London, UK - 27 March 2024 - Arqit Quantum Inc. (Nasdaq: ARQQ, ARQQW) (Arqit), and Vayana...
Back to the future(Financial World)
Dominic Broom explores how recent legislation and cutting-edge technology are breathing new life into old-style financial instruments and enabling a rapid evolution of trade and supply chain finance
Global trade still relies on shipping billions of pages of documentation, but change is under way as the UN’s Model Law on Electronic Transferable Records (MLETR) has set the stage for bringing trade processes into the twenty-first century. Trading economies are now enacting the legislation needed to support the adoption of digital trade documents, which is underpinning a rapid evolution of trade and supply chain finance.
In the most recent shifts, the French parliament gave legal recognition to digital trade documents based on the MLETR on 5 June 2024, and Mexico recognised amendments on negotiable instruments on 27 March 2024. But the most important breakthrough by far occurred in September 2023: the introduction of the UK’s Electronic Trade Documents Act (ETDA). With more than 60% of global trade being documented under English law, at a stroke the ETDA paved the way for the widespread reinvigoration of receivables and payables finance as electronic transferable documents.
New opportunities in old-style instruments
Going digital represents a huge transformation for trade, but the new supply chain finance landscape actually centres on some familiar tools: bills of exchange and promissory notes. A bill of exchange requires a debtor to pay the creditor a fixed sum of money on demand, or on a particular date. A promissory note is issued by the debtor and is, as it suggests, an undertaking to pay the creditor a particular amount. Both are negotiable instruments. Since their codification into law in the nineteenth century, they have facilitated long-distance transactions by providing secure and enforceable payment methods.
But as enhancements to the production and transport of goods – in particular the introduction of shipping containers – revolutionised physical supply chains (before containerisation one ship could take ten days to load and unload), these go-to solutions became less commonly used. Put simply, a paper-based short-term financing instrument just couldn’t keep up in a fasterpaced environment. For example, in a financing period of 30 days, the time it took to draft, approve, sign and exchange these paper documents – often over long distances – could take up a third of that period, thus seriously limiting their use and making them unviable in many modern supply chains.
With the digitalisation of trade finance, however, these inefficiencies are easily addressed, breathing new life into these proven, age-old instruments – and positioning them to become an invaluable supply chain finance tool once again.
Time to execution and time to cash
Digitalising negotiable instruments allows the financial supply chain to keep pace with the physical supply chain. Agreements can be completed in minutes or hours, rather than days, bringing 30-day financing periods firmly into scope. In fact, the automation and real-time capabilities of digital negotiable instruments mean that the speed of finance now by far exceeds the speed of the movement of goods. That in turn enables radically improved supply chain finance and working capital solutions, bringing many advantages for companies, suppliers and financial institutions alike.
In part, that’s because existing supply chain finance solutions rely on non-negotiable documents. Because digital negotiable instruments are unconditional, independent instruments free from underlying performance risk, they can provide suppliers with almost instantaneous payment, with 100% of the instrument’s value being financed. In supply chain finance, a haircut is usual. Digital negotiable instruments can also be used to facilitate early payment to suppliers, in exchange for corporate discounts. This results in improved working capital access for suppliers and strengthened relationships.
Furthermore, for companies looking to access external finance for their suppliers on an ‘as needed’ basis, digital negotiable instruments provide them with far greater control of their working capital management. They can now choose the frequency with which they access funding, depending on changing liquidity needs. Digitalisation also helps when it comes to any transfer of the instruments. As traceability and immutability are assured by the contract’s representation on a digital ledger, transactions are highly secure.
Digital negotiable instruments in action
How might this look in practice for a supplier? Take an Indian manufacturer looking to export to the UK market. This would typically involve a letter of credit, which can result in a cumbersome and administratively complex process. But, by raising a digital bill of exchange on the UK purchaser instead, the manufacturer can receive the same degree of payment assurance offered by a letter of credit without the administrative complexity. Once they have that assurance of payment, they can give the purchaser the title documents to the goods with full peace of mind.
What about a buyer? If they wanted to access postmaturity finance – that is, they wanted to effectively extend the payment terms – they would simply select invoices that they wish to finance and raise a digital promissory note of corresponding value with an agreed maturity date. That way, they settle their payables while optimising their cash conversion cycles, with no disruption to agreed supplier payment terms.
These financing solutions provide liquidity and flexibility, enabling businesses to meet their financial obligations without straining their resources. With businesses facing growing pressure from regulators and governments to make timely payments to their suppliers – including in the form of potential revisions to the Late Payments Directive that are currently going through the European Parliament – being able to rely on superior, digital instrument-based financing is particularly attractive.
Looking back to enable the future
The future of supply chain finance will be underpinned by the broad adoption of digital instruments. Digital bills of exchange and digital promissory notes will increasingly feature in the supply chain toolboxes of forward-thinking treasury and banking professionals across the globe, with companies embracing these instruments and the value they bring.
On a structural level, financial institutions and companies must collaborate to harness the full potential of these technologies and capture the new finance opportunities on offer. Fintechs will have a key role to play in this. For instance, Arqit, a provider of quantumsafe encryption, collaborated with the International Chamber of Commerce (ICC) UK and the Infocomm Media Development Authority (IMDA) in Singapore to launch the first cross-border quantum-secure digital trade transaction in 2023.
You don’t have to reinvent the wheel to implement digitalisation in trade and supply chain finance. Enhanced by their new digital capability, tried and tested negotiable instruments can return to their former glory, enabling global trade, securing supply chains and supporting businesses through optimised supply chain finance.
