Given the rapid pace of digital transformation, it is often surprising to learn how many critical industries and services remain behind the curve, relying on manual processes and large-scale paper documentation. Global supply chain disruption resulting from the COVID-19 pandemic has highlighted that international trade finance is one such industry.
International trade finance remains mired in an avalanche of paper, a plethora of conflicting national regulations and processes, and systems that do not communicate well with each other. These burdens, coupled with the industry’s failure to adapt quickly to more modern methods of analyzing credit eligibility, hit medium, small, and microenterprises (MSMEs) particularly hard. As MSMEs account for a large part of total global trade and are the largest employers worldwide, it is far past time for the industry to make changes that provide greater and simpler access.
This article reviews digital transformation efforts in global trade finance and considers the prospects for digitization and automation in the coming years.
The state of digitalization in global trade finance
After a drastic dip in 2020 as COVID-19 shut down countries worldwide, the international flow of goods rebounded strongly in 2021, and significant growth is expected to continue in 2022. And, according to the World Trade Organization, 80 to 90% of this flow is dependent on trade finance.
Unfortunately, trade finance is heavily document-dependent at every stage, and the burden of document preparation is only exacerbated by the need to verify and process documents along the way. In addition to being environmentally questionable in an era of extreme sensitivity to climate change, the paper-intensive processes underlying traditional trade finance are inefficient and create unnecessary access barriers.
It is somewhat surprising how far behind trade finance remains, given the advances in automation of many other financial processes and the benefits of digitalization. For example, automating invoicing and payment processing can lead to 15.4% more invoices getting paid on time, which is crucial for business success.
Despite the availability of tools and systems that can easily facilitate the automation of current manual processes, trade finance participants, especially banks and financial institutions, remain behind the curve.
The ICC’s annual report on global trade finance presents discouraging data about automation efforts. It reports that 45% of banks still have completely manual document verification processes, more than 30% have fully manual settlement and financing processes, and around 25% rely on manual processes for credit issuance and advising.
The net effect of reliance on traditional methods is that many organizations cannot effectively participate in trade finance systems. Outdated modes of assessing creditworthiness, coupled with overly burdensome documentation demands, combine to deny equal access to many businesses. And this result hinders global trade.
Roadblocks to digitalization
Not surprisingly, many objections to digitalization and standardization are familiar mantras. The cost and inconvenience of implementing new systems have long been favorite protests against digital transformations, and they have raised their heads again for trade finance automation.
However, time and again, it has been shown that companies taking this “moving forward is too difficult” approach don’t maintain their position in the industry; instead, they quickly fall behind their competitors. Indeed, the more forward-thinking companies can expect to reap the most important benefit from their investment – increased revenue growth and profits.
A more compelling concern about digitalization is data privacy and security. These concerns are more than relevant in an era where data privacy regulations are becoming more prevalent and more stringent, and the number of cybercriminals is increasing rapidly. But frankly, there is far more opportunity for data loss and misappropriation in paper-based manual systems.
Organizations can apply today’s advanced cybersecurity standards and tools to build robust and secure automated replacements for their existing manual processes. And the application of increasingly improved, artificial intelligence-based analytical tools can help financial institutions eventually make better decisions about extending finance to market participants, opening access to more organizations, and expanding both global trade and the finance market.
The International Commerce Commission digitalization plan
Recognizing the lack of progress on digitalization of international trade finance systems and the damaging effects on MSMEs, the ICC established a working group to build a new trade finance architecture. Working with McKinsey and Fung Business Intelligence, the ICC Advisory Group on Trade Finance put together a three-phase, ten-year trade finance modernization plan, which it published in late 2021.
The ICC plan attempts to address several well-recognized issues in global trade finance, including the complexity of transactions, the lack of transparency in trade finance decision-making, and the credit constraints preventing MSMEs from equal access to finance. The plan is highly ambitious and will require cooperation from governments, financial institutions, and trade organizations worldwide. But it can make trade finance simpler, more effective, and more inclusive.
While the details of the plan go far beyond the scope of this article, the plan generally proposes the development of a so-called interoperability layer. This layer is a virtual construct built by harmonizing disparate existing finance standards (specifically concerning data models and APIs), establishing new standards to address gaps in finance regulation, and creating uniform playbooks for global trade participants. Standardized automation playbooks have already achieved success in many other areas, such as closing business sales and increasing data consistency.
Phase 1 lasts 12-18 months and focuses on building buy-in for existing standards, bringing more organizations into a common framework. This phase will also identify areas where standards are lacking and propose options to fill these gaps in coverage.
Phase 2 takes place in 2-3 years. The goal of Phase 2 is to finalize the first round of standards that serve as the basis for the interoperability layer and develop standards and structures for APIs that market participants can use to access trade finance systems. In this phase, the governing body of the plan will push for greater participation, specifically from supply-side participants (i.e., financial institutions).
Phase three, which covers the next seven years, is primarily scale-up and refinement. Based on the previous years’ experience, market participants will work to improve on standards and drive usage of trade finance playbooks. Importantly, however, phase three is where architecture truly gets involved, with the launch of common systems that participants can access directly or via API.
Harmonization of laws and regulations has had varying levels of effectiveness in fields ranging from international trade to intellectual property to employment and human rights. It remains to be seen if the ICC proposal can effectively overcome the inertia that has so far gripped the trade finance industry. But if not the ICC proposal, then other digitization efforts must take place to facilitate supply chain 4.0.
Conclusion
The COVID-19 pandemic has put the global supply chain in the spotlight, unfortunately in a less than positive way. But as the world looks at how to resolve supply problems, global trade finance players have the perfect opportunity to revisit their processes and how they can facilitate international trade. As with so many other industries, the obvious answer is automation and digitalization. Hopefully, the market will heed this call and start the change sooner rather than later.
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