“Blockchain: the next wave in trade finance”

An Exploration of The Use of Blockchain Technology in Trade Finance

1. Blockchain technology is said to be the next big thing that is set to revolutionize the trade finance industry: The use of blockchain technology in trade finance is said to hold the promise in the elimination of days where transactions relied on voluminous paper documents, resulting in timely and costly processes. It is suggested that Blockchain technology holds the capability to revolutionise the operations of the industry, by introducing secure and paperless transactions. However, can the blockchain technology really deliver what it promises?

I. The promised land?

2. Today, trade finance operations are still largely dependent on paper documents (such as bills of lading, letters of credit etc) and manually intensive review processes. This is notwithstanding the rapid technological developments seen in the way we do business, including with the banks. Not only are these existing processes costly and time-consuming, but also the fact that they are subject to human error. Fraud may also arise, considering how paper bills of lading can be easily replicated and is a leading cause of theft and misdelivery of goods.

3. As a result, the industry has looked for ways to dematerialise paper documents. However, the efforts throughout the last thirty years have not achieved much success. Even though these attempts were not without merit, the use of electronic documents have remained problematic in both law and practice. In law, a major concern is that electronic documents are unable to replicate paper documents that are capable of transferring tangible rights. Unlike paper documents of title, where a change in possession of the tangible documents transfer legal rights, electronic documents do not physically transfer anything tangible. In practice, the challenge lies in the banks’ reluctance to accept and rely on electronic documents to secure financing. These electronic platforms lack in transparency, often confining access only to registered users, deterring banks from extending credits since they are unable to ascertain the status of their rights or priority with respect to other creditors.

4. Overcoming the above challenges, the blockchain technology is said to deliver the trade finance industry to the promise land users have been in search for over the past few decades: A transparent and autonomous trade system which ensures fast, cost-efficient, secure and paperless transactions. Unfortunately, the journey to the promise land is not a bed of roses as there are a number of legal challenges to overcome.

II. Understanding blockchain-based trade finance platforms

5. Before examining the existing legal challenges from the use of blockchain technology in trade finance, a preliminary understanding of blockchain technology and a blockchain-based trade finance platform has to be appreciated.

6. In essence, blockchain technology is a decentralised database that stores a registry of assets and transactions across a peer-to-peer network. This is unlike the past attempts to dematerialise paper bills of lading, which often required a form of trusted third party central registry to track ownership.

7. Under a blockchain-based trade finance platform, transactions are secured through cryptography, with each transaction chained to its immediate predecessor. As a result, an immutable and unforgeable record of all transactions is created across this network. On such a platform, two categories of transactions can take place: unpermissioned and permissioned. Based on recent trends, the latter appears to be preferred by users of the trade finance industry. Unlike the former which is a public system potentially accessible to everyone, the latter is a closed network. Consequently, only specified parties such as banks and approved individuals in a trade finance industry can access the network to submit secure transactions.

8. Be it the unpermissioned or permissioned network, the blockchain technology promises greater efficiency and security, compared to the paper dependent process in the industry. Unsurprisingly, such a promising innovation has caught the attention of trading houses and banks. A higher profle example would be the recent cooperation between ING and Societe Generale Corporate & Investment Banking, to develop a blockchain-based trade finance prototype platform termed the “Easy Trading Connect”. In light of the great publicity and visibility of this platform regarding its usage and functions, references would be made to this prototype when analysing the risks arising from the use of a blockchain-based trade finance platform.

III. Beware of risks

9. Although both banks have claimed that the “Easy Trading Connect” reduces costs, improves efficiency and eliminates documentary fraud in the industry, the reliability of the bill of lading used in the trading process is questionable.[1]

10. Firstly, it is unclear what exactly constitutes the “bill of lading” used under the prototype. It is merely described as a “electronic representation of a bill of lading”. Should the electronic representation be a scanned copy of the paper bill of lading, this platform would be no better than the use of paper bills of lading that are susceptible to fraud, as explained earlier. Alternatively, should the electronic representations be an electronic bill of lading, then the problems which hindered the widespread adoption of the use of electronic bill of ladings in the first place will still exist.

