Reconceiving the Global Trade Finance Ecosystem
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| Published | 2021-11-30 |
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| Organization(s) | McKinsey |
| Where | Huston TX |
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This report explores the increasing digitization of financial and commercial services, trade finance and how this has been relatively slow to modernize its decades-old processes. Multinational corporations have begun to leverage digital technologies that promise improved supply-chain efficiency and transparency, establishing new digital networks to facilitate trade and finance. But MSMEs, with their fragmented nature and limited scale, find it difficult to capitalize on such opportunities.
Trade finance does not work as well as it could, particularly for the millions of smaller businesses that help fuel the global economy. A new joint report sets out a vision for improving the ecosystem for all players.
The need to improve the $5.2 trillion global trade finance ecosystem—which facilitates the movement of goods and services around the world—has been evident for some time. A recent Asian Development Bank study estimated that the gap in trade finance availability reached $1.7 trillion in 2020, representing 10 percent of global trade. Disruptions fueled by the COVID-19 pandemic are widely acknowledged to have exacerbated this shortfall, which is expected to persist absent proactive measures.
These issues are particularly challenging for the micro, small, and medium-size enterprises (MSMEs) that play an increasingly important role in global trade. Financing rejection rates for such businesses run at 40 percent; a 2017 World Bank study indicated that 65 million MSMEs were credit constrained. Most Popular Insights
Against a backdrop of increasing digitization of financial and commercial services, trade finance has been relatively slow to modernize its decades-old processes. Multinational corporations have begun to leverage digital technologies that promise improved supply-chain efficiency and transparency, establishing new digital networks to facilitate trade and finance. But MSMEs, with their fragmented nature and limited scale, find it difficult to capitalize on such opportunities.
Resolving this issue is critical for all participants in the global trade finance system. The sector accounts for roughly 6 percent of global GDP, so its performance affects the health of the future world economy. An improved global trade finance ecosystem could add many of the 600 million new jobs needed by 2030 to absorb the growing global workforce, as well as enable progress toward the goal of financial inclusion, which is particularly needed in developing economies.
Our organizations—the International Chamber of Commerce’s Advisory Group on Trade Finance and Fung Business Intelligence, supported by McKinsey as analytical knowledge partner—collaborated on a research effort encompassing more than 150 interviews with end users and subject-matter experts around the globe to better understand the pain points and opportunity areas for enhancement of the existing trade finance ecosystem. In this article, we share a synopsis of our findings, as well as a proposed framework for digitally connecting and facilitating interoperation among existing networks through sets of shared standards, processes, protocols, and guiding principles. A copy of the full report can be downloaded on this page. An evolving landscape
The global trade finance ecosystem is characterized in part by the diverse array of its participants. At the heart of the system, buyers and suppliers include companies of all sizes. Most, however, are MSMEs, which serve as the backbone of economies around the globe and account for over 95 percent of firms and 60 to 70 percent of employment. These metrics suggest that a healthy trade ecosystem requires thriving MSMEs, which are a focus of our research.
Other participants are financial institutions, which provide the liquidity and the risk assessment necessary to execute trade transactions, along with a wide range of services satisfying a growing list of trade participants’ adjacent requirements. Although corporate banks remain the dominant presence in this area, opportunities for greater participation exist for institutional investors, export credit agencies, and credit insurance companies. Financing alternatives include both supplier-side and buyer-led models, depending on which yields the best commercial terms and working-capital outcomes for a given relationship.
A third key player in trade finance is the logistics industry, which not only delivers products, but also facilitates the accompanying flow of information. Other stakeholders include technology providers, trade organizations, governments, and their various regulatory bodies.
Given our focus on MSMEs, our research looked for the pain points they face. We identified three significant pain points, beginning with access to liquidity. Many MSMEs either lack the necessary collateral or can’t meet the risk assessment criteria for leveraging trade finance services. Compounding the problem, banks may feel that limited access to enterprise-related historical data constrains their ability to extend credit.
