A game changer for global trade: the new legislation liberating supply chains

Dominic Broom, SVP Working Capital Technology, Arqit, explains why a very succinct piece of legislation is unlocking a transformative approach to trade and supply chain finance, and thereby injecting stability and working capital across end-to-end supply chains.

For those involved in international trade, navigating the repercussions of recent global and geopolitical events has been tricky to say the least. Businesses, many of which are still recovering from the impact of the pandemic, are facing high borrowing costs and levels of inflation not witnessed in a generation, as well as disruption to supply chains and trade routes caused by the conflict in Ukraine. Moreover, at a time when stability and access to working capital are essential, these extreme headwinds are exacerbating what is an already challenging trade finance landscape.

The release of new figures on the global trade finance gap point to an escalating issue that needs prompt attention. Now at US$2.5trillion – an increase of US$1trillion over the last four years – this figure underscores a mammoth deficit in funding support, particularly for smaller businesses and those in emerging markets. For those that are able to access funding, the current approach to financing supply chains is adequate at best. This emphasises the urgent need for more effective supply chain solutions that can reduce funding barriers and reinforce supply chain stability.

Trade is an enduring, age-old industry that continues to be the beating heart of the global economy. Yet, while physical supply chains themselves have evolved with respect to the transportation and types of goods traded, the processes behind the documentation and funding of these transactions still largely rely upon the same laborious, paper-based methods that have been used since the 19th century.

Reliant on paper documentation, trade transactions are consequently manual, insecure and inefficient, often resulting in lengthy payment cycles that can leave suppliers – SMEs in particular – struggling to manage their working capital effectively. Digital documents are widely acknowledged as being the way forward for both physical and financial supply chains; enabling far greater efficiency, security and flexibility – and, in turn, improved access to finance. But adoption unfortunately isn’t straight forward.

That is because trade finance is built upon entrenched rules that are key to supporting safe, effective global transactions; rules that remain largely in place to this day in most jurisdictions. For instance, legal concepts such as “possession” and “transfer” continue to govern the exchange of negotiable trade documentation. These vitally important rules were, however, designed to facilitate trade in a paper-based world. Any change to trade documentation is thus predicated on the implementation of a new legal framework recognising possession and transfer of intangible assets; which is far easier said than done. New legislation, however, sets out to do just that.

The most important law you have never heard of

The United Kingdom was instrumental in establishing many of the rules and practices that underpin global trade, and its laws still form the basis for trade contracts across the world. This makes the new UK legislation all the more pertinent to digitalising trade documents across both domestic and global supply chains.

The Electronic Trade Documents Act 2023 (ETDA) came into force on 20th September. While most businesses will likely have paid little heed to this understated piece of legislation, its relevance is profound for companies of all sizes that trade domestically or internationally. The act allows for certain documents commonly used in global trade to be legally recognised in digital form in the same way as their paper-based equivalents. Superficially a small change, this amendment – which is applicable, inter alia, to negotiable documents such as promissory notes and bills of exchange – creates huge opportunities for optimising supply chain finance (SCF) solutions and, in the process, discarding inefficient and insecure paper-based processes. Similar legislation based on the UN Model Law for Electronic Transferrable Records (MLETR) is being/ has been adopted across G20 nations.

Furthermore, digital documents enable today’s impractical funding structures to be completely inverted – from a “bottom up” approach to a “top down” one.

SCF 2.0

Currently, supply chains are often financed from the “weakest link” in the chain upwards. Generally speaking, this is an SME, as they tend to have the tightest balance sheets, and are often located in complex geographies. Banks are therefore less willing or able to take on the perceived risks and/or the KYC costs they pose to plug funding gaps. Thus, long supply chains, involving negotiated payment terms and deferred payments between buyers and suppliers, place significant strain on SME working capital. To avoid this, the only option available to most SMEs is expensive factoring solutions – or even avoiding complex supply chain activity altogether.

This is a structurally inefficient situation for corporates looking to decrease costs and strengthen supply chains. Indeed, any vulnerability within the chain can have repercussions across its entire length, with multiple companies relying on a robust, streamlined flow of goods end-to-end to support their operations. It is a proven fact that revenues increase for all stakeholders when interruptions are avoided, and the easiest way to ensure that is for there to be plenty of liquidity in the system. It is therefore somewhat paradoxical that SMEs, which are the most in need of liquidity, have the hardest time accessing it.

It is here that digital negotiable instruments (DNIs), which are being made possible by ETDA, can come into their own, as a scalable, flexible and binding promise of payment by a corporate. DNIs, in the form of digital promissory notes (DPNs) and digital bills of exchange, can now be integrated into SCF programmes, dispensing with separate assignment agreements and irrevocable payment undertakings (IPUs), which are necessary for the transfer of non-negotiable instruments, including receivables and invoices.

DNIs can resolve the “bottom up” working capital dilemma for corporates. Acting as a standardised risk transfer mechanism, DNIs tie funding to the issuer’s own financial standing instead of the generally weaker creditworthiness of their smallest supplier. In practical terms, by borrowing based on a corporate’s needs and superior credit profile, financing can be cascaded down to suppliers, with the reach of the SCF programme being extended to the “long tail” – i.e. the smaller businesses. This way, corporates can inject and safeguard liquidity throughout the chain.

By enabling suppliers to have faster access to all-important working capital, as well as lower funding costs, ETDA and DNIs are, in effect, democratising SCF, enabling superior access to finance and ensuring a more resilient chain for everyone. It represents nothing short of a total transformation of deep-tier SCF.

Flexibility, control and security

DNIs are not just transforming the way in which end-to-end supply chains can be funded. Their digital nature allows corporates to have far greater control of how and when they use SCF. A current drawback of existing solutions is that they are siloed and inflexible, impacting corporates’ flexibility when optimising cash management and cash conversion cycles. Employing DNIs addresses this issue by allowing treasurers to effortlessly switch between different funding methods depending on which is the most effective for them at any given time, predicated, for instance, on their business cycle or cash position. For example, if a typically cash-rich business runs into liquidity issues, instead of having to limit their dynamic discounting programmes in which suppliers are paid early in return for a discount – which is often the most suitable solution for their overall business needs – they can use DNIs to access external liquidity to extend payment terms as needed.

Free from the rigidity of only being able to leverage siloed SCF solutions, corporates are given the flexibility to employ their own or third party cash, negotiate payment terms with suppliers to pay early or on time, and settle on payment dates, all whilst accounting for their own KPIs and cash positions.

From a security perspective, DNIs generated by platforms like Arqit’s TradeSecure™ are almost impossible to duplicate or tamper with because they are digitally secure and auditable from source and proof of their existence and ownership is quickly verifiable on a ledger, thereby making SCF processes less vulnerable to financial crime. Information is locked behind a secure digital seal requiring a specific cryptographic key, which ensures the easy trackability of otherwise verifiable and indisputable digital transfers, thereby streamlining and automating the audit process.

Ultimately, moving towards digitisation through DNIs anchors supply chains to corporates, leveraging their strength to create opportunities for scaling. Their widespread adoption will result in new finance becoming available to a wider range of businesses – thereby acting as a valuable, viable solution to the trade finance gap – as well as the adoption of new financing tools by banks for corporate clients. Thanks to the ETDA a new era of SCF 2.0 is here. What are you waiting for?