11. Secondly, it is doubtful whether the “bill of lading” under the platform is capable of transferring rights. Under a traditional trade finance process, bills of lading are transferred through physical, written endorsement transferred from one party to another. At the discharge port, the original, physical bill of lading is then produced to evidence that the last transferee is the rightful bill of lading holder whom is entitled to take possession of the cargo. However, the “Easy Trading Connect” does not appear to provide any guidance as to the mechanism for which the bills of lading may be electronically endorsed over. It is uncertain whether such electronic endorsement might become acceptable to the carrier’s agent at the discharge port. Hence, more guidance is necessary to assure users that goods are truly transferable from a party to the next, within this platform.

12. Thirdly, transactions are not as secured as hoped for since there are difficulties with the authentication of the electronic bills of lading. Ideally, this challenge could be addressed if the carriers issuing the bills of lading are participants to the platform, as they could assist by authenticating the electronic bill of lading used in each transaction.  It is suspected that, due to practical constraints, the carriers under the “Easy Trading Connect” platform are not participants to the system. Not all carriers have the technological capability to participate in the platform. Further, it may even be the intent of the creators of the platform to limit parties to each transaction, in attempt to provide transactions that are more secure. Therefore, unless there is a solution to aid with the verification of electronic bills of lading, the system is exposed to risks of fraud.

13. As seen, whilst the blockchain technology might make it possible to dematerialise most documents, the bill of lading, the crucial document that will form the basis of subsequent trading, remains potentially problematic. There has been more recently news in relation to a number of Japanese banks, insurers and trading houses coming together to explore and build a blockchain based platform to achieve similar benefits. Whilst the identification of specific partners and carriers to operate within the platform can potentially solve issues relating to the reliability of electronic bills of lading, difficulties remain as regards to trades involving third parties that are not a member within the platform, and this platform may limit the options available in relation of the carriage of the goods that are being traded.

IV. Future legal developments

14. Fortunately, there exists instructive expert opinion which holds the view that with sufficient legal infrastructure in the future, the use of blockchain technology in trade finance will be feasible and secure. The solution lies in using the blockchain technology as an open depository for electronic bills of lading, which one may access and obtain it via a token system[2].

15. First, it seems feasible for a blockchain-based bill of lading to replace a paper bill of lading as it satisfies the functions of the latter. As Professor Koji Takahashi analyses, among these functions, it is most essential to ensure that only one original copy of a transferable document is in circulation. This is made possible with the blockchain technology, that has an algorithm which guarantees a single true version of distributed ledgers, and that tokens recorded are subject to exclusive control of their holders. Thus, a blockchain-based bill of lading can replace the functions of a paper bill of lading and is a feasible innovation.

16. Secondly, using a blockchain-based bill of lading would ensure secure transactions if it is sufficiently supported by applicable legal systems. Here, Professor Koji highlights the importance of the Rotterdam Rules and the draft UNCITRAL Model Law on Electronics Transferable Records. With the adoption of the aforementioned rules, trade financing is secure as legal recourse is available to users when needed. Under these rules, electronic records such as bills of lading, are to be treated as transferable document. This means that the bill of lading entitles the holder to claim the performance of the obligation indicated in the document and to transfer the right of performance by means of the transfer of that document, thereby ensuring the holder’s legal rights and availability of legal recourse.

17. Therefore, with sufficient legal support, the innovative use of a blockchain-based bill of lading can potentially address the challenges faced with the current blockchain-based trade finance platforms as well as with electronic bills of ladings, proving to be a feasible and secure way ahead.

V. Conclusion

18. As it stands now, the use of blockchain technology in trade finance still faces considerable legal and practical impediments, and we have tried in this article to highlight some of the major concerns. However, given that widespread interest and exploration in this area by banks and traders, it seems inevitable that such technology will form the basis on which trade finance will be conducted in the near future. And if there is sufficient legal infrastructure then, making paperless and secure transactions in the trade finance industry may become a reality.

Contributed by:

John Sze

Deputy Managing Partner

JTJB Singapore Office
E : johnsze@jtjb.com
T : 6220 9388

[1] Videos to demonstrate how the “Easy Trading Connect” works:

https://www.youtube.com/watch?v=RLyiIXLEqg4, https://www.youtube.com/watch?v=alk3ENBE9k.
[2] https://www1.doshisha.ac.jp/~tradelaw/PublishedWorks/BlockchainTechnologyElectronicBL.pdf