Another challenge is the complexity of trade finance transactions. Intricate workflows span multiple parties, which causes significant manual work and typically requires the exchange of paper documents, increasing operational costs and elevating credit risk. In addition, regulations differ across jurisdictions, a situation that often leads to complex and opaque processes. Further complexity comes from the nuances and subsegments of the three primary product categories: documentary business, supplier-side financing, and buyer-led financing.
Finally, MSME suppliers face particular challenges in the search for new clients and revenue sources that are essential to their growth, including institutional barriers and bureaucracy, lack of resources, and a lack of access to overseas markets. Digitization of trade processes and trade finance could alleviate some of these conditions by increasing transparency and freeing up resources.
Progress on these issues has been slowed in part by the fact that trade finance has adhered to established and traditional technology approaches for many years. Recently, however, innovations such as blockchain, application programming interfaces (APIs), natural-language processing, and advanced optical character recognition have emerged in the space. These developments create significant roles for technology providers. A vision for network interoperability
Advancements in technology have led to a variety of new trade finance approaches and players, each addressing the shortcomings of legacy processes. To date, however, such pockets of innovation have given rise to “digital islands,” or closed systems of trading partners leveraging (usually) proprietary technology tailored to address specific use cases and pain points. In solving near-term challenges, these solutions can also unintentionally create longer-term disconnects.
An enhanced global trade finance ecosystem could address these issues by bridging the digital islands. Key to this vision is an “interoperability layer” fostering ubiquitous access across networks and platforms (Exhibit 1). Such a model would significantly improve global efficiency, in part by sharply limiting redundancies while simultaneously enabling the adoption of a series of global shared utilities and standards. Importantly, such a model is compatible with the ongoing development of bespoke solutions addressing the current and prospective pain points affecting specific sectors, geographies, and other subgroups.
The interoperability layer would be a virtual construct that acts as an umbrella for existing and future standards, protocols, and guiding principles. To be clear, it is not a proposal for regulatory change, nor is it intended to be a hardware or software entity to which parties must connect. It would be a collaborative effort involving relevant organizations in the trade finance market. It would give all parties—particularly underrepresented segments like MSMEs and businesses in emerging markets—a fair opportunity to participate.
The goal is an architecture of common standards and best practices enabling trade finance to become more inclusive, collaborative, and digitized. Such architecture could encompass three main logical blocks:
- digital trade enablers—standards enabling the digitization of global trade beyond financing activities
- interoperability foundations—standards enabling specific digitization of the trade finance industry
- guiding principles for trade finance interoperability—nonmandatory recommendations for market participants focused on improving service levels while reducing players’ cost to serve
Some of these building blocks are already present in the market, though not at scale; others remain partially developed.
An interoperability layer could be central to three key missions (Exhibit 2):
- Promoting adoption at scale of existing trade finance standards for operational interaction. Existing initiatives such as the Legal Entity Identifier and European Digital Identity are designed to solve know-your-customer challenges, while the Model Law on Electronic Transferable Records and electronic bills of lading create standards for global trade documents. An interoperability layer would facilitate adoption at scale of such efforts. A more recent example is the uniform data model being pursued by the Hong Kong Monetary Authority’s newly launched Commercial Data Interchange.
- Defining and disseminating additional global trade finance standards and protocols to fill market gaps. APIs have evolved into an efficient means of enabling interaction among core participants in the trade ecosystem. Such code is embedded seamlessly into millions of websites, enterprise resource planning systems, and mobile devices, revolutionizing the way participants transact and access information. For users to realize the full potential of these tools, however, someone must standardize the APIs employed for trade finance. At present, trade finance lacks a standard set of APIs to support its various services. An interoperability layer could help establish such compatibility and connectivity.
- Designing blue books and guiding principles for collaboration among participants in the trade finance ecosystem. An interoperability layer can also function as a think tank whose participants incorporate recommendations and achieve economies of scale that were previously out of reach. Although fully harmonized standards or regulations across all countries or constituencies may sometimes be infeasible, information sharing can achieve many of the same goals by adding clarity and fostering consensus among market participants. The creation and adoption of blue books and best practices—compendiums of information, recommendations, templates, and processes—can further this effort.
