BPO: a Valuable Component in Supply Chain Finance
by Frank-Oliver Wolf, Global Head Cash Management & International Business, Commerzbank AG
In an era of technological progression and innovation, corporate demand for efficient, reliable trade solutions is increasing; a trend reflected in the fact that no less than 90% of international trade flows are now conducted on open account.
Yet while corporates may be relatively comfortable trading on these terms with longstanding, trusted counterparties, new relationships in unfamiliar trade corridors are best approached with an element of caution. In this respect, open account trading offers little in the way of risk mitigation – particularly when compared with the traditional, secure, stalwart solution of the letter of credit (LC).
The answer, therefore, could lie with the bank payment obligation (BPO). BPO offers a level of security that cannot be provided when trading on open account while, at the same time, eradicating the significant documentation demands of LCs. What is more, with demand for liquidity, management of risk and working capital increasing across the supply chain, BPO also offers the opportunity to attain financing and manage risk throughout the value chain.
The BPO is an irrevocable payment undertaking given by one bank to another that trade settlement will occur on a specific date once a pre-agreed event has taken place. This event is identified electronically through the successful matching of agreed baseline data (i.e., the data set of the underlying trade transaction). This automation allows for increased efficiency and reduced costs while providing a high level of flexibility, allowing any transactional adjustments to be made at short notice. Given that no trade documents are presented and examined, BPO is unable to offer the same level of risk protection as that provided by an LC, and is therefore not an electronic documentary credit intended to replace the LC but rather a valuable instrument in its own right.
Furthermore, BPO should not be viewed purely as a new tool for trade finance, but also as a useful supplement to working capital management and supply chain finance (SCF). Significantly, unlike pure open account trade, BPO offers the possibility of confirming the payment obligation between banks, therefore acting as a type of payment assurance. This gives the seller the option of obtaining financing on the term of payment under the BPO. And by processing trade data on an electronic basis, treasurers can use the scheduled payment inflows to drive improved cash and working capital management; also reducing time and money spent on debtor management. As the trade data to be matched is co-ordinated in advance between buyer and seller, shipment and contract performance risk are also reduced.
With the health of the entire supply chain an important consideration for corporates, the buyer can extend payment terms and offer the seller financing under its own credit rating, without additional risk or having to establish new credit lines; improving the cash flow of suppliers, reducing risk and safeguarding future business. This corresponds to the financing model of approved payables finance (also known as reverse factoring) in SCF.
Essentially, the BPO offers optimisation of working capital, risk and processes management and, at the same time, possible provision of liquidity - the key factors for effective supply chain management. Its benefits are therefore apparent, and efforts to drive corporate uptake of this trade instrument are gaining momentum. The Uniform Rules for the Bank Payment Obligation (URBPO) – a legal framework developed by the International Chamber of Commerce (ICC), SWIFT, and banking and industry representatives to support the BPO initiative – came into force in July 2013. These rules aim to establish uniformity of practice in the market adoption of BPO and the related ISO 20022 messaging standards.
The ICC’s commitment to BPO has been further evidenced by its rallying support at international conferences and events. This recognition has certainly been valuable in generating awareness of the BPO, and in April 2014 SWIFT announced that 56 banking groups in 47 countries now have access to the trade service utility (TSU), the platform required for the matching of electronic trade data. In addition, the SCF working group of the European Banking Association (EBA) is discussing the BPO in connection with SCF.
Yet this alone is not enough. In order for the BPO to become successfully established in the market, banks have a key role to play in educating their corporate clients about BPO and its development; helping them to realise the extent of the benefits of BPO – both in trade finance and in terms of supply chain management. Only if exporters and importers recognise the practicability and profitability of the BPO, and make use of the new instrument for their trade transactions, will it gain in importance in the long term. Progress on this front has so far been promising with trading companies showing increasing interest in the BPO, especially in Asia where the first pilot transactions have been carried out.