) business is the mainstay of importers and exporters trading in foreign markets or with new, unknown clients. While an L/C and a guarantee are two different instruments, they achieve similar ends - they both provide a guarantee that the supplier of goods or services will be paid so long as they have fulfilled the conditions of the trade contract.
The L/C is a legal document guaranteeing that the buyer's bank will pay the agreed sum to the supplier, upon receipt of trade documents proving that the trade contract has been honored. A bank guarantee ensures the supplier will be paid, or that the buyer will be compensated, if part of the trade contract is not fulfilled - for example if the buyer cannot pay the supplier, or the supplier cannot deliver the goods as per the contract.
The development of electronic communication (e-communication) standards and the adoption of these standards by banks and corporates have had a fundamental impact on the landscape. There is great interest in electronic messaging (e-messaging) from multinational corporates (MNCs), as well as mid-caps. Many are looking for multi-banking capable solutions to process their guarantee business.
We have also been seeing a shift from the complex L/C business to open account transactions in recent years. But the financial crisis in 2008 and the current sovereign debt crisis have slowed this development. Now, about 80% of the economic trade volume is processed via open account transactions. The crisis and the following credit crunch have forced corporates to involve more banks in their L/C and guarantee business, which of course increases the need for multi-banking.
E-messaging in the Guarantee and L/C Business
E-messaging has been used in Germany in the L/C business since 1995 on a wide multi-banking capable basis between banks and corporates. The DTA standard was enhanced to include the guarantees business in 2009. DTA messaging is mainly used on a national basis between German banks and corporates, and is not restricted by company or transaction size.
It took quite a while for banks and corporates outside Germany to feel the need for multi-banking communication and to understand its benefits. Since the early 2000s, service providers have been offering e-communication on a bilateral basis.
But it was SWIFT who first offered real international multi-banking in the guarantee and L/C business by introducing its SWIFT Score MT 798 solution about two years ago. The market's adoption rate of the MT 798 is moving forward slowly but the demand and interest on our customers’ side is getting stronger. This is the reason why Commerzbank enhanced its back office applications and now has the capability of communicating with its corporate customers in the guarantee and L/C business via MT 798, as well as via the DTA.
Once a company decides to improve its processing by using e-messaging with its banks, first it will have to assess the capabilities of its own back office applications or enterprise resource planning (ERP) systems. The number and volume of transactions will determine whether it is worth making a major investment.
For those who are not in the position to make such an investment, banks such as Commerzbank offer sophisticated web-solutions for the efficient handling of guarantees and L/Cs.
The Benefits of E-messaging
E-messaging is about efficient processing. There is a significant saving in time and cost for both corporates and banks using standardised e-communications (whether DTA, MT 798 or the other communication tools outlined above).
It is estimated that e-communications in the L/C and guarantee business can reduce costs and time by 70%, compared to the manual, paper-based processing of a guarantee or an L/C. Onerous (and error-prone) tasks such as manual data entry or faxing data are avoided with e-messaging.
As soon as your ERP system is able to communicate with one of the above mentioned standards, you no longer need to send out paper-based orders, faxes or enter data manually into a web application. E-messaging solutions can significantly streamline the issuance of an L/C and guarantee compared to the paper-based process, providing greater transparency as well as more efficient reporting and cash flow forecasting.
Commerzbank is already using e-messaging in the guarantee and L/C business with about 1,300 corporate clients, mainly on the DTA standard. This figure is expected to increase as demand for the MT 798 increases and the standard becomes more widely available in 2012.
Future Developments in the Trade Business
There is another interesting development in the trade business done on open account (as opposed to trade done with L/Cs or guarantees) - the bank payment obligation (BPO) processed via SWIFT’s Trade Services Utility (TSU). The idea behind the BPO and the TSU is to notify financial institutions about trade transactions as early as possible.
Today without the BPO, banks get involved in an open account transaction only at the settlement, which is the last step in a trade transaction. In order to make use of a BPO, it would be necessary to involve financial institutions at the stage of contracting between the importer and exporter. Both the importer and exporter send a specified trade dataset to each bank. Both banks then forward the received data to the TSU. The TSU compares and matches the data and as soon as full compliance of both datasets is achieved, the trade contract will also be established as a valid financial transaction.
In the near future, for example, the importer’s bank could give a BPO to the exporter’s bank in order to ensure the payment on the due date of the open account transaction. On that basis, banks will be able to offer their whole range of trade and financing services for a transaction that they only provided the settlement before. The need for working capital management and liquidity optimisation has never been stronger. The BPO opens the doors for optimising liquidity for the major part of all trade transactions in the world as 80% of the global trade volume is processed on open account.
Of course the BPO will have to prove its suitability in future. Today, the BPO is not much more than a vision. Maybe only 10% or 20% of the necessary steps have been taken so far. There is much work still to be done, particularly on the standards side for e-communication between banks and corporates. We have to keep in mind that both the TSU (as the processing platform) and BPO (as the financial instrument) are to be used between banks only.
The International Chamber of Commerce (ICC) will provide unified rules for the BPO, similar to the UCP 600 for L/Cs by the end of the first quarter of 2013. Commerzbank is a strong believer in the BPO and thus the bank supports the ICC and SWIFT as far as possible in order to leverage market adoption of this new instrument.
Conclusion
There’s a whole lot of movement in the trade finance business. Most of the current offers under the headline financial supply chain management are not really new. But the ability to handle transactions in a sophisticated, efficient electronic manner has grown remarkably - and will grow further in future. Get in touch with your bankers if you want to learn more about this.
Sven Müller, Commerzbank - Michael Starke, Commerzbank - 22 Dec 2011
These days everybody is talking about financial supply chain management (FSCM). But what does it mean, how does it affect traditional trade and what in particular has changed?
