Estimated reading time: 11 minutes

The only constant is change, said Heraclitus in ancient times. Indeed, humanity has been evolving throughout history, accelerating the speed of advancements and innovations at an exponential rate. Humanity has created and lived through 3 major industrial revolutions, and we are now at the beginning of the fourth one. 

Technology has brought AI, the Internet of Things, digital transformation, human–machine interaction, connectivity and advanced engineering capabilities. All these technological disruptions lead to increasing labour productivity  –  efficiencies scale up many aspects of the economy and communication while improving day-to-day life. 

Change is constant in the financial system as well. Historically, both public and private markets have had a tendency to migrate from weak to semi-strong and strong forms of efficient markets. As your business becomes larger and more efficient, you reach economies of scale, and your gross and net margins initially get higher. 

However, with competitors entering the market and new technologies disrupting the old way of doing and managing business, you reach the end of your business cycle. 

Industry experience, a proven track record, a diverse vendor base, and robust competition contribute to a more balanced risk-return profile. Consequently, the labour market and cost of capital become highly competitive, leading to compressed margins across the entire industry.

The same logic could be applied towards the global markets – market efficiency and fair access to talent and capital in developed economies have always brought more opportunities and innovative technology faster than that in emerging ones. 

Developed economies have always been ahead of the game in regard to market efficiencies and innovation, especially helped by a strong and stable currency.  In the financial sector, we get fierce competition and price pressure. For example, private debt –  Bloomberg reported a few weeks ago that EQT’s Avetta Buyout received one of the cheapest loans in the private debt market at 4.5% over the benchmark rate, or a 1.25% cut compared to the company’s existing credit facility. 

Public markets, a strong appetite for higher yield and investor diversification requirements bring a lot of capital to deploy into private debt opportunities. Trade Finance is a sub-category of private debt and has been attracting significant investor attention globally in the last couple of years due to supply chain concerns, consequent pivot, supplier diversification and higher interest rates. 

The global trade finance market was valued at $9.3 trillion in 2022, while the trade finance gap has grown to $2.5 trillion, according to the recent finding by the Asian Development Bank (ADB). 

Meanwhile, if we analyse financing of the trade market in the 20th century and earlier, we can come to a conclusion that the era of high margins, high risks and returns, and untransparent transactions is far gone. Our new digital world with higher levels of transparency, sanctions, geopolitical oversight and more efficient capital servicing the industry doesn’t leave room for characters like Marc Rich anymore, but certainly welcomes public entities with full disclosures and compliance like Glencore today– of course, paradoxically the two are historically tightly intertwined.

International Trade Finance and the Small to Mid-Sized Enterprises (SME) market in the US and abroad currently still provide higher yielding opportunities to investors, but this is likely to change in the long term. There are several factors driving the increasing efficiency that will eventually lead to full commoditisation of the trade finance and SME lending strategy. 

Technology 

Trade documentation has always been paper-heavy, non-standardised and labour-intensive. During the COVID-19 pandemic, there were government shutdowns and shipping lags. 

Meanwhile, according to a McKinsey study, companies experience disruption of supply inflows lasting one or two months every 3.7 years. This ends up costing margin compression, sales disputes, loss or deterioration of vendor relationships and dissatisfied customers. 

Increasing resilience in the trade space and its financing initiatives will involve a lot of innovation and change: data input and connectivity, analysis and data storage and infrastructure. 

This will have a positive impact on all sides of trade financing: origination, servicing, portfolio management, monitoring, payments and reconciliation and other areas. Open API infrastructure helps connectivity between various departments and data pools which subsequent data analysis and synchronisation. 

There are multiple solutions that exist in the market currently addressing manual processes and other inefficiencies gaps – from OCR-based document conversion tools to full LLM-based models of not only converting information, but also analysing, summarising and producing sophisticated UI (User Interface). 

In the last couple of years, a few interesting players have emerged that focus on KYC/KYB, sanction searches and logistics analysis in the industry. The data is still fragmented but with open banking systems, integrations with ERP platforms, e-invoicing (electronic invoicing) and thorough integration capabilities the future could bring additional transparency, speed of execution and operational efficiencies. 

