Supply chain disruptions, lack of traceability, and sustainability issues plague the trade finance industry. How does digital transformation help?

Global trade is buffeted by major disruptions to supply chains. Meanwhile, lack of control and visibility over cross-border trade has been debilitating and financially devastating for businesses.

According to a policy brief by the Asian Development Bank, digitalization of trade would be transformational to the global economy and would make the world more secure through greater transparency and more robust global supply chains.

Would a blockchain-enabled digital cross-border platform become an effective tool to increase visibility across the entire supply chain? With shared and unalterable records of all transactions, would this enhance the resiliency of the supply chain, providing businesses with the ability to react quickly to unforeseen circumstances?

DigiconAsia put forth these questions and more to Farooq Siddiqi, CEO, #dltledgers.

What are the top challenges in trade finance?

Farooq: From lengthy and inefficient processes, to differing regulations and the heightened risk of cyber attacks, the state of trade finance today is fraught with challenges.

Many trade finance processes still involve large amounts of manual tasks and physical paperwork across multiple intermediaries. We have found that a cross-border trade finance transaction requires up to 240 copies of 36 original documents from as many as 24 parties.

These processes are highly inefficient and take months to complete. Worse, the workflows in these processes are prone to costly errors and delays.

Compounding this challenge is the inconsistency of government processes across borders. This adds a second layer of complexity to trade finance providers operating on a global scale.

As a result, leveraging technologies that ensure business agility, transparency and security is critical. From automation to the integration of artificial intelligence (AI) and machine learning (ML) into credit risk assessment tools and processes.

Farooq Siddiqi, CEO, #dltledgers

What are some digital transformation trends driving the future of trade finance in 2023?

Farooq: Blockchain, automation, AI and ML are some technology trends that are already beginning to significantly transform trade finance.

Automation, whether through smart contracts or the elimination of highly-repetitive and manual tasks, is the key to reducing turnaround times of trade finance transactions. In fact, we have documented an instance where automation helped reduce trade finance transaction times from six weeks to less than two hours.

This is done through two ways. First, automating and digitalizing records and other documents removes the need for physical paperwork and the time-consuming task of producing, reproducing, transmitting, and storing them.

Second, automated tasks are executed faster than those performed manually, while reducing the likelihood of costly errors. This, in turn, decreases the incidence of delayed transactions and additional expenses incurred.

Blockchain technology supports the digitalization of paper documents by providing a secure repository for it. Data stored within a blockchain is considered immutable because it is next to impossible to gain unauthorized access to it, much less alter the records.

Meanwhile, AI and ML can be integrated into credit risk assessment processes to improve transactional speed, accuracy, and efficiency. Algorithms can be trained on millions of data points available in the cloud to assess credit requests faster.

Do you see the rise of enterprise blockchain, and how would it impact trade finance?

Farooq: Blockchain technology is often, and unfairly, limited in the public consciousness to cryptocurrencies and NFTs. But the technology has the potential to revolutionize entire industries, and enterprise-level blockchain implementation in trade finance is an example of that.

For one, the very nature of distributed ledger systems makes any stored information immutable. On top of using cryptographic technology, blocks of data interact with each other in a way that makes any unauthorized alteration of stored records easily detectable. This gives sectors such as financial institutions the confidence that the digital documents they are using are accurate.

At the same time, all information in a distributed ledger is visible to all participants. Combined with the immutability of stored information within a blockchain, this ensures that no records are lost, misplaced, or even altered. Costly errors and delays are reduced, while attempts at fraud are deterred.

Blockchain technology is also the foundation for smart contracts, another Web3 technology which can automate the execution of entire transactions, including the processing of records, and potentially revolutionize trade finance. By utilizing automation, smart contracts can execute the processing of documents and fund transfers once certain pre-set conditions are met without any manual input from humans.

Where does Web3 and the metaverse fit in the trade finance industry’s digital transformation journey?

Farooq: Web3 has the potential to disrupt entire industries. According to McKinsey, Web3’s ability to do so largely rests on concepts such as smart contracts, digital assets, and the open data structures of blockchain technology.

A game-changing result of Web3 in trade finance is “disintermediation”, or the removal of intermediaries across an entire trade finance transaction. 

First, the open data structures of a blockchain, coupled with its near-unbreakable encryption of stored data, makes the former an autonomous alternative to traditional financial institutions in terms of being a central ledger. Members of any particular blockchain have full visibility over completed transactions, but not necessarily the actual details of said transactions, providing a deterrent to fraud and hacking.

Second, applying smart contracts, along with AI and ML, creates an automated decision engine for executing entire transactions. Smart contracts use the fulfillment of certain conditions, such as the filing of documents to indicate a fund transfer or a successful transit of goods, to detect when it should execute the next step of a transaction and then transmit the necessary funds or documents within its particular blockchain.

Last but not least, digital assets can be used by depositors and other blockchain participants to represent real-life assets within the ledger. This makes it easier for the movement of funds within a transaction, with the blockchain serving as the foundational infrastructure, while the smart contract ensures continuing movement within.

How can digitalization help promote inclusive and sustainable growth in the Asia Pacific region?

Farooq: SMEs play an important role in inclusive growth as they collectively account for a considerable share of the GDP and employment in any particular economy. For example, SMEs in China generate at least 60 percent of their GDP and 80 percent of all employment.

Meanwhile, Japan and India’s SMEs are responsible for 50 percent and 33 percent of their respective GDPs, while respectively accounting for 70 percent and 40 percent of national employment. In Southeast Asia, SMEs’ share in employment range from 96.9 percent in Indonesia to 42.3 percent in Vietnam.

Despite the significant role played by SMEs in the economy, especially in the Asia Pacific (APAC) region, they are often unable to access trade finance services which would enable them to participate in global supply chains and discover new markets overseas. According to the World Economic Forum (WEF), 40 percent of the USD 1.7 trillion trade finance gap comes from the APAC region.

Among the structural obstacles faced by SMEs in accessing trade finance, according to the WEF, are costly regulatory requirements such as know-your-customer and anti-money laundering regulations, the lack of collateral, and cumbersome documentation requirements.

Digitalization, particularly of financial technology, has the potential to reduce transaction costs for both trade finance providers and borrowers. Shifting trade finance processes from one that is largely paper-based to one where records are digital reduces the costs of screening borrowers and verifying information, while also reducing waste. It can also encourage the growth of alternative sources of finance, such as fintech firms, which can drive sustainable financing.

By expanding access to trade finance, SMEs gain the scalability to compete, while also normalizing new, ‘greener’ practices. In turn, this will equip economies in the region to weather the challenges of a potential downturn.