by Madhav Goparaju, Kersten Martin Meyer and Carol Chiu

During the past 10 years, trade services/trade finance has undergone tremendous change due to the ongoing shift from letter of credit business toward open account (OA) transactions, heightened customer expectations, the impacts of Basel III, major IT implement-ations and a significant decrease in global trade volume in 2008 and 2009. All these changes put enormous pressure on banks' return on investment and has affected the way trade services were set up.

In response, some banks reorganized their trade departments while others outsourced some or all areas that supported trade. A few institutions decided no longer to focus on developing their trade services department even though it is considered a core product for small- and mid-sized organizations.

To help simplify supply chain trade financing, SWIFT and ICC introduced Bank Payment Obligations (BPOs) in 2012. BPOs provide an electronic finance trading alternative, offering a paperless advantage to OA trades as well as payment guarantees for L/C business, an attractive option given the currently unstable economic environment. BPOs will allow banks to implement a substitute (or additional) service to L/C and OA transactions in the future. In addition, the visibility of BPO products via various data points encourages transparency and offers the ability to provide pre- and post-shipment financing for customers. This will lead to closer relationships between banks and their customers and the possibility for new cross- and up-sell opportunities.

Challenges confronting trade services

Banks, particularly their trade services, face continuing pressure to reduce operational costs and serve customers more efficiently. Key challenges confronting trade finance departments include:

Lack of visibility into client data for cross-selling opportunities - Due to manual back-office processes, trade services are not integrated with other bank systems. This makes it difficult for banks to obtain a holistic view of what products a customer uses across the institution and diminishes opportunities to cross-sell services.

High service costs - Manual processes decrease banks' revenue margins.

Heightened customer expectations and sophistication with technology - Today's technology-savvy customers expect banks to provide a global view of their business via visibility into their trade data and cash flow within a single portal.

High trade volume in OA transactions - With an estimated 80 per cent of trades conducted via OAs, banks need to play a bigger role in this space rather than just serving as payment agents. Being able to capture trade data early in the supply chain cycle will enable banks to provide pre- and post-shipment financing.

Rising demand for trade advisers - As more customers turn to banks to fill the role of trade advisers, banks need to have good insight into customer profiles and provide analytical services on demand to help them make informed business decisions.

Need to invest in technology - Larger banks are investing in technology for trade services to reduce operating costs and provide customers with better and quicker service. Banks that do not invest in technology will lose customers, especially those that are expanding overseas.

Desire for new trade finance instrument during time of instability/distrust - Amid concerns stemming from the recent financial crisis, as well as the current situation in Europe, customers with OA transactions may seek out trade finance instruments that offer protection against default payments. Going back to L/Cs is likely not an option due to its paper-intensive process. An electronic form of OA trading, but with the payment guarantee of the BPO, may be a good choice for customers that trade with European partners.

More stringent regulatory and compliance requirements - As a result of regulatory requirements, banks face additional burdens to catch illegal trade activities and provide customers with more transparent services. An automated and electronic process will help banks simplify the compliance process.

Continued pressure to reduce costs - Most banks do not know the true costs of servicing a transaction and will need to implement 100 per cent straight-through processing (STP) to ensure healthy profit margins.

Lack of trade service expertise - As experienced financial experts retire and fewer new entrants join the industry, scared away by the financial crisis, banks are having a hard time finding experienced trade service professionals.

The new saviour?

At first glance, the BPO appears to be the saviour of the modern trade environment, leading to new business while at the same time allowing higher returns based on the extension of the supply financing chain. The BPO is expected to increase efficiency for both customers and banks, as well as serve as a potential settlement tool for B2B and B2C web portals. In fact, the first few trades have already been managed successfully using the BPO. After the first trade, facilitated by Standard Chartered, the list of potential market participants doubled within a month. To date, 44 banks have confirmed plans to adopt BPO in the coming months.

However, uncertainty remains. In most cases, the BPO requires a new infrastructure (SWIFT's Trade Services Utility and front-end application) within banks and will focus only on transactions rather than dealing with portfolios.

Even more threatening is the fear that existing revenue might be cannibalized (e.g., through document negotiation revenues and courier charges), as well as potential legal concerns in certain countries with respect to an electronic data-only approach. Keeping the weaknesses and threats in mind, the BPO's key strength is its ability to allow an electronic presentation of data in an incredibly efficient manner, providing a paperless office while simultaneously matching trade details immediately with reduced discrepancies and higher consistency. In addition, banks will face low transactional costs due to a fully automated process and standardized data formats used in international trade documentation.

Other benefits

In addition, BPO can help banks:

gain a new revenue stream - Except for a few international banks, the majority of banks were left out of OA processing. This new finance trade instrument allows banks to enter the OA space and capture new business.

transact in electronic data - BPOs allow 100 percent STP.

provide payment guarantees - The recent economic risk and instability within trade finance in some countries has affected buyers' settlement capabilities. As a result, customers are looking for alternatives to mitigate risks. BPOs offer an alternative that provides more certain arrangements without the degree of administration and cost typically associated with L/C transactions. In addition, BPOs enable pre- and post-shipment financing.

stabilize overall trade finance revenue - BPO revenue will offset any revenue loss due to migration from L/Cs or SCFs to the BPO.

standardize message formats - With ISO 20022 being adopted by cash management in most banks, the BPO provides a format that banks can easily leverage from cash management to trade services.

Challenges of implementation

Some market participants question whether it is worth spending a large amount of money on a service when a bank might not find a trading partner that can provide a similar electronic set-up. On the other hand, if customers ask for such services and banks are unable to provide them, they could lose customers to competitors that can. Banks should thoroughly assess BPOs as well as their customers' expectations and requirements. This analysis should include potential implementation road maps, IT implications and business cases.

Some organizations may also find it difficult to make a strong business case for the BPO given its currently limited use in the marketplace. Senior management may be wary of signing off on such a large technology investment. The BPO also requires more than bank-to-bank touch points. To ensure a successful implementation, all connection points must be fully explored, including bank-to-bank, customer-to-bank and bank-to-transaction matching application.

Another key question banks face is whether businesses will only shift from L/C and OA transactions to the BPO by increasing their product offerings. A shift between these products is bound to occur as risk awareness within OA and the costs of L/C business support growth in the BPO. Keeping in mind that the BPO enhances the supply finance chain, banks will be able to enhance revenues (via pre-shipment finance, payment assurance, post-shipment finance and timely payments) from OA customers that so far have only been supported during invoicing, payment and cash management.

Competitive advantage

Although the BPO is still in the early stages, organizations looking to reduce operational costs, identify new cross-selling opportunities and attract potential customers should seriously consider entering the BPO market. Banks that are first out of the gate to adopt BPO products are likely to attract new customers away from those not able to provide these trading instruments from the beginning. Furthermore, the costs of providing L/C transactions may decrease by steering those transactions toward the BPO as the market grows. As a result, the BPO is likely to enable new business opportunities, lower costs and strengthen key customer relationships.

Madhav Goparaju is a Partner in Capco. Kersten Martin Meyer is a Principal Consultant, Capco; and Carol Chiu is also a Principal Consultant, Capco. Mr Goparaju's e-mail is