The Business Case and Contractual Setting for the Bank Payment Obligation
13.05 The banks spearheaded the creation of the BPO early in the twenty-first century due to the perceived need for a digital payment instrument that addressed the drawbacks of letters of credit and open account transactions.
That need for a digital instrument had arisen due to a convergence of several factors in trade, finance, and technology.13.06 First, documentary credits were generally perceived as inefficient, costly, and subjective since they required the manual transportation and processing of documents which was slow, time consuming, and inherently subjective, leading to avoidable disputes.[1242] One case study reported that replacing the manual document checking process with the BPO could abridge the payment process by seven days, reduce the documentation for the seller by at least 30%, and enhance accuracy and objectivity in examining the documents.[1243] Furthermore, the bank intermediation fees and the regulatory cost of capital for documentary credits, which were passed on to the customer, made this traditional financing instrument expensive. Since the documentary credit creates a contingent liability on the part of the bank issuer and any bank that incurs a payment obligation, a regulatory cost is incurred and then passed on to the applicant of the letter of credit. Furthermore, since the bank is required to hold capital against that obligation, it makes credit more expensive and reduces the amount of available capital for lending.[1244] Because of these drawbacks, there was a perceived need for a more efficient, cheaper, and objective instrument. That need was partly met by the migration of some business to the open account method, as discussed in the next paragraph, and partly by the creation of the BPO, which was structured to increase the operational efficiency and objectivity of the documentary credit payment process.
Secondly, by the beginning of the twenty-first century there was a near global shift in world trade payment methods to open account terms, which grew exponentially, while traditional finance methods, such as documentary credits, grew only modestly.[1245] Open account transactions are those where the trade between seller and buyer is not supported by any banking instrument or financing facility and the bank's role is limited to making payment.[1246] That shift to open account transactions was partly attributable to the increased share of trade between related parties, which do not require the strong security features of the documentary credit,[1247] and partly because open account transactions are cheaper and faster than documentary credits since the banks are only payment facilitators without making any undertaking to pay the seller and without any duty to examine documentary compliance for the benefit of the buyer.[1248] Open account transactions, however, have the inherent limitation that they secure neither payment for the seller nor performance for the buyer and, thus, leave the parties exposed to payment and performance risks.[1249] Furthermore, open account sales offer limited financing options and typically, the finance is limited to receivables or payables financing—essentially, post-shipment finance when the goods have been accepted and the invoices approved.[1250] Yet, suppliers frequently require pre-shipment finance before any invoices have been generated.[1251] These were important factors in the development of the BPO, which is intended to offer a wider menu of financing options across the supply chain.
Thirdly, by the beginning of the twenty-first century, globalisation had significantly extended supply chains for trade in commodities across the developing and emerging markets[1252] at a time when there was a significant contraction in the liquidity available for trade finance coupled with increased regulation that required higher margining requirements.[1253] Typically, the suppliers were small- and medium-sized enterprises (‘SMEs') with varying funding requirements and practices by industry or region, and they required innovative solutions to keep trade flowing and to remain afloat.[1254] At the time of increasing global trade, however, SMEs were severely constrained in raising working capital from banks, which were the traditional lenders for trade finance.
They, thus, had to look for alternative ways of funding and that resulted in the larger corporate buyers seeking new ways of assisting their suppliers obtain finance.[1255] Innovative financing solutions led to the creation of the BPO. Supply chain finance was required to provide more funds for working capital, mitigate risk, and enhance the multitude of business processes. Effected properly, supply chain finance could facilitate trade by giving the suppliers more finance options for enhancing liquidity while giving the buyers extended payment terms.[1256] The BPO met that need by making financing potentially available from the time the seller obtains a purchase order and before it produces any goods or services. The BPO, especially the deferred payment type, also increased the financing options for the supplier who required working capital. By assuring the seller of payment upon receipt of the purchase order, the instrument formed the basis on which pre-shipment finance could be based, much like an advance payment letter of credit, and generates crucial working capital. It is noteworthy, however, that the BPO has the same capital requirements as documentary credits since they are also characterised as contingent liability; that is, the obligor bank commits itself to make a payment when there is a data match with an established baseline or a mismatch that has been accepted.[1257] That is one significant factor why the BPO has not made significant inroads into the documentary credit territory, as will be seen later.13.07
13.08
13.09 The fourth and critical factor for the creation of the BPO was the development of new and innovative technologies by banks, specialised financial institutions, and independent providers that increased the digitalisation of trade, including the transmission and processing of messages on electronic platforms.
The technology was based on the familiar concepts of eDocumentation and ePlatforms and aimed to deliver trade-finance products more efficiently and cost effectively.[1258] The BPO is one such financial product which adapts technology and the familiar legal features of the documentary credit in trade finance by utilising banking channels to mitigate risk and assure efficient and costeffective payment.[1259]A. Transaction and Contractual Setting
13.10
The BPO serves the same purposes of assurance of payment and performance as the documentary credit which, of course, is a well-known financial instrument. Like the confirmed documentary credit, the BPO in the four-corner model for supply chain finance, involving two banks and the two counter-parties to the trade transaction, is most suited to crossborder trade. This model reduces Know-Your-Customer and other compliance requirements for each bank because the trading counterparties would normally be customers of the bank.[1260] In that model, the first relationship is the contract for the sale of goods and their shipment between the buyer and seller, for which they directly exchange the trade documents. That transaction forms the basis for, but is not part of, the BPO. It is not a standardised transaction. However, the International Chamber of Commerce has a template in the form of the ICC Model International Sale Contract.[1261] The second relationship is that between the banks and their respective customers, the buyer and seller. That relationship, too, is not standardised, but the International Chamber of Commerce (‘ICC’) has launched the Guidelines for the Creation of BPO Customer Agreements.[1262] In the performance of their duties under that relationship, the seller and buyer respectively extract and send the trade data to their respective banks, which, in turn send it to the TMA.
When the seller's data matches the pre-agreed data received from the buyer, there is an established baseline on which the TMA would, subsequently, base its decision regarding whether there is a match of data to trigger payment. The third relationship is the one between the TMA and the two respective banks. Since the TMA plays a central role in the BPO transaction, the involved banks must subscribe or participate in the same TMA[1263] and be subject to its rules.[1264] Presently, all BPOs use the Trade Services Utility (,TSU'), which is the TMA at SWIFT. Furthermore, as seen above, the contractual framework for the BPO requires the use of industry standards in the transmission of structured digital messages among the banks and the TMA. The advantage of using industry standards is that any party can exchange data by using a trade transaction matching scheme, and that eventually, the BPO can be used by any TMA that uses the same standards.[1265] Thus, according to the URBPO, the use of the ISO 20022 Trade Services Management (‘TSMT') messages is mandatory and the use of any other message type is outside the scope of the Rules.[1266] If there is a successful match of the trade data by the TMA, the TMA sends the match report to the two banks, at which point the BPO becomes payable according to its terms (at sight or deferred payment). Copies of the match report are relayed to the buyer and seller by their respective banks, and payment is then made to the seller by the seller's bank.III.