DCI ICC, along with the Asian Development Bank, has set up a Trade Finance Default Register to gather data about the percentage of trade finance transactions that suffer a default. Can you give a little background about why this was set up and how it operates?

Taylor The project was initially set up to provide empirical data around losses related to various trade instruments so that we would have information to provide the regulators concerning the exact trade losses. As you know, we as an industry have always said that trade transactions are short-term and self-liquidating. We all acknowledged that the losses were low, but we didn't have the empirical data that actually backed that up.

DCI So, the Register, for now, is mostly to provide information to the Basel Committee deciding on the capital adequacy requirements and the maturity period for trade transactions?

Taylor Primarily, yes. One of the reasons we created it was to be able to have discussions with the Basel Committee and other regulators specifically on the losses that have been experienced, and we are continuing those discussions. But also we thought it was time for the industry to really know what the actual losses are and to be able to provide some hard facts behind them. We started the project in cooperation with the Asian Development Bank (ADB), and we had a pilot program with about nine banks in the first study.

Now that we have the pilot study done, we are working with a number of banks that participated in the initial study to try to refine the data gathering process. We have also reached out to quite a few banks to try to expand the number of banks participating. We are at about 20 to 25 banks at this point, and gradually, over time, we will open it up to any bank that wants to participate.

DCI The Basel Committee proposes to increase the capital requirement for trade to 100 per cent from the present 20 per cent. How will this affect trade finance?

Taylor It would have quite a significant impact on trade from the standpoint of having to allocate that much more capital. Any time you have to allocate capital, you have to pay for it, and that would involve an incremental number that banks would have to add to the price of the trade product.

I also suspect that some smaller banks, when they consider the continuing regulatory costs and the increase in capital requirements, are starting to reconsider the trade business because there may be cheaper places to deploy their capital. As a result, we may see some smaller banks withdraw from the trade finance business.

The capital requirement for trade finance under Basel II was 20 per cent. At that level, it may have already been too high. A 100 per cent capital requirement is a five-fold increase and is quite significant. I think it is a matter of trying to work with the regulators to come up with a compromise for what is actually realistic to expect in terms of trade. Whether that results in an adjusted capital allocation or happens in another way is yet to be seen.

DCI Have ICC representatives met with the Basel Committee to discuss these points?

Taylor Some of the officers of ICC met with the Basel Committee in October 2010 to go through the data that we had from the Registry study and talk to them about what we thought were the dramatic changes that were being proposed. We hope to have some follow-up conversations with them early in 2011.

It is early, but I think they are listening carefully. They have a lot on their plate right now and have just released the final version of Basel III. But it is my understanding that in the next couple of years, they will have the possibility to make some changes, and we are hoping that, with continuing conversations, we can convince them to effect changes related to trade. Trade is a small part of the overall picture. In terms of the Basel Committee, it is probably not at the very top of their agenda.

DCI Quite apart from the Basel Committee, is it possible that in future the mission of the Trade Finance Register could be expanded, for example, to provide a service to banks indicating the possibilities of default in various countries?

Taylor The Register has a huge amount of potential. We are going to take it a step at a time. We will deal with the traditional trade products first. But things are starting to move more towards supply chain finance and open account and some of the other products that banks are offering, and we could perhaps include some of those in the data as we go forward. So the Register has a great potential to expand and to provide a lot of very useful data for banks. We are also talking to some academic institutions about assisting in analyzing the data we collect.

DCI You mentioned supply chain finance, which is a subject of considerable current interest. For banks, what are the advantages of supply chain finance over more traditional forms of finance?

Taylor It is a different product. Over the last few years, the corporate market has been tentatively moving away from the traditional trade finance products that are costly and time-consuming. The corporates have moved more into the open account, supply chain world. And as they have moved, the banks have been shifting, creating new products, providing information, doing all of the things that they could do to assist their customers outside of the traditional trade channels. I believe this will be a continuing trend.

During the financial crisis, some of the shift to supply chain finance slowed or returned to traditional trade finance because of the credit squeeze. But we are now seeing banks turning to the more innovative forms of finance and trade support. This is a growing area and ICC should become involved in it.

DCI How would you see the ICC involvement?

Taylor I believe ICC could help define the space, define the products, and start talking about this as a bank trade product. There may be some opportunities to create some operating rules around these kinds of developments.

One of the projects that ICC is considering would be to take the Bank Payment Obligation (BPO) created by SWIFT as part of its Trade Services Utility (TSU) and to create a set of rules around it where the BPO could be used outside of the TSU.

DCI I have the impression that for the time being, banks' involvement in supply chain finance is limited to only a few highly sophisticated international banks. Is that the case?

Taylor I think that generally that is the case. The larger banks have been the first to move into this space, to provide products for their customers. But I think you will see more and more banks moving in that direction simply because this will become a lot more popular with corporates. Whether the smaller banks will do that and where and how they will do it, I am not quite sure. The jury is still out on that at this point.

DCI Yes, because one needs significant technical capacity to engage in these kinds of products and you will also need some partners as well. Can banks do this on their own?

Taylor For the most part, banks can pretty much do it their own. But you do need the software and the systems, as well as the ability to deal with all the product side and the reporting. One of the things that banks are finding is that this is as much about providing timely information on payments as the actual financing of the product itself. The corporates seem to be willing to pay for the information flow.

DCI But for the time being, isn't it still the case that most trade finance specialists and banks are tied to using paper? To give an example, the eUCP has never really taken off.

Taylor I think that is right. This has been a gradual trend over time. I can remember having a discussion with Bernard Wheble [late Chair of the Banking Commission] in 1989 and 1990. He said then that the traditional credit would be gone by 1995. It is still there. It has been more of an evolution and not a revolution. It is going to take some time, and it is very slow moving, but I believe we will see it continue to develop.

Does that mean that traditional trade and letters of credit are going to die? I don't think so. There is always going to be that need for an independent third party to guarantee the transaction and to make the payment.

The volume of traditional trade has reached a plateau. It's not growing and not shrinking. It doesn't show the huge fall-off everybody was predicting.

DCI On that subject, for years people have been talking about how electronic trade is going to supplant paper. Do you believe UCP 600 will be the last UCP to be written?

Taylor It very likely could be. Unless there are changes in the market place, for instance, major changes in transport logistics, those are the things that might change it. Looking forward ten years, UCP 600 may very well continue to be just fine for traditional trade. There may not be any reason to revise it.

Dan Taylor is Vice Chair of the ICC Banking Commission and Executive Director, TSS Global Market Infrastructures at J.P. Morgan in New York.
His e-mail is