RISK MANAGEMENT | 21 JULY 2022

Trade Enablement’s
Silver Bullet

Absa-CIB-Author

Riaan Louw

Head Unfunded Wholesale
Trade Finance

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Why Letters of Credit remain the safest, surest way to connect buyers and sellers in international trade transactions.

International trade transactions are simple – exporters sell something and expect to be paid on time in an acceptable currency, while importers buy something and expect to receive what they pay for on time. At least, international trade is simple in theory. In the real world, both buyers and seller take a world of risk – whether they have established relationships, or especially where they embark on a new business relationship for the first time.

A mechanism is required to facilitate trust between traders, while also solving the problem of distance, time-zones, and disparity of laws and regulations in their respective jurisdictions, and which consider the political and sovereign risks of the countries involved in the transaction value chain. For all parties involved in the transaction ecosystem, this trust is vested in access to accurate information – primarily evidenced in documentation such as commercial invoices, packing lists, shipping documents, certificates or origin, quality and quantity certificates and insurance certificates – through the lifecycle of a trade transaction.

Blockchain, which aims to create this transparency through its distributed ledger system, may seem like the obvious solution. “However, while the technology itself has been proven many times over in many industries, blockchain as a short- to medium-term alternative to traditional Letters of Credit requires a lot of evolution to truly enable international trade transactions,” says Riaan Louw, Head of Unfunded Wholesale Trade Finance at Absa Bank Ltd.

Enabling the relationship between the buyer and seller

The best solution, Louw says, remains a Letter of Credit. “LCs have evolved over hundreds of years, and are widely recognised throughout the global international trade value chain, with continuous updates in globally accepted governing rules (UCP600 and Incoterms®), SWIFT standards as well technological advancements such as digital channels which connect clients with their banks,” he explains. “A LC solves the fundamental problem of trust between trading partners, where you have a seller and buyer who either don’t know each other, or where geographical distance means they cannot do business as they would domestically.”

“By using an LC, the seller moves credit risk from the buyer to the buyer’s bank, or their own bank when the instrument is confirmed, where the banks provide a committed and irrevocable guarantee of payment when the seller performs as contracted with the buyer. The LC also allows for refinancing and discounting, which can create a win-win cash-flow position for both parties.”

Louw further highlights that, “The buyer, meanwhile, is similarly represented by all banks in the LC value chain, who take responsibility of ensuring that the documents the seller has presented evidence performance, i.e., that the contracted supply terms have been fulfilled and that the goods that were ordered have been packaged correctly, have been shipped, are of the right quality, quantity and origin, and have been adequately insured, amongst other things.”

“With an LC, the seller is in a much stronger position to get paid when they perform, and the buyer is more assured of receiving the goods they expect and which they are paying for,” Louw says. “With the banks intermediating the transaction based on common and globally standardized rules, the risk of either the buyer and seller losing control of the goods and the money at the same time can be largely eliminated.”

Added to that, banks are bound by Know-Your-Client, Trade Based Money Laundering, Financial Crime and Sanctions regulations, local and international laws, Central Bank exchange controls, as well as financial reporting standards, to name a few, and are required to ensure transactions are recorded and reported, legitimate and legal and is not being used to finance terrorism or facilitate money laundering. “Current blockchain solutions lacks a number of, if not most of, those safeguards at this stage,” he says.

Enabling innovation

Louw emphasises that he is very excited about the rate of innovation and the possibilities around digitising trade. “In my 26 years in international banking, the past few years have seen the most innovative changes to take traditional and established instruments, such as LCs, to new frontiers,” he says. “However, we are honest in our conversations with clients and other stakeholders on our views that blockchain aimed at revolutionising these instruments will take time to develop, become scalable and available at a commercial level.

“In parallel, we are continuously building partnerships with correspondent banks and DFIs, refining and enhancing our current products, services and processes to enable our clients’ international trade, bring efficiency and cost saving as well as access to funding to them,” he adds. “Our most recent innovation, Trade Management Online, is an award-winning digital solution for our trade clients.”

Ultimately, Louw concludes, LCs are here to stay. “In their current form they provide us with time to collaborate with all players in the international trade ecosystem to ensure blockchain, or potentially completely new cloud based alternative digital solutions reaches their potential to become the trade enablement silver bullet they have the potential to be,” he says.

Absa-CIB-Author
Riaan Louw

Head Unfunded Wholesale Trade Finance

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