Digitization in Trade Finance: Convenience or Risk Mitigation? Both.
June 1, 2021
By Sri Vasireddy and John Galani
Sending goods from one country to another on a large container ship is by definition risky. Cargo could be stolen. Ships could have problems or be delayed. Signed paperwork thought to be legitimate could be fraudulent. Language barriers and jurisdictions could get tricky. The risk inherent in trade finance is why banks and investors engage in it: yields can be quite good, broken down into credit and operational risks.
The need for digitization in trade finance is obvious. But digitization is about much more than convenience; in our world it’s also about risk mitigation targeting the operational risk level.
Using the analogy of trading a share of stock online, retail investors can now do so on their smartphone with no commissions and instant confirmations. Thirty years ago, such trades took place over the phone, were recorded on paper, and took three business days to cash settle. With this process came greater execution risk, high fees and low transparency. Investors today would not stand for this. But some elements of trade finance still resemble the above.
Below are three areas of our business where we see digitization transforming the landscape.
KYC, AML and Onboarding Protocols
Know Your Customer (KYC) and Anti-Money Laundering (AML) protocols are the foundation of risk management in trade finance, but are notoriously resource intensive. Digitally native platforms now are able to tap into companies via Application Programming Interfaces (APIs) that specialize in performing these functions, meaning that customer onboarding is easier and more dependable than ever.
Companies in our space with legacy systems have to reinvent the wheel every time new regulatory and capital requirements come about, compounding existing burdens. Digitizing these processes not only shortens onboarding times dramatically, but also formats relevant data that conform to industry standards and presents it to potential funders (with the consent of borrowers) instantaneously.
But digitization will not automate risk management entirely. Just because KYC/AML processes are simpler does not mean that domain knowledge and human judgment go out the window. These qualitative assessments are especially important in emerging markets, where awareness of local rules and business dynamics are paramount.
Tamper Resistant Contracts
One foundation of the Kratos platform is the ability to log transaction entries into ledgers that are immutable and tamper resistant. In theory, such a protocol creates a level of trust and transparency for which there is no going back to analog practices and increased risk of trade failure.
Forming the consortiums to use such a platform to its full potential is still a work in progress. One element inherent in blockchain-based systems that will help cement these communities of traders, lenders and suppliers is the smart contract.
Again using a consumer analogy, when someone orders a product online, the ecommerce provider keeps a longitudinal record from when the order is placed to when the package arrives at your door, documenting all the stops along the way. Similar levels of transparency and accountability are being implemented in trade finance right now.
For example, buyers of agricultural commodities may want to maintain a certain temperature in a shipping container during its journey. With Internet-of-Things (IoT) technologies, it is possible to connect sensors in the container to the cloud and have the desired temperature be tracked and recorded throughout the shipment. Those recordings can then be stored in a tamper resistant fashion on a blockchain network to help enforce a contract.
The first iteration of any digital platform is more focused on a Minimum Viable Product (MVP) to ensure key capabilities and iron out any kinks. Great companies are always updating and improving their customer experience based on feedback.
But making major changes to a platform to incorporate this feedback often takes months of work and robust testing before going live. Transitioning one platform to another is fraught with execution risk if not handled properly. Once the building blocks are in place the pace of change standardizes from major revamps to continuous enhancements, as can be seen from Operating Systems and Microsoft Office for example.
As you focus on the chain of financing trade, the individual links come into focus. Given the complexity and risks inherent in trade finance – supply, geopolitical, weather, credit, logistics – we decided early on to tackle one link at a time with our various services. This reduces the risk of disrupting the customer experience when making visual and functional changes to the platform. By keeping services separate, we ensure that changes to one module does not disrupt the functionalities of another.
We understand that digitizing our industry is a dynamic undertaking across each and every facet of multiple sectors, participants and industry. It will remain a "work in progress" for many years. Thankfully there are precedents we and our valued partners can look to in order to help achieve our business and growth goals.
Sri Vasireddy was recently named the Chief Technology Officer at Triterras.
John Galani is the Chief Operating Officer at Triterras and oversees the firm’s business development team, which recently announced an expansion.