The Principle of Independence in Trade Finance In As Zero Trust environment: an amalgamation of Blockchain, AI and IoT

Venu Borra Jose Gonzalez Bishop Sally Bryan Campos DTG USA CIFI Labs

Introduction

Welcome to our article, actually a series of articles, As authors, we embark on a journey to delve deep into the evolving landscape of Trade and Supply Chain Finance, especially through the prism of groundbreaking technologies like blockchain, the Internet of Things (IoT), and Artificial Intelligence (AI) within a Zero Trust environment.

The Principle of Independence is a cornerstone concept and a foundational one in the realm of trade finance, playing a critical role in facilitating international trade. This principle asserts that the financial instruments and obligations used in trade finance are distinct and separate from the underlying contracts for the sale of goods or services.

Our objective is to explore and expand the Principle of Independence in trade finance. Traditionally, this principle has been pivotal in ensuring that the financing aspect remains unaffected by underlying commercial disputes or performance mishaps. Our opinion is that, in today's digitized and interconnected world, this principle shall undergo a transformation, influenced significantly by emerging technologies.

To whom we address this article

The series targets two main audiences: Trade Finance experts who are keen on digitalization and innovation, and IT developers aspiring to create cutting-edge solutions in this domain.

For Trade Finance professionals, we aim to provide comprehensive insights into how these technologies can revolutionize traditional practices, offering enhanced security, transparency, and efficiency. We'll be dissecting as much as we can, complex concepts and presenting them in a manner that is both enlightening and practical for implementation.

For the IT developers, our series is a clarion call to action. We present a unique opportunity to understand the nuanced needs of Trade Finance and develop solutions that not only address these needs but also push the boundaries of what's currently possible. Our articles will serve as a bridge between the theoretical underpinnings of blockchain, AI, and IoT and their practical, real-world applications in Trade Finance.

We will demystify key concepts and break down complex ideas such as Zero Trust model, blockchain’s immutable ledger, IoT's data-gathering prowess, and AI's analytical capabilities. We will also showcase real-world applications and provide tangible examples of how these technologies are being integrated into Trade Finance.

Lastly, we will highlight challenges and solutions, address potential hurdles in adopting these technologies and propose viable solutions, with the goal to foster a collaborative dialogue and encourage interaction and idea exchange between finance professionals and technologists.

Let’s familiarize the technical terms

What is a Zero trust approach?

The Zero Trust approach, which has gained significant traction in the realm of cybersecurity, operates on a simple yet fundamental principle: "never trust, always verify." This approach marks a departure from traditional network security models that operate on the assumption that everything inside an organization's network should be trusted.

The key concept is that there is no Implicit Trust. Unlike conventional security models that assume internal network traffic is safe, Zero Trust treats all traffic as potentially hostile. This includes traffic and users, regardless of their location (inside or outside the network).

This requires strict identity verification for every person and device trying to access resources on a private network. This is often implemented through multi factor authentication.

Under Zero Trust, the access to resources is limited to what is necessary for users to perform their job functions. Users are granted the minimum level of access, or privileges, needed to do their job. Once a task is complete, access is revoked.

This involves dividing security perimeters into small zones to maintain separate access for separate parts of the network. A person or program with access to one of these zones cannot access any other zones without separate authorization.

Key Principles of Zero Trust can be easily enlisted:

1. Verify Explicitly: Every access request, regardless of where it originates, must be rigorously verified using an array of dynamic data points, including user identity, device, location, and other variables.
2. Least Privilege Access: Users should have the minimum access necessary to perform their duties, reducing the risk of unauthorized access to sensitive data.
3. Micro-Segmentation: This involves dividing security perimeters into small zones to maintain separate access for separate parts of the network. If one zone is compromised, the others remain secure.

The network and its resources are continually monitored and assessed to ensure compliance with security policies. This helps in detecting and responding to threats in real time. By verifying each request as if it originates from an open network, Zero Trust limits the chance of unauthorized access or data breaches.

As a result, there is a reduced attack surface. By implementing least privilege access, the potential impact of attacks is significantly reduced.

Zero Trust is well-suited for contemporary IT environments, including cloud-based applications and mobile workforces. It helps organizations meet stringent regulatory requirements by providing robust data protection and privacy.

Blockchain overview

Blockchain technology has emerged as a transformative tool in the realm of trade. Its core attributes of decentralization, transparency, security, and immutability make it particularly appealing for various applications within trade and supply chain management.

