Monthly TFG & ICC DSI Column - May 2024

Welcome to the monthly TFG & ICC DSI Monthly Column! Check back here on the 3rd Wednesday of every month to hear from Pamela Mar , Managing Director, ICC Digital Standards Initiative (ICC DSI) and get the latest insights into digital trade!

Spotting the innovation frontier for digital trade and finance

The annual BIS Innovation Summit offers a glimpse into how technology might transform finance.?

It brings together three key groups:

Central bankers, who are responsible for managing risk and growth in the current financial system.

Innovators, technologists, and disruptors who seek to introduce new methods and approaches.

Large financial institutions, which benefit from the existing system but also recognise the potential for technology to enhance their operations and the movement of money in the modern economy.

This year focused largely on what BIS chief Agustin Carstens called “small steps and gigantic leaps”. Small steps are the innovations which introduce incremental changes, tweaks, and upgrades to existing systems; they are low risk, but deliver returns steadily within today’s operating framework.??

Gigantic leaps drive a fundamental rethinking of the entire system in order to transform it for the better, to achieve new goals that become reachable, most commonly due to the rise of new technologies.??

Tokenisation: The next big step?

The summit offered insights into three core components of BIS innovation hub’s program: central bank digital currencies (CBDC), tokenisation and smart contracts, and AI.???

All three have the potential to both disrupt and drive the digitalisation of trade and finance. Of these three, the first is largely under the purview of central bankers, with the private sector largely following their lead. By comparison, the latter two offer excellent grounds for experimenting with different applications, with the race clearly on to pilot, develop and chart the path to scale.??

Tokenisation and smart contracts are a little further ahead than AI, and we can already see how might be able to transform digital trade and finance.??

About a decade after blockchain burst into mainstream business media as the killer app for the supply chain of the future, today tokenisation and smart contracts have the potential to realise this promise.???

Because tokens carry unique identifiers for assets and owners, they can eliminate the settlement risks created by the need to check, match and clear in any payment situation when paired with smart contracts.

A supplier receives payment a certain number of days after the buyer issues the payment instruction due to several necessary steps. Data must be checked, identities must be matched, and as the payment travels across the globe, delays occur at each stage. Some of these delays are caused by paper processing.?

Even when instructions are electronic, human intervention is required to verify all details. As noted by Carstens, these delays incur both monetary and human costs.

By applying tokenisation tied to a smart contract, the transaction can be automated on the basis that certain conditions have been fulfilled. Because the token carries unique but secure data attributes, it can be passed along any number of parties without being connected, and without divulging sensitive information.

Tokenisation can thus not only solve settlement and payment delays, but also helpg financing in multi-tier supply chains, where a buyer may not know a supplier or processor several tiers upstream and for whom financing is critical for executing their part of the supply chain.??

Today, that upstream supplier might fall into the $2.5 trillion trade finance gap, and have to resort to money lenders with their costly rates, in order to fulfil the order.

Case studies: Practical application

The application of tokenisation to the trade finance supply chain has already been experimented with the BIS Innovation Hub Hong Kong through its Project Dynamo, which used tokens and smart contracts to finance SMEs upstream in the supply chain.??

Payments were triggered by the creation of the electronic bill of lading (eBL), to denote the fulfilment of an order. The Global Shipping Business Network working with ANT group is going one step further, where they have combined the concept of eBL with tokenised deposit through Project Ensemble, spearheaded by the Hong Kong Monetary Authority (HKMA).?

This is the first step towards using blockchain to merge the transfer of title for goods and the corresponding cross-border financial payments between various parties involved in global trade. Trusted trade data (logistics and financial) can also serve as the basis to support trade finance and help bridge the trade finance gap for SMEs.

The trade finance supply chain has long been saddled with many intermediaries: parties who absorb the risk of matching and clearing, money lenders who step in because trade finance does not reach upstream, or local lenders who offer bridge financing for suppliers who might be paid only in delay.??

There are also intermediaries within banks, — staff involved in checking, legal and compliance officers who stand guard over SOPs to manage the risk, and so on.??

Panelists at the BIS event noted that scaling these new models for finance will deliver a more streamlined financial system, with fewer intermediaries, fewer layers, and more transparency.??

In other words, there will be losers, i.e. those who make money from the inefficiencies present today. On a macro level, their elimination means more resources going towards real needs in the real economy, like the millions of SMEs who today cannot find financing.??

On the micro level, expect every change to be fought by vested interests whose rents are being jeopardised.

Politics aside, it does appear that the use of tokenisation and smart contracts when applied to eBLs is just a small sliver of the opportunity present in the digitalisation of trade, to drive a better way to finance needs in the world.?

Our task is twofold: one, drive the use of eBLs so that that these financing models can be scaled; and two, discover more of these opportunities at every point of the digital supply chain.