Blockchain Experiment Could Change Trade Finance

When the Marie Schulte rounds the breakwater off the Chinese port of Qingdao in early November, bankers on two continents will be watching anxiously.

In particular, they'll be focused on 88 bales of cotton worth approximately $35,000 that the container vessel is carrying — not because of the value of the goods, but because of the technology attached to the shipment.

Unloading the goods at the end of their 7,000-mile journey from Houston will mark the final stage of an experiment by Commonwealth Bank of Australia, Wells Fargo & Co. and the trading firm Brighann Cotton to prove for the first time that the combination of much-hyped technologies — blockchain and smart contracts — can deliver real-world benefits.

As port staff scan the bales, an update to an electronic contract will be triggered, transferring ownership of the goods and authorizing the release of payment. The deceptively simple sounding process is only possible because digital-ledger technology encrypts and stores the parameters of the contract, ensuring all parties are working off the same synchronized version, which cannot be unilaterally altered or tampered with.

This assurance allows the various phases of the transaction to be coded into the smart contract, and triggered automatically when certain conditions are met, without the need for a long-winded paper trail and human authorization. The experiment offers a glimpse into how transactions might one day be managed in the $4 trillion trade-finance industry, a global business that's been in the spotlight in recent years owing to high-profile fraud cases.

“This is a truly innovative step,” said Scott Farrell, a Sydney-based partner at law firm King & Wood Mallesons who sits on the Australian government's financial technology advisory body. “This experiment turns up the dial,” he said in a telephone interview.

Fraud Risk

While other banks have researched blockchain solutions for trade finance, Commonwealth Bank and Wells Fargo appear to be the only ones to publicly announce a real-world transaction for one of the most cumbersome processes in global finance. Reams of paper, faxed statements and multiple contracts typically follow the movement of goods around the world through the hands of exporters, shipping companies and importers — and all of these must be kept synchronized.

As well as the risk of human error, the process is also highly vulnerable to fraud. Qingdao, where the ship will dock, was at the center of a multi-billion dollar scam in 2014. The Chinese government discovered that firms were taking advantage of inefficiencies in the paper-based system to use the same stockpile of metals to secure multiple loans.

“Trade finance is one the most clunky processes in business,” Michael Eidel, head of transactions at Commonwealth Bank, said in an interview at the bank's office in Sydney. “It is ripe for disruption.”

It could take a while before the technology takes off and transforms trade finance. The “scalability and interoperability of different blockchains” is still something that needs to be further explored, Eidel said. Chris Lewis, Wells Fargo's head of international trade services, said “significant regulatory, legal and other concerns” need to be addressed.

For future iterations of the technology, Commonwealth Bank is looking at widening the number of participants to include insurance companies as well as opening up to other banks and clients, Eidel said, declining to give any timeframe for rollout.

CBA and Wells Fargo, which is based in San Francisco, aren't the only banks actively experimenting in this area. Globally, Greenwich Associates estimated that the annual budget for blockchain initiatives hit $1 billion this year.

For a snapshot of the blockchain initiatives some Asian banks are exploring, click here.

The two are among the more than 50 global financial firms affiliated with the R3 consortium, which is developing blockchain applications for use in financial services. Barclays Plc, a member of the consortium, earlier this year said it had been testing the use of an R3 distributed ledger in developing smart-contract templates that would simplify legal documentation.

Two other members, Bank of America Corp. and HSBC Holdings Plc, are currently working with the Singapore government on a distributed ledger that enables paperless letters of credit for trade finance.

The number of different banks working on blockchain initiatives underscores the challenge for the widespread adoption of any new fintech application: getting players in a highly competitive and secretive industry to agree on common standards in using the same platforms.

“Absolutely trade finance is going to move this way,” Jonathan Perkinson, who leads Deloitte's payment advisory practice in Sydney and is part of the professional services firm's global blockchain initiative. “Really the question becomes how quickly the sector can align to one solution.”

From: Bloomberg News

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