An interoperability layer also could support progress toward sustainability goals. Public and private enterprises have increasingly embedded sustainable finance into their governing principles, setting specific targets for delivering the measurable sustainability expected by their stakeholders. Investing with environmental, social, and governance (ESG) performance in mind has led to global sustainable investment now topping $30 trillion. The trade finance community has recognized its central role in meeting these goals: products are adding new dimensions, and the agendas of financial institutions, export credit agencies, and trade organizations are evolving to incorporate sustainability objectives. Building a consensus for global interoperability
Already, ecosystem participants are taking constructive steps toward trade finance modernization and inclusion, as seen in the recent proliferation of networks, digitization efforts, and standards. This wave of activity also validates the premise that market participants—especially banks—recognize the importance of enhancing trade finance efficiency. The industry’s current challenge is to build on this momentum by providing a framework for scaling of best practices and building out key parts of the reconceived ecosystem.
In this endeavor, it is vital to keep the welfare of the end users, particularly MSMEs, at the heart of a collective vision, and to increase inclusion in the trade finance ecosystem. While all players can expect to benefit from implementation of the proposed vision, the timing and extent of these benefits will vary. The greatest potential benefit would likely flow to the end users—suppliers and buyers—of trade finance instruments.
Financial inclusion—that is, financial products and services accessible and affordable to all businesses—is a fundamental pillar of a healthy trade ecosystem. While barriers to financial inclusion are a longstanding problem, increased coordination of all trade participants, boosted by technology and standards, will be a significant step toward closing the MSME financing gap. Solving buyer and supplier pain points will, by extension, generate opportunities for the ecosystem players supporting them. Benefits for suppliers and buyers will include cost reductions, access to liquidity, reduced transaction complexity, and greater access to B2B markets—the last of which addresses MSME pain points identified in our research.
Although 40 percent of global trade is currently supported by bank-intermediated trade finance, coverage is not uniform across countries or segments, particularly in developing countries and with MSMEs. Full deployment of an interoperability layer would enable substantial structural change to the financial industry, benefiting existing providers (primarily banks) while attracting much-needed new credit capacity from entities such as institutional investors, who should be drawn by the added transparency, access to technology, and regulatory support. In addition, an enhanced ecosystem could create additional revenue streams and value-added services while making the processes more efficient and cost-effective.
For technology and digital deployment to deliver benefits such as faster time to market and optimally expanded markets, they must be supported by a framework of standards and best practices. The same holds true for the contributions of logistics providers and trade organizations.
Finally, governments and regulators play an important oversight role for the trade ecosystem. Advances in standardization and digitization should help streamline their tasks, in turn limiting the administrative challenges for those being regulated. Enhanced market monitoring and influence, combined with potential boosts to local or national economies, are among the additional benefits for governments.
Putting it all together
Given the complexity of the global trade finance market, a comprehensive effort to reconceive the ecosystem could easily take five to ten years to reach a point at which most participants reap its full benefits. However, some building blocks of an interoperability layer could be deployed on an accelerated path, leveraging the work already done by trade organizations, technology providers, and others. A strong commitment, particularly from banks, should deliver tangible benefits in two to three years and build momentum for the remaining initiatives.
A road map for the full vision would consist of three phases (Exhibit 3). The first would focus on mobilizing the current ecosystem; the second would develop the new ecosystem and begin the push for adoption. The third phase would scale up efforts on a global level, bringing solutions to the full array of market participants.
The overarching vision is to build on the collaboration already gaining momentum among participants in the trade ecosystem, address gaps in existing operating models, and, most importantly, promote wider adoption through further coordination. If the global trade finance community can be inspired to cooperate, the joint objectives—and an equitable distribution of benefits—are well within reach.
About the author(s)
Alessio Botta is a senior partner in McKinsey’s Milan office, Adolfo Tunon is a senior advisor based in London, and Reema Jain is a senior knowledge expert in the Delhi office. Pamela Mar is Executive Vice President, Knowledge and Applications, Fung Academy, Fung Group. Andrew Wilson is Global Policy Director and Permanent Observer to the United Nations for the International Chamber of Commerce.