Bank Payment Obligation: New International Trade Standard

On April 17th, the ICC Banking Commission approved the URBPO contractual rules, which will be brought into effect from July 1st 2013.This recent announcement is likely to create ripples in the financial services industry. In this blog I will review what BPO means, what are the uniform rules (the UR in URBPO) mandated by ICC, and what would be the implications of these rules on international trade.

The Current State of International Trade

According to a recent WTO press release, world trade growth in 2012 fell to 2% from 5.2% in 2011 and is likely to remain at a sluggish 3.3% in 2013 due to the ongoing economic crisis and slow growth in developed economies. Slow growth in international trade has a direct impact on the balance of payments for economies and profitability of corporates, thereby exacerbating the economic slowdown. On the other hand, an HSBC trade forecast predicts that:

• World trade will grow by 73% in the next 15 years and companies across the world will increase their trade activity by a combined 4.1% between 2011 and 2025
• Merchandize trade volumes in 2025 will hit US$ 48.5 trillion, compared to today’s US$ 27.2 trillion

To enable a favorable international trade growth outlook and to build confidence among international traders, financial messaging service provider SWIFT and the banking commission of ICC  have jointly introduced an innovative bank assisted trade instrument—BPO, a potential game-changing innovation shaping supply chain finance and international trade in coming years.

What is BPO?

BPO, as defined by financial messaging service provider SWIFT and the banking commission of ICC is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after successful electronic matching of data, generated by SWIFT’s Trade Services Utility (TSU) or any equivalent Transaction Matching Application, based on Uniform Rules for BPO issued by ICC. Essentially, BPO is an alternate payment instrument to settle international trade with automated processing and reduced risk (assurance of payment to the seller). It offers:

• Automated and secure processing
• Standard set of ISO 20022 messages that enable interoperability between participating banks, thereby helping them extend global market reach
• Straight through Processing (STP): As the ISO 20022 messages are extended to corporate users, the same can be adopted for communication between Corporates and their Banks. This message will enable end-to-end straight through processing with corporate ERP systems.
• An assurance on payment to the seller similar to a confirmed letter of credit, which helps mitigate risk across of the parties of the trade
• Flexible financing options from banks based upon confirmed purchase orders and invoices on pre-shipment and post-shipment finance respectively

How does BPO differ from traditional trade finance instruments?

• In case of traditional trade finance instruments like Letter of Credit (LC), the undertaking on irrevocable payment is between the banks and their corporate clients, whereas a BPO is an irrevocable payment undertaking between the buyer’s bank and the seller’s bank.
• Legacy trade finance processing and matching are paper based, manual, time consuming and expensive; whereas BPO processing is automated (electronic processing and matching) with the global standard ISO 20022 messages.
• While a LC guarantees exchange of goods for payment based on physical presentation of compliant documentation, a BPO guarantees exchange of goods for payment based on electronic presentation of compliant data.
• Traditional trade finance instruments are characterized by high cost due to manual processing, frequent discrepancy handling and liquidity pressures. On the other hand, a BPO’s automated processing and matching reduces the processing cost and enables banks to offer competitive rate to corporate for the BPO transaction. Timely delivery of matching reports on POs and invoices enables corporates to have quicker access to liquid resources.

How will Banks benefit from BPO?

For a BPO transaction, the bank will be involved in all stages of an open account transaction, starting from the initial baseline submission and it will reduce the overall operational cost associated with the trade transaction. Banks can also offer value-added services like financing, cash forecasting, liquidity and working capital management to their corporate clients based on underlying trade transactions and reporting. Large banks can also offer white label processing tools for the banks that would not like to build their own BPO processing tool.

How will Corporates benefit from BPO?

BPO will benefit corporates operationally as there is no manual processing like document creation, verification, validation, tracking and reporting. It will also result in significant cost savings for the corporate through:

• Early access to pre and post shipment finance needs.
• Risk mitigation, as the undertaking is between buyer and a seller bank.
• No need to reissue the document in case the shipment happens at a different location, due to external factors such as natural disasters.
• No banking fees on document discrepancy handling and tracking.
• No verification and amendments charges.
• Early liquidity/working capital management due to faster transaction processing and settlement for the exporters.
• Importer can able to access the good early, as he will receive the documents quickly.

What will be the capital and accounting treatment of BPO?

Based on the initial reference of ICC Banking Commission, the BPO has the characteristics and behavior of contingent liability and at the time of issuance; this would be an off-balance sheet item for the obligor bank and characterized as unfunded (The execution of a BPO is contingent upon agreed transaction terms between the obligor and recipient Bank). The BPO, once utilized, will be removed or liquidated from the books and balances of the obligor and the recipient bank upon the execution of a BPO for a payment “at sight”. It will be on-balance sheet item if the deferred payment undertaking changes into definitive undertaking at the time of dataset match by the transaction matching application.

What could be the potential shortfalls of this system?

• Banks that are willing to offer BPO services need to invest in technology infrastructure/system capable of supporting and communicating with ISO20022 compliant messages as well as the Transaction Matching Application. Else, they may not be able to provide BPO services to their clients.
• BASEL III 100% Credit Conversion Factor (CCF) - The 100% CCF in calculating the leverage ratio for contingent trade finance exposures is applicable for  most of the off balance items, and it will impact the cost of trade finance instruments like Standby LC, Trade LC and BPO.
• Physical trade documents are required under local legislation and to release the delivery of goods from customs.

I hope this description clears some of the doubts regarding BPO and its implications. I would be glad to answer any further queries you have and to learn from your comments.