This technology allows for the tracking of goods as they move through the supply chain. Each transaction or movement of goods is recorded as a block on the chain, which can be viewed by all participants. This greatly enhances transparency and traceability, helping to verify the authenticity of products and reducing the likelihood of fraud.

The decentralized nature of blockchain ensures that data recorded on the ledger is secure and immutable. Once a transaction is recorded, it cannot be altered or deleted, which provides a tamper-proof record of the entire transaction history.

By digitizing and automating trade processes, blockchain can significantly reduce paperwork, streamline operations, and lower costs associated with trade documentation and administrative procedures. It eliminates the need for intermediaries, which further reduces costs and expedites transactions.

These are self-executing contracts with the terms of the agreement directly written into code. In trade, smart contracts can automatically execute actions (like payments) when certain conditions are met, reducing the need for intermediaries and speeding up transactions.

Blockchain can simplify and secure cross-border trade processes. It can help in complying with regulatory requirements, reducing trade barriers, and improving customs clearance processes.

In the context of trade and trade finance, blockchain features several applications:

• Supply Chain Management: Blockchain provides real-time tracking of goods, from the manufacturer to the end consumer, enhancing supply chain transparency and efficiency.
• Trade Finance: It offers a more secure and efficient way to handle trade finance transactions, including letters of credit, by reducing paperwork and the risk of fraud.
• Provenance Tracking: Blockchain helps in verifying the origin and authenticity of products, which is particularly useful in sectors like food, luxury goods, and pharmaceuticals.
• Customs and Compliance: Streamlining the customs processes by providing accurate and tamper-proof records of goods, thus aiding in regulatory compliance.

Blockchain technology can revolutionize the trade industry by making it more transparent, efficient, and secure. While there are challenges to be addressed, the ongoing advancements and increasing adoption of blockchain in trade signify its critical role in shaping the future of global trade operations.

What can Artificial Intelligence offer to Trade-Finance

Artificial Intelligence (AI), with its data-crunching prowess and automation capabilities, is playing a pivotal role in reshaping the landscape of trade finance. Trade finance transactions are well-known for their paper-intensive processes, involving a multitude of documents and data entry. AI steps in to streamline these workflows.

• Customer Service Redefined
• Risk Management Reinvented
• Operational Efficiency

AI can analyze market data, economic indicators, and historical trade information to provide valuable insights into trade trends and emerging opportunities. This enables trade finance professionals to make informed decisions about trade deals, investments, and risk management.

Automation of Complex Processes

AI-powered automation can streamline and optimize complex trade processes, reducing the reliance on manual labor and minimizing human error.

For instance, AI-driven chatbots can handle customer inquiries and order processing, improving customer service and order accuracy.

Supply chain management can benefit from AI's ability to optimize routes, manage inventory, and predict maintenance needs, leading to cost savings and efficiency gains.

Understanding IoT use in Trade Finance

The Internet of things describes devices with sensors, processing ability, software and other technologies that connect and exchange data with other devices and systems over the Internet or other communications networks.

The IoT typically features in international trade in the form of smart devices attached to containers to track the journey of cargo, including location, intrusion, door opening, humidity and temperature, in real time.

Real-time monitoring enhances decision-making by providing accurate and up-to-date information on the supply chain, which is critical for meeting customer demands and ensuring product quality.

IoT devices, when integrated with AI, provide real-time data on trade-related activities. This includes tracking goods in transit, monitoring storage conditions, and managing inventory levels.

For banks, the idea behind implementing IoT is to obtain real-time information about the physical flows they are financing.Inventory finance is just one use case for IoT in trade finance. In a proof of concept in late 2016 involving Commonwealth Bank of Australia, Wells Fargo & Co. and Australian cotton trader Brighann Cotton, IoT sensors were used to trigger the automatic release of funds once the goods arrived at their destination.

IoT will also not be very significant on its own. Only when combined with other technologies such as machine learning and blockchain or cloud-based platforms will the technology have an impact.For instance,AI can analyze IoT-generated data to identify issues or inefficiencies promptly. It can detect temperature variations in storage facilities or track the location of goods in transit.

Dynamic realm of Trade - A complex ecosystem

The intricate web of trade finance presents both opportunities and challenges for businesses and financial institutions. Understanding and addressing the key areas of concern within this complex ecosystem are crucial for sustainable growth and successful transactions.

