Will commodity traders embrace trade financing’s digital future?
As the dazzling array of online trade tools and products continues to evolve, the diverse world of trade and commodity finance has begun to seek out digital solutions to help tackle efficiency and some complex problems. Commodity traders have operated with traditional methods for decades but research suggests they too will have to adopt digital opportunities to stay competitive in the future.
As the dazzling array of online trade tools and products continues to evolve, the diverse world of trade and commodity finance has begun to seek out digital solutions to help tackle efficiency and some complex problems. Commodity traders have operated with traditional methods for decades but research suggests they too will have to adopt digital opportunities to stay competitive in the future.
The advent of digital trade has well and truly come with billions of transactions happening daily in a thriving space of e-commerce and online exchange. From contactless payment to Apple Pay improved digital solutions compete to meet our myriad needs and the same is happening in the trade and commodity finance industry. Though it is yet to be fully explored there are several options available to banks and commodity traders, as well as intermediaries, to benefit from a digital future.
According to a recent report, entitled ‘Reimagining Commodity Trading’, by consultancy Oliver Wyman, commodity traders would gain an immediate advantage by digitising their trade and commodity financing arrangements.
The development of paperless trade solutions such as electronic letters of credit (LCs), bills of lading (BL) and title documents are becoming increasingly commonplace in commodity trading, improving some of the current inefficiencies and discrepancies within trading.
It is very early days yet, but there are greater advantages still to be had for traders through the use of distributed ledger or blockchain technologies in the future. Inevitably there are numerous hurdles to clear before these opportunities become a reality, but the cost savings and efficiency improvements digitisation could bring traders are too important to neglect.
Mercuria’s chief executive Marco Dunand recently commented that traders’ current payment systems were stuck in the 17th or 18th century. In doing so, he highlighted the need for commodity traders to take digitisation seriously. The question is whether they will.
Marginal gains?
Commodity trading relies on intricate and complex global flows of goods, with most major traders operating with high value, high volume trades which often have razor thin margins.
Despite making approximately $44 billion last year from arbitrage around oil price volatility, commodity traders can grow larger still if digitisation takes hold.
The ability to control and manage this nebulous network of trading and payment is currently serviced by seemingly outdated systems. Most traders rely on centuries old documentation in the 21st century to manage extensive global client bases.
One treasurer of a Middle Eastern oil products trading company, tells TXF: “Banks are far too comfortable living with the status quo. Lack of innovation is all too obvious. So I get rather frustrated – but of course it takes two to tango. However, the inertia causes me grief.”
Asked what would make his life easier, he tells TXF: “Top of my list is paperless trade. We are in the 21st century, and we have to deal with government bureaucrats that seem to just want to shuffle paper. Are they crazy?
“Ultimately, the real solutions will come from the USAA – the United States of Amazon and Alibaba. That’s where it will come from, not traditional sources such as trade banks. They have run out of ideas, and they might have run out of money on this as well!”
The benefits of digitisation come with the potential to reduce payment costs by up to 30%, an important amount considering the thin margins on offer.
Jacco de Jong, managing director at essDOCS, tells TXF: “The main driver [for traders] will be cost and efficiency. Because they work on thin margins, any way they can shave off a few bucks on cost they will.
“It’s a huge community of parties which touch upon these types of transactions for either the physical part or the financing part.”
Back-office costs such as courier services, payment and the costs of creating and countersigning documents can be diminished by increased digitisation and innovations such as smart contracts.
This extends to the cost of business and payments between participants in a supply chain with much of the technological development coming from a combined approach by banks and fintechs in cooperation.
As Roland Rechtsteiner, a partner at Oliver Wyman and one of the report’s authors, tells TXF: “What is still predominantly driven by the banks is how can you reduce costs in the back-office but also in the interface between trading companies and their counterparties.
“It’s important not to try and solve the whole world at once with blockchain but to look for efficiency gains where you can learn step by step how that technology can help you and what the pitfalls are.”
Next stop trade finance?
Trade finance appears to be the most fertile ground for digitisation to grow as a process for traders given its regular use and importance to the industry.
A competitive market already exists around digital trade solutions with essDOCS, Misys, Bolero, and numerous blockchain fintechs looking to supply banks and financiers with improved options.
According to Dr Rouben Indjikian, professor of commodities, energy, and trade finance at Geneva’s Webster University: “The trade finance world is also very digitised in terms of the multitude of softwares and solutions, which are proposed in the market to participants.
“The main problem continues to be how to get commonly accepted standards and how to standardise these commodity trade and trade finance instruments.”
Despite the current lack of standardisation, digital trade finance arrangements are still becoming more commonly used and developed globally. Trade finance would be a more likely first step for traders to see digital solutions in, as the transactions are usually large, meaning an increased cost saving, according to Rechsteiner
He tells TXF: “The big commodity traders are using trade finance and it’s going to remain extremely important for the traders. Banks are pioneering the application of blockchain technology and it’s an area where sooner rather than later we can see the application.”
