Article

by Jacco de Jong, Partner and Commercial Director, TradeWiz International, Amsterdam

In our role as a trusted and SWIFT-certified partner in the complex field of trade and supply chain finance, TradeWiz consultants often find themselves in a unique position due to their work with the main parties involved in BPO transactions - financial institutions, corporates and (system) solution providers. Needless to say, we have been following the discussions and developments around the BPO with great interest.

Many of our clients are now looking into this concept, but they often struggle to get a grip on how the BPO could work out for their bank organization and their clients. It's clear that the positioning of the BPO can be a challenge, both toward internal stakeholders within banks as well as their external client-base. Initial discussions have been leaning toward the BPO as an alternative and sometimes a future replacement for traditional letters of credit. This perception has led to more interest across the globe.

Alternative

Although the BPO is not a replacement for letters of credit, it can be an alternative for particular L/C transactions of modest value or others depending on their intended purpose. It could well be that if the main purpose of the L/C is to secure payment or as an instrument to obtain finance, the BPO product could be one preferred alternative. This angle is already being addressed and commented on by trade experts.

However, the BPO can also be an alternative to high-value transactions where letters of credit have historically been used. Examples are transactions in Asia where the goods travel by boat between countries within a day or two, and for which documents take far longer to reach the applicant via the negotiating and issuing bank. This is a cause of frustration for both buyer and seller, and it can result in incurring additional costs such as demurrage or additional guarantees (for missing documents) to be issued. This could be especially applicable to transactions that generally covered by L/Cs, such as those for chemicals transactions between large corporates that have been in business with each other for years, if not decades.

We have also learned that these corporates would definitely welcome the BPO as an alternative for oil transactions as well. However, this will first require that the BPO be accepted in the market. Once this is achieved, it would make this type of transaction less cumbersome and "document heavy" when compared with the requirement for regular L/C documents and especially for LOIs.

Credit insurance

Having stated some of opportunities for the BPO to gain ground, there is still an area we believe to be under-exposed in the BPO discussions. As mentioned in the title of this article, the BPO could offer banks an opportunity to win back transactions from the credit insurance market. For years, many corporates have been conducting cross-border business on open account terms. Often, corporate internal risk policies prescribe the terms and conditions for these sales to be allowed, in particular to have a risk mitigation system in place.

The open account risk mitigation instrument for suppliers has often been credit insurance, the main objective of which is to cover the buyer's insolvency risk (i.e., the risk that the buyer' will be unable to pay the invoice). Apart from the apparent risk of the buyer's not being able or willing to pay, credit insurance also comes with other potential disadvantages: documentation burdens, the difficulty of securing just one transaction at a time, the problems of using it for some industries and almost always a substantial waiting period.

In addition to these product-related specifics, the credit insurance industry has been struggling as a result of the financial crisis. Many corporates remember the moment when credit insurers went off-risk on transactions or on complete industries almost overnight. Much has been improved since then, but the sentiment still lingers with many corporates. It is here that there are many opportunities for both banks and corporates in open account secured by the BPO product as an alternative for credit insurance and for which banks can definitely win back transactions from the credit insurance market.

For banks it could mean an opportunity to offer BPO as an alternative, enabling clients to mitigate open account risks more efficiently, whilst addressing and removing many of the issues mentioned above. Banks can benefit from generating (risk-related) income from these types of transactions as well as being able to offer financing on transactions previously unknown to them (i.e., open account transactions). If desired, and once BPO transaction volumes have reached a certain level, the processes for handling BPOs can be optimized to involve little or even no operational handling, thereby reducing operational risks and costs to the fullest.

Corporates

For corporates the BPO will offer additional benefits, such as industry-independent risk mitigation opportunities, "last-minute" open account risk mitigation (e.g., if supported by their bank system infrastructure, for the BPO could be established on line almost immediately to secure a shipment scheduled for the next day). It can be valid for a time period as short as needed, thereby minimizing the number of days banks will charge for risk premiums. But even more important than all of the above, the BPO transaction is based on data only, so there is less pressure for documentation to be presented to the bank and for discussion about possible discrepancies. Data will be matched which is either correct or not.

We clearly notice a positive shift in the perception and public opinion concerning the BPO. It is now up to the banks, SWIFT and its partners to facilitate the offering of this supply chain finance and risk-mitigation solution to their corporate customers. Already banks like Standard Bank, Deutsche Bank and J.P. Morgan are gearing up and breaking new BPO ground, and many others are taking these first steps as well. Now that the ICC URBPO has become effective, the adoption process will accelerate even more.

Jacco de Jong's e-mail is jacco.de.jong@tradewiz.net