Regulatory Compliance: The ever-evolving landscape of trade finance regulations demands meticulous attention. Navigating through diverse international and domestic regulatory frameworks, including anti-money laundering (AML) and know your customer (KYC) requirements, is paramount for seamless cross-border transactions.

Risk Management: With the inherent risks associated with global trade, effective risk management becomes a linchpin. From credit and currency risks to political and legal uncertainties, businesses must employ robust strategies to safeguard their interests and ensure financial stability.

Documentary Accuracy: The abundance of trade-related documents poses a challenge, emphasizing the need for accuracy and authenticity. Errors in invoices, bills of lading, or certificates of origin can lead to delays and disputes, underscoring the importance of meticulous documentation practices.

Technological Integration: Embracing technology is inevitable, but its integration must be approached with caution. Balancing the benefits of blockchain, digital platforms, and automation with security concerns and interoperability challenges is a delicate task.

Collaboration and Communication: The multitude of participants in trade finance, including importers, exporters, banks, insurers, and logistics providers, necessitates seamless collaboration and communication. Efficient coordination among these stakeholders is pivotal for successful transactions.

It involves various actors, each playing a specific role:

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Exporter/Seller i.e. the party that sells goods or services. He provides goods/services, prepares and sends commercial invoices, and often requires financial assurance (like a Letter of Credit) that they will be paid upon meeting the terms of the contract.

Importer/Buyer (i.e. the party purchasing goods or services from the exporter.)- He agrees to meet the payment terms set by the exporter, often through various financial instruments like Letters of Credit, and receives the goods or services.

Banks

• Issuing Bank: Typically a bank in the importer's country that issues the Letter of Credit guaranteeing payment to the exporter upon compliance with terms.
• Advising/Confirming Bank: Usually a bank in the exporter's country, advises the Letter of Credit to the exporter and may add its guarantee (confirmation).
• Negotiating Bank: The bank that pays the exporter under the Letter of Credit.
• Reimbursing Bank: Manages the reimbursement to the negotiating bank.

Financial institutions specialized in trade finance who provide short-term finance and other financial services like factoring and forfaiting to facilitate international trade.

Export Credit Agencies (ECAs), i.e. government or quasi-governmental institutions. They offer guarantees and insurance to exporters to promote foreign trade, particularly in challenging markets with higher risks.

Chambers of Commerce that provide support, information, and sometimes documentation (like certificates of origin) to businesses engaged in international trade.

Quality Inspectors i.e. third-party agents who ensure that the goods meet the specified quality and standards as per the contract before shipment.

Warehouse Operators and Storage Providers i.e. logistics service providers offering storage facilities for goods before they are shipped or while in transit.

Freight Forwarders i.e. Logistics experts and providers who arrange for the transportation of goods, handles documentation, and ensures compliance with export and import country regulations.

Transportation Companies i.e. providers of shipping services (sea, air, road, rail). Their function is to transport goods from the seller to the buyer, ensuring safe and timely delivery.

Insurance Companies i.e. providers of trade credit insurance. They protect exporters from the risk of non-payment by foreign buyers, covering political and commercial risks.

Customs Brokers i.e. customs and compliance experts who facilitate the clearance of goods through customs, ensuring that all regulations are met for import/export.

Clearing and Forwarding Agents i.e. specialized logistics service providers. They ssist with the clearing of goods through customs and handle the forwarding of goods to the buyer.

Navigating the Complex Landscape of Trade Finance

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In a traditional, paper-based trade transaction, the interaction among the various actors is a complex and often lengthy process. This is due to the reliance on physical documents and manual processes, which necessitates careful coordination and verification at each step. Here's an overview of how these interactions typically unfold:

Keeping things as simple as possible, we can state that the transaction starts with the exporter (seller) and importer (buyer) agreeing on a trade deal. This involves negotiating terms, including price, quantity, delivery dates, and payment terms. They sign a sales contract that lays out these agreed terms.

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A Common exampe, a Letter of Credit (LC) is used an irrevocable payment commiment. The importer approaches their bank (issuing bank) to issue an LC in favor of the exporter.

The issuing bank sends the LC to the advising bank (usually in the exporter's country), which notifies the exporter.

Upon receipt of the LC, the exporter prepares and ships the goods. He thenthen collects and prepares various shipping documents, including commercial invoices, packing lists, bills of lading (B/L), certificates of origin, and insurance documents.