Blockchain technology relies on a public distributed ledger which would allow all parties in a trade finance transaction to countersign their payments and receipts digitally. The digitisation of documents is a key cornerstone of this shift, according to de Jong.
He adds: “At this point in time this is where we see traders gaining the most efficiency and this is where they are embarking on the road to digitisation - by slowly progressing and doing more and more of the documentation digitally.”
‘End to end’ digitisation, as it is known, entails the entire financing process taking place without paperwork. Diminished costs in preparing documents and the reduction in potentially costly mistakes are ambitions that can be readily completed if traders embrace digitisation.
Commodity finance and the transparency dilemma
While trade finance appears to be an obvious home for digitisation given its ubiquity on the global stage and constant innovation. Commodity financing could be a more complex proposition for digitisation due to the secrecy of commodity traders.
Much of the value in commodity trading comes from understanding and utilising particular commodity flows and finding profit in niche or difficult markets. The risk is high on some of these trades and requires detailed and structured financing to ensure all parties are satisfied with the deal.
Rechtsteiner tells TXF: “Once you understand flows from your competitors you take their advantage away and therefore there is impact on the arbitrage.
“Traders are trying to disguise where their physical flows are going but also spending a lot of money trying to work it out and get better data on where the other physical flows are going.”
The trade of commodities is digitised in a number of ways already with algorithms and computer programming key to the much of the industry but the financing arrangement for traders takes the technology a step further.
The transparency of public distributed ledgers would allow traders to see all payments and financing along the supply chain. Though digitisation could see decreased costs it would also remove parts of traders’ ability to find value in different markets.
As Rechtsteiner adds: “This industry is one which comes out of a very secretive history and has always had manual processes. It needs to feel really comfortable using this new technology before they apply it.”
This secrecy means that it is unlikely that the industry would move as one towards digital solutions given the level of competition between traders along the supply chain. For de Jong it is unlikely that the entire industry would cooperate enough to digitise en masse.
Another key challenge for digitisation to overcome is inherent to commodity trading itself, the physical commodity. Digitisation allows traders to monitor the commodity flows at each stage of a transaction but quality control and inspection must still be done physically.
“It’s a huge community of parties which touch upon these types of transactions either the physical part or the finance part,” de Jong tells TXF. “You want to be absolutely sure about risk mitigation, payment and quality – so I can see also see digitisation from a quality perspective whereby you can monitor the quality of the commodity in transit.”
Whether checks on ships and their contents are assessed physically and then entered into the value chain digitally is key to understanding the importance for traders of having full control over their assets.
Digitising the point of payment is also challenging, given the nature of the physical supply chain according to Indjikian.
He tells TXF: “Upon the arrival of the commodity the main problem is the payment and financing of that commodity which could also be based on different solutions of e-trade finance instruments.”
Disruptors and decision makers
Digitisation can be construed as a generational divide between companies, with many fintechs and technology companies operating solely on the basis of digital innovation. Commodity traders on the other hand are more invested in physical supply chains and come from a different mentality, according to Rechtsteiner.
He tells TXF: “A lot of the commodity traders are very sceptical about digital technology and they will have change and think about the best way of adopting that.
“Even if it will reduce costs by a significant level, if they are not sure whether it will affect their competitive advantage then they will not adopt it.”
This reluctance may be justified due to the a forementioned challenges but in a fast-paced environment, traders may face an alternate challenge from technology companies moving into different industries.
The report cites the example of large companies such as Google and Amazon who have massive power needs forming their own trading arms to supply new markets.
Companies with large market capitalisations could feasibly leverage their own power needs. These companies have the advantage of large amounts of customer data and far greater contact than other parts of the supply chain.
This is evidenced by the oncoming roll out of smart meters for energy in homes across the UK giving corporates unique access to data and consumer needs. Traders need to be more nimble and agile to counter disruption in the future.
Rechtsteiner adds: “Companies like Google and Amazon with their connection to the customer and end user, more than what power companies have, will be able to build certain business models which could significantly disrupt that market.”
Trade and commodity finance is a space which has seen plenty of disruption on the banking side with the rise of fintechs and corporate trade finance solutions. The next step is for some of financing’s largest recipients to adopt the processes that govern the digital age.
For Indjikian the issue lies in standardisation and adoption of systems, the current competition is healthy and will ensure the best format possible for future digital trade and commodity financing.
The traders that adopt digitisation earliest will have the biggest efficiency gains and a new competitive advantage in the industry, with an estimated timescale of 2025 currently mooted as a reasonable date for such technology, according to the report,
As Rechtsteiner notes: “The application of digital technology in commodity trading is still nascent at this point in time. But my perspective is that we will see some significant quick developments there because both sides know the challenge well.”
For traders, the process of digitisation may no longer be an ‘if’, but rather a ‘when’.