1. GenAI

Generative AI (GenAI) allows to classify and analyse large volumes of data based on visual, numerical and textual data. The potential range of applications and business cases could be limitless as long as input data has been tested and verified and there’s a significant layer of transparency. 

2. Distributed Ledger Technology 

Distributed Ledger Technology (DLT) is a peer-to-peer digital record where multiple nodes store, validate and keep the information blocks updated. Secure transfer of digital assets, rendering of payments, operational verifications and automatic process could all be the outputs of the DLT strategy, although the implementation seems to be taking much longer than expected. 

3. Internet of Things  

Internet of Things (IoT) is a network connecting physical objects with software, sensors, analytical tools, and other forms of technology to have a larger integrated system of devices and data analysis as a layer on top of this connectivity. Sensors and GPS tracking systems can provide real-time data on the location and condition of inventory and goods in transit, warehouse management capabilities and predictive analytics. IoT is here to revolutionise logistics and therefore visibility and transparency.    

4. Quantum Computing

The potential tools and applications Quantum Computing could bring to international trade, logistics and finance are endless due to instant analysis of vast amounts of data, its authentication and verification and cutting costly intermediaries to collect and reconcile payments. 

Embedded finance, Information Flow 

Corporates, fintech companies and ecosystems embed banking and other financial services in their offerings much more frequently these days as customers demand easier integrated experiences. Open Banking, increasing universal access and BaaS (Business as a Service) business models and instant data portability offer endless opportunities for payment processing, treasury, lending, insurance, investing and other embedded functions. Specifically in the trade finance and lending space, a few successful applications are the following: 

  1. Integrations with Enterprise Resource Planning (ERP) Systems can provide a tremendous distribution capability as lending or any other type of financing can be offered as a white-label solution through any ERP system an SMB uses. The main benefits are operational efficiency, security, reduced costs, user experience, access to data, ability to scale and build credit models around existing data and predict future trends, thus being able to provide various forms of financing – factoring, supply chain, revenue-based, and others. For example. Oracle’s Netsuite launched NetSuite Capital, an embedded finance solution for its customers which allows them to instantly accelerate payment to their suppliers by submitting for payment. NetSuite’s analysis of existing data and transactional volume, building an AI-enhanced credit decisioning tool will solve cash flow visibility problems, and improve operational processes for a customer. 
  1. Strategic partnerships with large big box retailers, marketplaces, service and e-commerce hubs that have their own proprietary vendor platforms are another scalable embedded finance distribution channel. Large corporates like Walmart or Amazon with thousands of suppliers and customers require a customised approach. Embedded finance in these cases could entail both providing financing to the customer and supplier: for example, Walmart offers BNPL (Buy Now Pay Later) option to its customers and simultaneously gives an opportunity to its vendors to get paid early on their invoice by submitting their invoices through a fintech platform.  
  1. Credit cards and supply chain programs for SME’s are another direction of automated information and payment flow. Accounts payable to suppliers could be streamlined and paid on time via partnerships with such giants as Visa, Mastercard and others. For example, Mastercard advances B2B payments under its supply chain program to its customers, which helps increase working capital and lower funding costs at the same time. This could be a scalable solution for a lot of lenders and allow businesses to focus on the core business while getting their payables covered via extended payment terms or early-pay discounts from the vendors.    
  1. The payments space has been a focus of the US venture capital for a while now and we see change under the embedded finance structure as well – embedded payments involve incorporation of payment processing within the original platform or software while often cutting off the middle man, saving on credit card and bank fees and simultaneously receiving rewards. All mean ease of use, direct connectivity, speed efficiency and cost cuts. 

Regulatory and initiatives: 

Regulation always moves at a slower pace, but it navigates the industry in the right direction which leads to digitisation, and standardisation, which ultimately means efficiency, fraud mitigation and security protection. 

