Trade Finance: the challenge for RegTech

In discussion with Farah Shaikh, Trade Finance Expert, member of the ITFA* FinTech Committee

Tell us about Trade Finance – how big is this market? 

In simple terms, when goods are exported, the exporter will require payment for the goods in advance of the shipment, meaning the importer bears the risk of those goods not arriving. Trade Finance is where an intermediary (such as a bank) will step in to finance the business transactions between the buyers and sellers, reducing payment risk by accelerating the payment process.

The global Trade Finance market was estimated at US$59 billion in 2018 and is expected to reach US$71 billion by the end of 2024, growing at a CAGR of 3.0% between 2019 and 2024. Yet, the global trade finance gap was last estimated at US$1.5 trillion by the Asian Development Bank (ADB).

To facilitate the global development of Trade Finance, banks need common rules and guidelines to avoid any disputes or confusion that may arise with conflicting national rules.  A set of rules was established by the International Chamber of Commerce (ICC) in the 1930s. The Uniform Customs and Practice (UCP) is a set of rules to govern the use of Letters of Credit. 

As a Trade Finance expert, what are your main challenges and pain points?

Manual processes and huge systems reliability are the main challenges in Trade Finance operations. In addition, there are a number of trade and compliance systems used for different purposes, which means more systems, more data and hence more complexity. Also, constantly increasing compliance mandates and updates require ongoing employee training. Another challenge is managing the large volumes of false positive hits when undertaking transaction screening, which consumes valuable time and resources.

Most of the process can be automated and banks and financial institutions looking to grow their Trade Finance business will need to invest in more technology-based solutions to increase efficiency and reduce costs.

You sit on the ITFA FinTech committee. Do you think that FinTech firms or RegTech firms have a good understanding of your business and the regulatory and risk requirements to support your business effectively?

There are many FinTech and RegTech companies today providing different solutions. What the industry is looking for is a single solution where all stakeholders can participate, or to be able to use one platform to communicate. The challenge is to get the entire trade cycle automated by the use of one single platform. 

As discussed above, banks need to increase efficiency and reduce costs in their business processes adopting more innovative technology solutions. It is vital that the vendors selling these solutions understand the business and regulatory requirements. Banks are looking into RegTech firms, but the offering is currently limited – especially for more complex relationships and those in Emerging Markets.

What are the main regulations impacting Trade Finance?

Compliance risks associated with KYC requirements, customer due diligence (CDD) and financial crime risks have a major impact on Trade Finance deals. Today KYC checks are done within Trade Finance departments. These checks can often be very time consuming and require knowledge and understanding of trade based compliance. For example, if a Letter of Credit shows the goods exported as wooden furniture, the trade operations department needs to check the profile of the buyer and the seller to ensure that their business is in line with the goods mentioned in the Letter of Credit. 

There are several other types of checks that banks may need to perform such as:

  • the purity levels of  dual used goods (goods, software, technology, documents and diagrams which can be used for both civil and military applications)
  • the presence of licences for goods that require them for import or export
  • higher risk and sanctioned ports or locations, transporters, vessel and container tracking
  • over or under invoicing by checking fair market prices of goods, particularly commodity prices which can be difficult when prices are subject to market volatility and can vary across different territories. 

The compliance process isn’t easy; it requires time, resources, knowledge and expertise. Data can be collected from a variety of open sources and different in-house or external systems. This process is complex and time consuming, however it is an essential piece of work with the increasing regulatory pressures on banks and financial institutions.

How do you see the Trade Finance industry evolving over the next 5 years, in terms of business, technology and regulations?

Challenging but interesting times are ahead for the Trade Finance industry. With increasing regulations and client requirements, the traditional trade finance and compliance model is moving towards innovative and agile solutions. 

We are seeing the increased digitisation of trade finance, with initiatives such as:

  • The introduction of SWIFT messaging services MT798 for corporates
  • The understanding of electronic rules by banks and other participants in a trade that handle traditional trade finance products like Letter of Credit and Documentary collections
  • proofs of concept in trade and supply chain business with the use of Blockchain and Distributed Ledger technology

However, a holistic approach is needed which is inclusive of not only local and regional banks, regulators and FIs but also importers and exporters and all other stakeholders involved in a trade who need to align themselves with the new digital ecosystem to bring transparency, speed and efficiency in the end to end process in business, technology and regulations.

* ITFA is the International Trade and Forfaiting Association