HKMA is working on the project with Deloitte and a consortium of banks are Bank of China (Hong Kong) Limited, The Bank of East Asia, Limited, Hang Seng Bank Limited, the Hongkong and Shanghai Banking Corporation Limited (“HSBC”) and Standard Chartered Bank (Hong Kong) Limited. Deloitte is consulting on it.
A proof-of-concept platform for banks, buyers and sellers, and logistics companies demonstrated the application of DLT in digitising paper-intensive processes through prototype smart contracts for open trade financing. The use of DLT reduces the risk of fraudulent trade and duplicate financing, and improves the transparency of the transactions.
The project also explored the operations, legal, (cross-border) regulatory, governance and data security implications of DLT.
Li Shu-pui, Executive Director of the HKMA, commented, “We are very pleased to see this industry-led fintech effort on trade finance. The proof of concept result has shown the potential of using Distributed Ledger Technology for trade finance though there are still a number of matters such as legal, regulatory and governance issues which need further consideration. We will continue to work with the banking industry to explore the possibility to materialise the value proposition of this proof of concept work.”
Details of trade finance proof-of-concept from HKMA’s white paper on DLT
HKMA and the Hong Kong Applied Science and Technology Research Institute (ASTRI) revealed in a white paper on DLT last year that they were going to conduct proof-of-concept work in three areas: mortgage loan application, trade finance, and digital identity management. For each area, an industry working group was established to discuss the proof-of-concept
plan, formulate the scope and design of the work, and carry out the work in the HKMA-ASTRI Innovation Hub. end of October 2016, a DLT prototype for carrying out property valuations for use in the mortgage loan application had been built to the final stage, and testing carried out.
Driven by the ease of communication and the exchange of information between market participants over the Internet and market competition, trading has transitioned from being carried out on a documentary credit basis to open account terms. It means that a seller delivers the goods to a buyer directly before any payment is due, and without relying on documentary credit issued by a bank. This exposes banks to a heightened risk of fraud and money laundering as compared with documentary trade, due to the lack of third-party documentation and the low visibility of the transaction status.
The paper stated that DLT could help improve the transparency of trade transactions and facilitate the banks’ financing services for customers in three major ways:
- Use of smart contracts in open account trade: A smart contract is formed, when a buyer creates a PO, validated and accepted by the seller. The PO is digitally signed by both the buyer and the seller. Both the import bank and the export bank are permitted to read the PO and financing triggers are generated when conditions under the smart contract are met. On the payment due date, the smart contract alerts the buyer and the import bank of the payment obligation, and reminds the seller and the export bank to settle the export financing.
- Tracking of trade transaction statuses: Key trade documents, including the goods delivery status reported by the seller, shipping information from logistics service providers, and the funding status from banks can be shared and stored on the DLT network and accessible by all stakeholders in the transaction. Data feeds from logistics service providers can be collected at key touch points to reveal the most current status of the flow of goods.
- Matching of invoices to POs: When the seller creates an invoice against a PO, the DLT platform matches the line item details of the invoice and the transport documents with the PO. Depending on the status of the matching results, either “clean” or “discrepant”, post-shipment financing request is triggered from the seller to the export bank, or an alert sent to all parties for reconciliation.
FinTech innovation and regulators
Following a flurry of developments in 2016, financial regulators in Singapore and Australia are racing to keep up with the rapidly evolving innovations. The Monetary Authority of Singapore concluded a proof-of-concept project to conduct domestic inter-bank payments using blockchain in March 2017. MAS has plans for two spin-off projects, the first driven by the Singapore Exchange (SGX), focuses on making the fixed income securities trading and settlement cycle more efficient through DLT, while the second project focuses on new methods to conduct cross border payments using central bank digital currency.
In March, the Australian Securities and Investments Commission (ASIC), Australia’s corporate, markets and financial services regulator,released an information sheet on DLT, designed to help both ASIC and financial service providers or infrastructure operators evaluate whether the use of DLT would allow an entity to meet its regulatory obligations.