Below are a few acts and initiatives at various stages of implementation in different regions of the world that are likely to drive industry commoditisation and financing margin squeeze. Those could be currently fragmented in certain aspects, but the process of international integration and document synchronisation is soon ahead of us. 

1. The Model Law on Electronic Transferable Records (MLETR)

The Model Law on Electronic Transferable Records (MLETR) is a 2017 uniform law adopted by the United Nations Commission. Its goal is to create a legal framework around electronic documents in order to transfer titles, keep records clean and assist in the claim process or obligation enforcement. Transferable documents could be promissory notes, warehouse receipts, checks, bills of lading, etc. Essentially, the fact that the documents exist in electronic form means they are as enforceable as paper ones and have an option and right of transferability. This was probably one of the first major steps on the way to achieving a legal framework around documentation, especially trade and financing documentation. 

2. The Electronic Trade Documents Act (ETDA)

The Electronic Trade Documents Act (ETDA) released under the UK law in 2023 has become an important milestone in trade digitisation. The Act doesn’t list any specific types of documents but provides broader areas of identifying the right scope of documentation in the operational trade and cargo category, payment space and insurance coverage. 

Positive outcomes are multiple such as fraud protection, ownership transfer transparency, protection from unauthorised parties, standardisation of the actual documents to streamline the operational flow and others. The most important type is the electronic bill of lading (eBL) – for example, nine ocean carriers committed to 100% adoption of an electronic bill of lading by 2030

The Digital Container Shipping Association, whose members include major ocean carriers committed to converting 50% of original bills of lading to electronic within five years, and reach 100% by 2030. This step will drastically help standardise trade and trade finance markets and improve globalised economies, access to capital, and mitigation of fraud among other benefits mentioned above. 

3. Electronic Invoicing (E-Invoicing) 

The mandate for Electronic Invoicing (E-Invoicing) in various parts of the world is becoming increasingly popular and common. The global shift towards automation, continuous transaction controls, heightened tax compliance and customs regulations in our globalised yet fragmented world push for e-invoicing across all regions. 

In the EU, mandatory B2G (business to government) receivables reporting has existed since 2014 and overall B2B e-invoicing reporting regulations becoming effective in the coming years across the entire region. In the UK, e-invoicing is required for the public health space, while it remains optional in other industries. 

Invoice generation and processing, potential mobile invoicing, interoperability between ERP, AP and AR systems, cross-border regulatory and tax compliance will all contribute to streamlining the operational thus financing flow, leading to commoditisation of the industry. 

As part of the enhancing cross-border payments initiative by G20 in 2020, The Financial Stability Board (FSB) proposed the adoption of a Legal Entity Identifier (LEI) to be particularly utilised for cross-border payment transactions to improve existing payment transparency and infrastructure, data quality and standardisation and fraud prevention. 

This 20-character code identifies an entity or institution involved in a financial transaction.  Its implementation is still in process and varies on various aspects in regard to mandatory vs. voluntary usage. 

There are current examples of the move towards the commoditisation of trade finance, such as the Trade Finance Distribution (TFD) initiative

It creates a blueprint for transactions and  financing distribution, where several institutional investors have become members. Although this initiative is voluntary and is not an official and/or regulatory act, or drastically shifted the industry, it shows the direction in the industry and automation possibilities in the near future.  

The entire holistic chain is undergoing significant enhancements and innovations across several areas. These improvements include data gathering, data analysis, ESG compliance, and services such as payment reconciliations, reporting, and portfolio management. 

Additionally, there are advancements in predicting sales and trends, forecasting returns and preferences, planning production, optimising manufacturing and maintenance, managing risks, navigating the supply chain, and improving logistics. These areas are all set to be transformed by the upcoming wave. 

Notwithstanding significant threats to the industry brought by the same tech tools such as hacking, space satellite disruption, bad actors, trade and geopolitical tensions, the trade finance and SME lending industry are moving towards a scalable, lower cost and margins semi-efficient market, where there won’t be much space left for those not tech-enabled or practising old school marketing, origination and servicing tools. 

Cross-border trade will become less fragmented and small businesses will benefit largely, and thus us, the consumers.