The exporter submits these documents to their bank (the advising or negotiating bank), which examines them in order to ensure they comply with the LC terms and the sales contract.

The advising/negotiating bank forwards the documents to the issuing bank. The issuing bank checks the documents for compliance. If compliant, the bank makes payment to the negotiating bank, which in turn pays the exporter, then sends them to the importer.

The importer uses the received documents to clear the goods through customs. Once cleared, the importer takes delivery of the goods.

If the payment terms include a deferred payment (e.g., 30 days after receipt of goods), the importer settles the payment as per the agreed terms.

Every step requires careful preparation, verification, and exchange of documents.

Through LCs and other instruments, banks provide a safety net for both parties against non-performance. Physical documents transportation and manual processing lead to longer transaction times and time-consuming

Each document must adhere to international trade laws, customs regulations, and banking norms and the process involves various fees, including banking charges, insurance premiums, and potential costs due to delays.

This means a nuanced understanding of these key areas of concern is indispensable for those navigating the multifaceted landscape of trade finance. By addressing these challenges head-on, businesses and financial institutions can unlock the full potential of international trade while mitigating risks and ensuring compliance in this intricate ecosystem

A new viewpoint - Envisioning a new premise

The synergy of Zero Trust approach powered blockchain, and the Internet of Things (IoT) can significantly enhance Artificial Intelligence (AI) in delivering improved decision-making and efficiency. When these technologies are combined, they create a robust, secure, and intelligent ecosystem that can transform various industries and operational processes.

The new security model offered by a Zero Trust approach, i.e. based on the principle of “never trust, always verify,” ensures that every access request to a network or system is authenticated, authorized, and continuously validated. For AI, this means enhanced security in data processing and decision-making tasks.

Blockchain then provides a decentralized and tamper-proof ledger, ensuring the integrity and traceability of data used by AI systems. This is crucial for AI decision-making, as the quality and reliability of data directly impact the accuracy of AI outcomes.

The integration of Blockchain technology with the Zero Trust model offers a comprehensive solution to securing trade transactions. This combination not only enhances security through decentralization, immutability, and continuous verification but also fosters transparency and trust among trade participants. It reduces the risk of fraud, streamlines operations, ensures compliance, and prepares the trade industry for future security challenges. Together, Blockchain and Zero Trust create a more resilient, efficient, and secure trade environment.

Combining Zero Trust with blockchain can significantly bolster the security of AI systems. AI algorithms can operate on data that is consistently verified and protected against unauthorized access and tampering, leading to more reliable and trustworthy AI-driven decisions.

When it comes to Improving data acquisition and quality, IoT devices collect vast amounts of real-time data from various sources. This data is essential for training and fine-tuning AI algorithms, allowing them to make more accurate and timely decisions.

By storing IoT data on a blockchain, the authenticity and accuracy of this data can be ensured. Blockchain's immutable ledger means that once the data is recorded, it cannot be altered, which is crucial for maintaining the quality of data fed into AI systems.

AI can analyze data from IoT devices to make automated decisions. For instance, in a manufacturing context, AI can predict equipment failures and schedule maintenance, thereby reducing downtime and improving efficiency.

Artificial Intelligence (AI) enhances Zero Trust in trade by enabling smarter, data-driven decision-making. AI algorithms can analyze vast amounts of data to identify potential security threats or anomalous behavior. In trade, AI can automate complex processes, predict market trends, and provide insights for better decision-making, thus reducing human error and increasing efficiency.

In environments where data exchange is crucial, such as in supply chain management, the combination of blockchain and Zero Trust can ensure that data exchanged between different parties is secure and reliable. AI can use this data to optimize supply chain processes, forecast demand, and manage inventory more efficiently.

Integrating Zero Trust with Blockchain, AI, and IoT creates a robust framework for secure and efficient trade. Zero Trust ensures continuous security and verification, Blockchain provides transparency and integrity, AI offers intelligent analysis and automation, and IoT contributes real-time monitoring and data accuracy. Together, these technologies revolutionize the trade landscape, making it more secure, efficient, and trustworthy.

These technologies together transform the trade landscape, making it more secure, efficient, and trustworthy. Businesses that adopt these technologies can gain a competitive edge by making data-driven decisions, improving security, and optimizing their trade processes.

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