The world has taken a step closer to a paperless trade system with the announcement that blockchain could be applied to letters of credit (LCs).
HSBC, Bank of America Merrill Lynch and the Infocomm Development Authority of Singapore (IDA) have developed a prototype solution, built on blockchain technology, which could simplify trade processes.
The technology mirrors a paper-intensive LC transaction. It does this by sharing information between exporters, importers - and their banks - on a private blockchain. Firms can then process their trade transaction automatically, through a series of digital smart contracts. This system increases visibility by sending prompting notifications to all parties as the transaction moves from application, through to completion. As Vivek Ramachandran, HSBC’s Global Head of Product explains: “Many people are talking about the theory of blockchain, but for the first time we can start to see how this technology might be used to solve the real world challenges our customers face.”
LCs are an important part of the trade system because they mitigate risk. Last year this type of financing supported over USD2 trillion of trade.
However, LCs are based on 20th century technology, not 21st. They are essentially a bank provided guarantee that a seller will receive payment from a buyer, once certain conditions are met. For instance, once the seller provides documents which prove the buyer’s goods have been shipped.
LCs reduce risk and provide assurance to sellers, buyers and their banks. However, they are also time and labour intensive, because the process involves multiple documents and checks.
The blockchain prototype shows the potential for streamlining manual processes, improving security and increasing convenience. The consortium now plans to test the concept’s commercial application with selected partners such as corporates and shippers.
“We have a valid proof of concept,” says Vivek “but much more work needs to be done to commercialise the idea. However, it is still an exciting breakthrough.
“This work could eventually lead to the conversion of a paper-based financial instrument to a digital one, with all the resulting benefits for companies conducting global trade."
The consortium used the Linux Foundation open source Hyperledger Project blockchain fabric, the development of which was supported by IBM Research and IBM Global Business Services.
How it works:
Step 1: Importer creates an LC application for the Importer Bank to review and stores it on the Blockchain.
Step 2: Importer Bank receives notification to review the LC and can then approve or reject it based on the data provided. Once checked and approved, access is then provided to the Exporter Bank automatically for approval.
Step 3: Exporter Bank approves or rejects the LC. Once approved, the Exporter is able to view the LC requirements and is prompted to view through the application.
Step 4: Exporter completes the shipment, adds invoice and export application data and attaches a photo image of any other required documents. Once validated, these documents are stored on the Blockchain.
Step 5: Exporter Bank approves or rejects the application and documents.
Step 6: Importer Bank reviews the data and images against the LC requirements, marking any discrepancies for review by the Importer. When approved, the LC goes straight to completed status or is sent to the Importer for settlement.
Step 7: If required due to a discrepancy, the Importer can review the export documents and approve or reject them.
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