Industry November 2011

Minimising Operating Risk

Over the past 10 years, open account trading has become the standard approach taken by exporters wishing to maintain a competitive position vis-à-vis importers. Moreover, since this form of trading—which helps firms better manage their cash flow while also providing credit protection—now accounts for more than 85% of cross-border trade transactions, the letter of credit has become a niche product.

However, when the financial crisis hit, executives saw that open-account settlement exposed them to risks previously mitigated by letters of credit.

Most firms have had to accept some risk by offering open-account terms, typically a sale in which goods are shipped and delivered before payment is due, usually in 30 to 90 days. This credit and payment risk borne by the exporter creates a funding gap that the exporter must finance.

The key questions now include how to minimise losses from bad debt, and how to use credit granted to importers as a source of competitive advantage, while managing risk effectively in an international environment.

Many exporters have rediscovered the letter of credit—despite knowing its disadvantages, namely, that it is paper-based and comparatively labour-intensive—for its visibility, predictability and legal standing, while recognising its importance in the context of mitigating risk and accessing liquidity both pre- and post-shipment.

With new, sophisticated electronic channels such as MaxTrad™, many labour-intensive aspects of the letter of credit had already been significantly reduced. We focused on how to reduce the complexity of the letter of credit by simplifying the issuance and ongoing management processes, as well as by providing extra online tools to help exporters present a compliant set of shipping documents and fully benefit from the risk mitigation and finance benefits inherent in the instrument.

The Trade Services Utility (TSU), launched in 2007 by the Brussels-based financial institution co-operative SWIFT, provides a framework for broader bank participation in open-account trade and is a starting point for banks to agree on a data format and standardisation that permits automated data matching with little or no manual intervention. The TSU provides bank and bank-neutral benefits, where buyer and seller data regarding a particular order can be matched at the purchase order stage, demonstrating that both parties have clarity regarding the order content and at the shipment stage.

The TSU is a vehicle that offers enhanced efficiency in supply-chain management, which enables a client to continue using their bank’s trade platforms, rather than adopt another solution.

The Bank Payment Obligation (BPO) introduced by SWIFT in 2009 represents an irrevocable obligation by a buyer’s bank to pay a specified amount to a seller’s (beneficiary) bank. Early in a transaction lifecycle, the BPO and the TSU together help to support participating banks that wish to offer value-added services and alternative forms of financing, including the following:

• Improved working capital management
• Post-shipment financing
• Vendor performance management
• Proactive management of foreign exchange risks
• Payment reconciliation
• Pre-shipment financing

The TSU improves the interoperability of banks and, with the development of the BPO, may usher in a new era of correspondent banking in the open account space. For example, a third bank may guarantee a BPO obligor Bank’s payment, much as it would when confirming a letter of credit. There may be opportunities for shared and, possibly, syndicated financing between a buyer’s and a seller’s bank.

Common guidelines required

Banks are generally looking to the International Chamber of Commerce (ICC) for BPO validation. The ICC’s endorsement of BPO by creation and implementation of a uniform set of Rules would help the adoption of a common set of guidelines and dispute resolution that would make the BPO a viable alternative to unsupported open-account trading, providing certainty regarding interpretation and enforceability, as well as a high degree of predictability for both sellers and buyers. It is also essential that the BPO rules are ISO 20022-compliant, so that they might provide even greater certainty about, and stimulate confidence in, the BPO.

Simplifying global information management

The first BPO transaction was conducted by a Chinese bank in April 2010. The bank has since used BPOs to foster domestic inter-bank trade, while the TSU’s local language capabilities are supporting input and transmission, and matching information in double-byte characters. Banks plan to use BPOs in support of pre-shipment and post-shipment financing.

I predict a broader adoption of TSU and BPO in the coming 12 to 24 months, partly because SWIFT is recognised as a trusted and respected provider for banks worldwide and partly because of the involvement of the ICC. Once firms understand how BPOs can help establish buyer credit, reduce supplier fraud and streamline transactions, the system should be adopted by an increasing number of firms.