Cash & Liquidity ManagementCash ManagementBank Payment Obligation: A Tortoise in the Race?

Bank Payment Obligation: A Tortoise in the Race?

LCs have a long and respected history as facilitators of trade. They have undeniable benefits, particularly for transactions with more complex workflows such as structured finance deals where there are several payment junctures. LCs also reduce the risks when entering new markets – unquestionably a key and perennial concern for corporates. Additionally, regulations in some parts of the world continue to require physical documentation.

That said, open account is now the preferred payment option for more than 80% of the world’s trade, mainly due to the fact that the benefits of speed and efficiency outweigh risk concerns. Open account provides flexibility for settlements and lower risks for the buyer, as well as the expected benefits of digitisation.

Yet neither option is ideal, nor do they collectively cover all the potential needs of corporates trading globally. LCs are slow, often arriving after the goods they are meant to cover and are also cumbersome, with documentation being initially rejected as often as seven in 10 times due to discrepancies or non-compliance. Meanwhile, open accounts result in the seller being unprotected from payment risk.

Clearly there’s space for a third option – not a replacement, but one presenting different benefits in order to broaden the choice for corporates. Introduced in 2007, BPOs offer just such an alternative. They share some characteristics with both solutions, yet they are also unique. They offer the bank intermediation of LCs – as the obligor bank offers assurance of payment to the recipient bank – but an electronic, rather than paper, matching process that mirrors open account.

Despite their apparent strengths, however – and their distinction from other tools on the market – they have been adopted only slowly by trading entities. However, recent trends are generating optimism that finally BPOs are making a breakthrough in terms of volume and market penetration.

Equipping Treasury

BPOs tally with many of the key aims and anxieties of corporate treasurers: in essence, they reduce time and inefficiencies, risks and document handling, yet increase visibility, reliability of reconciliation and control. They do so in an elegant manner, with standardised data creating improved opportunities for interoperability.

Purchase order information, in the universally compatible ISO 20022 format, is sent from the buyer’s bank to a Transaction Matching Application and on to the seller’s bank. Arguably, the greatest benefit is that accounts payables reconciliation is significantly accelerated, with the entire process usually taking less than week or one third of the time for LCs.

The obligor bank assures payment upon confirmation that the seller has met all terms and conditions, while no such assurances exist with open accounts. This allows BPOs to be used as collateral for pre-shipment and post-shipment financing and, most importantly, eliminates counterparty risk for both sides.

The reduced settlement period results in enhanced flexibility and control over working capital for the exporter, as well as reduced document handling: a clear benefit for both sides, not least because of the reduction in human error as well as the administrative costs of labour.

Certainly, the decreased risks mean that BPOs work well in riskier open account situations, perhaps involving unfamiliar regions, new markets or counterparties. In real time, BPOs offer an end-to-end service that is easily monitored by all parties. This is achieved without loss of granularity; invoice and shipping information are easily accessible and the automation of the trade flow and electronic management of data creates further transparency and eases compliance.

Slow but Steady

Given the distinctly advantageous nature of this tool, it may be surprising that market take-up of BPOs has been slow. Potential causes of the industry’s sluggishness or reluctance may include lack of information about BPOs, concerns about implementation and wariness of what is still a relatively new product.

The first two can be tackled with education. Banks must inform corporates of the nature and benefits of BPOs and the potential ease of adoption. For example, UniCredit hosts a series of workshops aimed at both treasury and sales departments, in order to encourage dialogue and disseminate expertise. The bank has also worked to develop an IT framework that allows straight-through processing (STP) and aims to incorporate BPOs into a corporate treasury’s workflow with as few changes as possible to organisational and IT infrastructures.

The introduction last year of International Chamber of Commerce (ICC) rules, drawn up in collaboration with SWIFT, was also intended to encourage and reassure corporates and banks regarding the utility of the product as a facilitator of trade.

Banks with an extensive network of correspondent banks can position corporates to leverage BPOs globally and their established relationships with regional banks can be utilised to better calculate local counterparty risk for example. They shoulder only the client’s risk (and that of the banking affiliate) while leaving the other side of the deal to the better-placed regional bank.

The benefits of BPOs are apparent, while adoption is becoming steadily easier and more established. Whether this will put BPO on a par with LCs within, say, a decade remains to be seen. Yet it cannot be denied that this is a valuable and expedient alternative for corporates that wish to speed up their settlements without increasing their risk.

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