Open account settlement is the most popular form of trade finance, but only now is it being brought in line with other instruments in the trade finance sector. Daniel Schmand, Deutsche Bank’s Head of Trade Finance and Cash Management Corporates EMEA and newly appointed Vice-Chair of the ICC Banking Commission, explains the modernisations taking place.

Despite challenging market conditions and the accompanying need to minimise risk, open account as a means of trade settlement has continued to grow in popularity – a long-term trend that is apparent in all markets. According to statistics, approximately 81% of global trade is now settled using open account, confirming its importance compared to alternative trade finance instruments such as letters of credit (LCs) and import bills for collection.

That said, despite constituting the most common form of trade settlement, open account is also the largest unregulated area of the market – yet to receive the benefits of the regulations that have brought structure to other areas of trade.

But this is hopefully set to change. In recognition of the importance of the open account space, the International Chamber of Commerce (ICC) Banking Commission has created a new role – which I am proud to be taking on – with responsibility for the newly created area of supply chain finance.

Looking across the breadth of supply chain finance, from forfaiting and factoring to open account trading, I’m looking forward to aiding the delivery of best market practice across the sector. And this has started with the implementation of the Bank Payment Obligation (BPO) – a key project that will bring flexible risk mitigation and increased efficiency to trade finance, combining the advantages of documentary credit trade and open account settlement.

A new era of trade

The BPO – expected to gain the formal approval of the Banking Commission in early 2013 – is an initiative that will bring international trade into the 21st century. Born out of the need to combine the efficiency and freedom of open account trade with the security and structure of LCs, the BPO is an irrevocable undertaking given by one bank to another that payment will be made on a specified date following a successful ‘match’ report. This report, to be generated by SWIFT’s Trade Services Utility (TSU), or an equivalent application, will match data via ISO 20022 messaging standards.

Certainly, the BPO is designed to meet the developing needs and preferences of the trade finance marketplace. Banks and corporates alike are seeking to improve working capital management and increase flexibility and transparency, at the same time as managing risk and reducing costs. Furthermore, corporates have until now faced the restriction of, and have effectively been tied down to, a limited number of big banks with suitable platforms for receivables. Without a doubt, the need for increased inter-operability has also become readily apparent.

And the BPO has been designed to meet these needs and more. Most importantly in today’s volatile environment, the accuracy of the solution – alongside its assurance of payment – will mitigate the risks associated with international trade, for both buyers and sellers alike. The objectivity and automation of electronic data-matching will consign the risk and inefficiency of manual processing to the past. Also, the speed of automation, coupled with the provision of access to flexible financing propositions, will serve to reduce costs – particularly welcome at a time when corporates are under increasing pressure in this respect. Certainly, the provision of flexible financing (for example, the BPO can be used for pre-trade finance, unlike LCs) and the bank-to-bank nature of the obligation (again, unlike LCs) sets the solution apart from other forms of trade finance.

Equally important is the solution’s support of interoperability, with the use of a standard set of ISO 20022 messages enabling collaboration between banks and across global markets – a key feature in an era of true globalisation.

A strong foundation

Of course, this is not the first e-commerce solution for the open account space. This is, however, the first to have achieved the market-wide interest needed to revolutionise global supply chain finance. In this endeavour, the BPO has been aided by the unprecedented partnership between the ICC and SWIFT.

Certainly, there can be no doubt as to the strength of the offering’s foundation. By combining the neutrality and expertise of a leading rule-making body (the ICC) with the technology and clout of a highly-trusted provider of financial messaging, the ICC/SWIFT partnership is in a better position to modernise open account trade finance through the industry-wide adoption of the BPO than any previous initiative.

Indeed, at Deutsche Bank our own confidence in the partnership – and in the BPO, generally – is reflected in our close involvement in the process. For example, my colleague David Meynell, Head of Product Management, Trade Finance Financial Institutions, is on the Drafting Group which has been producing the BPO rules – a formal draft of which is expected to be completed in the second half of this year. In addition Deutsche Bank has representation on several of the ICC working groups and is currently in the process of concept testing the BPO together with SWIFT and corporates. Deutsche Bank is proud to be at the forefront of this exciting development in trade finance.

The role of corporates

  That said, the drafting and implementation of these rules should not be carried out without the involvement of the wider trade finance community. In fact, the active engagement of corporates in the design of these rules is vital in ensuring they are commercially compatible. Certainly, corporates will be significantly affected by the rules, despite the BPO’s bank-to-bank nature, and should make the most of this opportunity for much greater involvement.

As the growth in both supply chain finance and open account trade accelerates, it is the strength of partnerships – such as that of the ICC and SWIFT – combined with the collaborative efforts of the wider trade finance community that is key to the production and implementation of innovative solutions that meet the market’s developing needs.

BPO fact boxA Bank Payment Obligation (BPO) is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after successful electronic matching of data according to an industry-wide set of ICC rules. Key stages of a BPO transaction:l Exchange of contracts between buyer and sellerl Instruction of obligor bank by the buyer to establish the BPO. This will contain the data the seller needs to provide to obtain paymentl Obligor bank issues the BPO to the recipient bankl Recipient bank notifies the BPO to the sellerl Post-shipment, the seller provides the BPO-required data, which flows through both banks and is matched to original BPO requirements Benefits for importers:l Safer than prepayment. The buyer does not have to pay up-front before receiving the documents of title to the goods purchasedl Facilitates financing for the buyer, e.g. extended payablesl BPO strengthens buyer/seller relationships. Secures the supply chainl BPO helps to expand business opportunities. May increase competitiveness in foreign marketsl The buyer can confirm that the goods are shipped on or before the due date to the required specificationl The buyer can structure payment according to the buyer’s interestsl The buyer can negotiate better terms and conditions. By issuing a BPO, the buyer demonstrates the ability to pay and can negotiate improved terms in the futurel The BPO protects the buyer since the bank only pays when the seller complies with the specific terms and conditions and produces the data requiredl The buyer can build safeguards into the BPO, including inspection of the goods and quality control, and set production and delivery timesl BPO increases convenience; and reduces cost Benefits for exporters:l Assurance of paymentl Access to flexible pre-shipment or post-shipment financel The credit risk is transferred to the obligor bankl Reduces risk of buyer cancelling or changing the orderl The buyer cannot refuse to pay due to a complaint about the goodsl Foreign exchange risk can be eliminated with a BPO issued in the currency of the seller’s countryl The seller can structure the delivery schedule according to the seller’s interests, determining when payment will be made and shipping the goods accordinglyl The bank bears responsibility for any oversightsl Automated data matching reduces complexity and increases reliabilityl By removing subjectivity of physical document-checking the risk of discrepancy, dispute and delay is reducedl BPO can be introduced at any stage of the transaction. Mismatches can be acceptedl Automated processing accelerates settlement and financing Benefits for banks:l Low risk businessl Prudent use of capitall Steady source of commission and fee incomel Opens door to new business opportunitiesl Strengthens core relationshipsl Automated solutionl Lower operating costsl Meets the market requirement for banks to collaborate more on risk and client on-boarding.