The guarantee and letter of credit (L/C) business is the mainstay of importers and exporters trading in foreign markets or with new, unknown clients. While an L/C and a guarantee are two different instruments, they achieve similar ends - they both provide a guarantee that the supplier of goods or services will be paid so long as they have fulfilled the conditions of the trade contract.
The L/C is a legal document guaranteeing that the buyer's bank will pay the agreed sum to the supplier, upon receipt of trade documents proving that the trade contract has been honored. A bank guarantee ensures the supplier will be paid, or that the buyer will be compensated, if part of the trade contract is not fulfilled - for example if the buyer cannot pay the supplier, or the supplier cannot deliver the goods as per the contract.
The development of electronic communication (e-communication) standards and the adoption of these standards by banks and corporates have had a fundamental impact on the landscape. There is great interest in electronic messaging (e-messaging) from multinational corporates (MNCs), as well as mid-caps. Many are looking for multi-banking capable solutions to process their guarantee business.
We have also been seeing a shift from the complex L/C business to open account transactions in recent years. But the financial crisis in 2008 and the current sovereign debt crisis have slowed this development. Now, about 80% of the economic trade volume is processed via open account transactions. The crisis and the following credit crunch have forced corporates to involve more banks in their L/C and guarantee business, which of course increases the need for multi-banking.
E-messaging in the Guarantee and L/C Business
E-messaging has been used in Germany in the L/C business since 1995 on a wide multi-banking capable basis between banks and corporates. The DTA standard was enhanced to include the guarantees business in 2009. DTA messaging is mainly used on a national basis between German banks and corporates, and is not restricted by company or transaction size.
It took quite a while for banks and corporates outside Germany to feel the need for multi-banking communication and to understand its benefits. Since the early 2000s, service providers have been offering e-communication on a bilateral basis.
But it was SWIFT who first offered real international multi-banking in the guarantee and L/C business by introducing its SWIFT Score MT 798 solution about two years ago. The market's adoption rate of the MT 798 is moving forward slowly but the demand and interest on our customers’ side is getting stronger. This is the reason why Commerzbank enhanced its back office applications and now has the capability of communicating with its corporate customers in the guarantee and L/C business via MT 798, as well as via the DTA.
Once a company decides to improve its processing by using e-messaging with its banks, first it will have to assess the capabilities of its own back office applications or enterprise resource planning (ERP) systems. The number and volume of transactions will determine whether it is worth making a major investment.
For those who are not in the position to make such an investment, banks such as Commerzbank offer sophisticated web-solutions for the efficient handling of guarantees and L/Cs.
The Benefits of E-messaging
E-messaging is about efficient processing. There is a significant saving in time and cost for both corporates and banks using standardised e-communications (whether DTA, MT 798 or the other communication tools outlined above).
It is estimated that e-communications in the L/C and guarantee business can reduce costs and time by 70%, compared to the manual, paper-based processing of a guarantee or an L/C. Onerous (and error-prone) tasks such as manual data entry or faxing data are avoided with e-messaging.
As soon as your ERP system is able to communicate with one of the above mentioned standards, you no longer need to send out paper-based orders, faxes or enter data manually into a web application. E-messaging solutions can significantly streamline the issuance of an L/C and guarantee compared to the paper-based process, providing greater transparency as well as more efficient reporting and cash flow forecasting.
Commerzbank is already using e-messaging in the guarantee and L/C business with about 1,300 corporate clients, mainly on the DTA standard. This figure is expected to increase as demand for the MT 798 increases and the standard becomes more widely available in 2012.
Future Developments in the Trade Business
There is another interesting development in the trade business done on open account (as opposed to trade done with L/Cs or guarantees) - the bank payment obligation (BPO) processed via SWIFT’s Trade Services Utility (TSU). The idea behind the BPO and the TSU is to notify financial institutions about trade transactions as early as possible.
Today without the BPO, banks get involved in an open account transaction only at the settlement, which is the last step in a trade transaction. In order to make use of a BPO, it would be necessary to involve financial institutions at the stage of contracting between the importer and exporter. Both the importer and exporter send a specified trade dataset to each bank. Both banks then forward the received data to the TSU. The TSU compares and matches the data and as soon as full compliance of both datasets is achieved, the trade contract will also be established as a valid financial transaction.
In the near future, for example, the importer’s bank could give a BPO to the exporter’s bank in order to ensure the payment on the due date of the open account transaction. On that basis, banks will be able to offer their whole range of trade and financing services for a transaction that they only provided the settlement before. The need for working capital management and liquidity optimisation has never been stronger. The BPO opens the doors for optimising liquidity for the major part of all trade transactions in the world as 80% of the global trade volume is processed on open account.
Of course the BPO will have to prove its suitability in future. Today, the BPO is not much more than a vision. Maybe only 10% or 20% of the necessary steps have been taken so far. There is much work still to be done, particularly on the standards side for e-communication between banks and corporates. We have to keep in mind that both the TSU (as the processing platform) and BPO (as the financial instrument) are to be used between banks only.
The International Chamber of Commerce (ICC) will provide unified rules for the BPO, similar to the UCP 600 for L/Cs by the end of the first quarter of 2013. Commerzbank is a strong believer in the BPO and thus the bank supports the ICC and SWIFT as far as possible in order to leverage market adoption of this new instrument.
Conclusion
There’s a whole lot of movement in the trade finance business. Most of the current offers under the headline financial supply chain management are not really new. But the ability to handle transactions in a sophisticated, efficient electronic manner has grown remarkably - and will grow further in future. Get in touch with your bankers if you want to learn more about this.
