How small firms will benefit from simpler, integrated trade finance systems

Micro, small and medium-sized firms make up the backbone of the world economy but struggle to gain access to financing and global markets
The solution is to simplify processes and integrate isolated systems to help such firms access increasingly complex trade and supply chains

Victor Fung,Bob SternfelsandMarcus Wallenberg

Published: 2:30pm, 24 Nov 2021

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Goods and services move around the world through the work of ships, trucks, planes, bytes and money. The US$5.2 trillion global trade finance system is as essential as the container or the data server to facilitate global trade.

But it doesn’t always work as well as it could. According to the Asian Development Bank, the trade financing gap reached US$1.7 trillion in 2020, up 15 per cent from 2018. As a percentage of the global goods trade, the gap grew from 8 per cent in 2018 to 10 per cent in 2020.

For micro, small and medium-sized enterprises (MSMEs), the financing shortfall is even more acute as they account for around 40 per cent of trade finance application rejections by banks. These are the challenges that the International Chamber of Commerce’s (ICC) Advisory Group on Trade Finance has been wrestling with since its creation in 2020.

The problem has real-world consequences. MSMEs represent about 90 per cent of global businesses and the majority of employment. By 2030, the world will need to add 600 million jobs to absorb new entrants to the workforce, most of them in the developing world.

MSMEs will be a huge part of meeting that demand. In addition, supply chain bottlenecks are slowing economic recovery, depressing corporate profits and contributing to inflation.

But this is also a problem with real-world solutions. Today, the trade finance system is characterised by a complex web of decades-old manual processes and isolated “digital islands” – closed systems of trading partners formed to address specific pain points. The answer is to simplify processes and integrate these islands so they can work together across networks and platforms.

There have been efforts to do just that with a proliferation of networks, digital standards and digitisation initiatives. A few banks have completed technological transformations in trade finance, and trade groups have supported the development of standards and best practices among their members. But these efforts are not enough, as the trade financing gap indicates.

We need a more systematic model that brings everything together, something we’re calling an “interoperability layer”. That is an awkward term, so first let us say what it is not. An interoperability layer is not a new bureaucracy or a replacement for regulation.

It is a virtual construct that provides a global framework for existing and future standards, protocols and principles with the goal of connecting participants to present and future networks. Such a construct would be built on three main logical blocks.

First, there are digital trade enablers, which would be standards enabling digitisation of both trade finance and global trade at large. Second, there are standards enabling specific digitisation of the trade finance industry. Third, there are best practices for trade finance interoperability.

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Governance could be provided by a single global industry entity or a consortium that also leverages existing initiatives such as the ICC Digital Standards Initiative, which was launched last year. We think significant progress could be made in a five-year period.

There is no perfect analogy but, as we see it, this interoperability layer would create something akin to the global ISO standard for quality for the trade system. It would operate along the lines of the Internet Engineering Task Force, which develops standards for the internet.

MSMEs are fragmented and lack scale as a group, so it is more difficult for them to access increasingly complex trade and supply chains. A more digitally interconnected trade system would help them reach countries and client segments they previously could not.

This is a complex project, but it is also one whose benefits would be broad and deep. Buyers and suppliers would be likely to see more liquidity, lower costs, less transaction complexity and greater access to credit and markets.

Moreover, by creating a common language and standardised technology, we believe an improved and integrated trade finance system could draw in institutional investors who have largely stayed out.

Logistics providers, many of whom still use paper, would benefit from the lower costs and greater security and efficiency that would come with standardisation of trade documents. Governments and regulators would have access to more and better information to support collaboration with financial players and potentially unlock extra financing capacity.

The time is right. Fast-paced innovations in areas such as digitisation and blockchain are perfect building blocks for improving the global trade finance system and ensuring the benefits extend to businesses of all sizes.

Victor Fung is chairman of the Fung Group and co-chair of the Advisory Group on Trade Finance. Bob Sternfels is global managing partner of McKinsey & Company. Marcus Wallenberg is chair of the board, SEB, and co-chair of the Advisory Group on Trade Finance. John Denton, secretary general of the International Chamber of Commerce, also contributed to this article