There has been more than significant interest in blockchain in the world of commodities over the last couple of years. While, at times, some of this interest may have been only hype, we are now beginning to see some small-scale commercial application of blockchain, or perhaps more accurately, distributed ledger technologies (DLT), emerge via consortia in the space such as the Vakt initiative, for example. Many of these blockchain projects have focused on the post-trade world of settlement and reconciliation.
Areas where blockchain, or DLT, may potentially result in a paradigm shift in approach are those were there are compatibility, trust and/or transparency issues among and between both systems and participants. Traditionally and historically, players like traders, brokers, regulators, exchanges, insurers, banks and other parties have had to go through a lot of processing that often involves middlemen and have dependencies that can take a lot of time and effort to resolve and process. By applying blockchain and smart contracts to some of these post-trade activities, much of these issues may be eliminated while also speeding up trade settlement.
What are the main benefits of Blockchain?
Among the often-cited benefits of blockchain are improvements like streamlined and/or real-time settlement, significantly improved liquidity, optimisation of supply chains, improved traceability and increased transparency. Performing trade confirmations through smart contracts can also help to reduce the number of intermediaries and steps in the process. In turn, costs for activities like trade capture, audits, and trade verifications can also be reduced. The idea is that blockchain can potentially help eliminate the middlemen as the transactions become validated by the community itself and helps to increase trust between the parties involved. Blockchain can also help to reduce costs via increased automation. As costs are lowered, so too is the barrier to entry that can help increase both liquidity and investment.
In 2014, an Oliver Wyman report estimated that the financial industry spent $80 billion (€70.6 billion) annually on such post-trade processes, with most of that money going either to depositaries or the numerous agents and middlemen that were employed along the settlement chain. Plainly, this expenditure presents a large opportunity and significant incentive to look at blockchain for post-trade processing cost reduction.
One recent example of the potential benefits is the FX Everywhere platform from HSBC, which has settled more than three million FX transactions and made more than 150,000 payments worth $250 billion using distributed ledger technology (DLT) as of January of 2019 according to an HSBC announcement. In use for more than a year by HSBC to orchestrate payments across its internal balance sheets, it has resulted in ‘significant efficiencies and opportunities’, according to HSBC. HSBC says that key benefits include:
- Singularity, transparency and immutability. A shared, single version of the truth of intra-company trades, from execution through to settlement, which reduces risk of discrepancy and delay,
- Payments orchestration. Confirmation and settlement is automated by matching and netting transactions, which reduces costs and reliance on external settlement networks.
- Balance sheet optimisation. A consolidated, global view of forward cash flows, and certainty of funds throughout the funding cycle, supports greater balance sheet optimisation.
Voltron is another example. It connects Corporates with their Banks and Trading partners, on a distributed ledger for the issue of letters of credit (LCs) and to exchange documents, to make those transactions more efficient. The distributed ledger technology provides‘a single, transparent, end-to-end trade, executed quickly and seamlessly between buyer, seller and their respective banking partners’, say Voltron’s backers. “Being conducted on a single, shared application, rather than multiple systems, it delivers a substantial reduction in the time it takes to execute the trade, from up to 10 days, down to 24 hours.’ Voltron is backed by Bangkok Bank, BNP Paribas, CTBC Holding, HSBC, ING, NatWest, SEB and Standard Chartered.
In commodities, one of the most visible initiatives is the Vakt consortium. Using blockchain technology, Vakt helps to manage physical oil transactions, eliminating reconciliation and paper-based processes. It’s a consortium of oil companies and banks (BP, Gunvor, ABN-AMRO, Equinor, Koch, ING, Shell, Mercuria, Chevron, Total, Reliance and Societe Generale) focused on developing and deploying solutions for post-trade processing. It is designed to help ‘eliminate reconciliation and paper-based processes, enhance efficiency and create new trade finance opportunities’.
Recently, the platform went live for the physically traded BFOET crude oil business and is arguably the world’s first fully operational, enterprise-grade blockchain platform to enter the market. Vakt can also offer blockchain-based financing solutions to its users via its alliance with komgo.
Komgo is also a blockchain-based platform and is also now live. It digitises and streamlines trade and commodity finance. It offers two products,
- a digital letter of credit (LC), which allows commodity players to submit digital trade data and documents to their banks, and
- a know your customer (KYC) solution to standardise and facilitate the KYC process enabling exchange of documents on a “need to know basis” without a central database.
The aim is for komgo to help speed up deal processing and enhance trust between parties as each can monitor and verify the operations progress helping to reduce the risk of fraud and resulting in a shorter cash cycle.
To some extent, blockchain is a hammer looking for the right nail and identifying where the technology may be best and properly applied remains hazy. For Adaptive, that makes it even more critical to monitor all of these developments to see which approaches succeed and indeed add value or shift the paradigm. One thing that seems to be a truism is that by reducing settlement times, there is an increase in liquidity and trade volumes, and to us, this seems like another benefit to getting this right. Meanwhile, market forces will continue to drive this technology.
CEO and co-founder,
Adaptive Financial Consulting