Blockchain continues to make inroads into financial services, especially trade finance. This may seem rather remote from the realm of securities finance and capital markets – after all, trade finance is about bricks-and-mortar, factories and warehouses, ships and railroads… not exactly subjects we often talk about. However, there are important parallels here to securities finance and related activities.
International trade finance has many similarities to global capital markets. From the bank perspective, it is a credit-based, risk absorption business in which banks take on interim risk for “unsettled” transactions between trade counterparties; there are numerous agents, brokers and other intermediaries both functionally and economically; there is a web of conflicting regulations, standards and practices across multiple jurisdictions; there are complex legal and contractual performance obligations, in which various parties assume their part of the outstanding risk; there is escrow and collateral, and provisions for performance-based payments; there are fees, rates of interest, currency conversion considerations… According to 2015 WTO statistics, the value of merchandise – over and above services – is US$18 trillion annually, a majority of which is financed by a handful of large international institutions and that roughly corresponds to the rolling global value of outstanding collateralized financing trades.
It’s a big dollar, high risk, operationally intensive and complex business for banks and their customers. Barclays, HSBC and Bank of America amongst others have recently announced successful demonstrations of blockchain in trade finance, and these banks are also major securities finance market participants.
It would be easy to assume that the banks implementing this technology would be focused on the settlement of payments, but this is not the case. As in securities finance, settlement of payments is relatively highly evolved, utilizing many of the same long-standing mechanisms like SWIFT, Fed Wire, etc. The settlement of payments is a very small part of the problem, and while it might benefit from blockchain initiatives like those we’ve recently reported (See Securities Finance Monitor September 8: Blockchain news…), the real trouble spots have to do with the workflow.
Increasingly, banks and other institutions faced with complex workflows are turning to blockchain technology as an efficient solution. In the trade finance space, the complexities include document exchange and processing, and the tracking of the state of the “control points” in the process. The parallels to some of the more paper-based and/or manual processes in securities finance are strong. Examples that come to mind immediately are customer “papering”; credit qualification and credit limit utilization; confirmation of settlement instructions; collateral substitution in repo financing; recalls and buy-ins; and corporate action claims processing.
Banks are finding that blockchain and Distributed Ledger Technology (DLT) are well suited to digitizing paper processes, particularly those that involve multiple touch points and a structured information flow (aka, a Smart Contract). In these applications the touch points become a form of asset, transferred from participant to participant along with the digitized artifacts, as each completes their part of the workflow. The current owner and the current state of the process is known at all times, and the tool allows for the near-instantaneous exchange of the information necessary to move the process along.
The upshot is: some of the more immediate applications of blockchain we may see in collateralized trading markets may have more to do with the exchange of information in structured workflows than with the exchange of assets. Three good applications in this respect would be in the ALD credit approval process; the so-called “ARMS” (Automated Recall Management System); and in the emerging Peer-to-Peer market where the exchange of agreements and credit-related documentation have been identified as key pain points and/or barriers to adoption. All of these procedures are paper and process heavy, and could benefit from more streamlined and smarter workflows.
For more on this, see Finadium’s December 2016 research report, “Practical Applications of Blockchain in Settlements and Securities Finance.”