- The global trade market is dominated by a few large players protected by competition by steep barrier to entry for new firms, despite accounting for a smaller portion of national GDP.
- New firms leveraging emerging technologies like blockchain could offer solutions to a number of these entrenched challenges.
Historically, banks only disintermediate approximately 36% of total trade finance transactions with the remainder as cash-in-advance transactions or open account transactions. In addition, these transactions are lower risk, with an average duration of less than 90 days and very low default rates with high recovery rates for defaults. This particular form of finance yields a low, but steady margin in the range of 4% with relatively low risk. While this certainly leaves the opportunity set wide open and makes the operation an attractive one from a risk perspective, the reality is that slim margins, lack of balance sheet, and other regulatory issues limit how large the trade finance market can grow.
Trade finance is a traditional banking service that generates fee revenues. However, the high cost of manual contract creation, verification, validation, fraud prevention, and regulatory and compliance make trade finance margins quite thin. In addition, the high fixed costs associated with regulation and compliance limit banks from working with smaller clients.
Distributed ledger technology, also known as blockchain, offers the ability to reduce costs and increase margins, as well as increase access to trade finance. In doing so, blockchain platforms such as R3 and we.trade promise not only to expand the trade finance market, but also to expand global GDP and help to reduce inequality. In fact, the World Economic Forum in partnership with Bain and Co. estimates that blockchain can potentially add $1 trillion in trade finance transactions that would not otherwise be possible under the traditional trade finance model. And, this added supply of trade finance would likely be entirely consumed by the estimated $1.5 trillion gap of unmet trade finance demand generated in the emerging markets. A 2017 Greenwich Associates report called “Trade Finance: A Market Eager for Disruption’ suggests that trade finance is an outlier in the world of finance for having so little technological innovation.
The biggest challenge is not whether or not to make an investment in this growing trade finance market, given the massive unmet need that will likely survive the current bout of de-globalization by directly addressing the inequality issues currently presented by the current policy regime that favors corporations over workers. The real question is, how?
Currently, R3 and we.trade have attracted large banks as partners and have attracted initial capital to launch. But the big difference is their approach: a slow and steady focus on system-wide integration proffered by R3 versus the more nimble and faster-to-market approach offered by we.trade. Since we believe that network effects will be the largest value creation of these platforms, we see the R3 approach as the one with the best longevity over time because it will ensure that all intermediaries are on a platform that can effectively connect them all with a process that re-establishes trust, verification, and authenticity at a lower cost.
In conversations with market participants, the biggest problem is that there are so many parties beyond banks that must participate in a platform in order to make it ultimately successful. Manufacturers, insurers, ports, customs brokers, etc. This is not a small ecosystem to cultivate, so the first to achieve a real network quickly will likely attract the largest network in the end. Think Facebook versus MySpace. In that regard, We.Trade may be able to leap frog participants onto the platform.