International Trade and Technology: Letter of Credit and Blockchain

by Matilde Serena

In international trade, a Letter of Credit (LoC) is a payment mechanism used to minimize risks for both buyers and sellers. However, the traditional process of issuing an LoC is time-consuming and expensive, requiring a lot of paperwork. Digitalization through blockchain technology can significantly reduce the time and cost of cross-border transactions while improving transparency, compliance, and risk procedures. Two blockchain platforms, Voltron and Contour, have been developed specifically for digitalizing the process of issuing LoCs.This post examines (1) the notion of LoC, (2) the need for digitalization of this payment mechanism, and (3) the rise of Voltron and Contour, the first LoC Blockchain platforms.

What is a Letter of Credit?

Before discussing the need for digitalization in international trade, it is instrumental to understand what an LoC is. The LoC is a common payment mechanism used in cross-border transactions. It is deemed to be the greatest facilitator and enabler of international commerce, and its usage dates back to the 17th Century’s merchants. What makes the LoC such a necessary tool in international trade is the risk that both buyer and seller incur when paying prior to goods’ receipt or when delivering goods prior to payment. This is especially relevant if parties have no prior business history. This risky situation calls for a third party i.e. a bank to guarantee for the parties to the sales contract. In practice, the bank guarantees that the buyer has enough liquidity to fulfil their payment obligations and that the seller conducts a legitimate business. International bodies such as the International Chamber of Commerce set out laws governing international bank payment obligations, which are given effect by means of incorporation in the contracts between a bank and its customers and the payment’s beneficiaries. The Uniform Customs and Practice for for Documentary Credits (“UCP 600”) is an optional set of rules that parties can adopt when drafting their sales contract. This instrument includes rules specific to the LoC i.e. the parties involved, the principle of autonomy in abstract payment undertaking, fraud, documentary nature, and doctrine of strict compliance.

In practice, the buyer enters a contract of sale with the seller agreeing to the issuing of an LoC. The buyer, then, requires an “issuing bank” to open an LoC for that specific transaction. The issuing bank opens an LoC with a “confirming bank”, which advances the LoC to the seller. The seller ships the goods to the carrier, which provides a Bill of Lading (“BoL”) in return (i.e. a document of title evidencing the carriage contract). The BoL is, subsequently, transferred to the confirming bank, which transfers the payment to the seller and transfers the BoL to the issuing bank. The latter then reimburses the confirming bank and transfers the BoL to the buyer. The buyer reimburses the issuing bank and transfers the BoL to the carrier as proof of ownership. Finally, the carrier ships the goods to the buyer.

Why the need for digitalization?

Based on the analysis conducted above, it emerges that the issuing of an LoC is a quite lengthy and expensive process requiring a considerable amount of paperwork. Digitalization is, therefore, desiderable to ensure the cost-efficiency and speediness of cross-border business transactions. Arguably, sharing data via a digital ledger technology leads to faster financing decisions and decreases the costs for reconciliation between companies and their trading partners. Moreover, technology in international trade can improve compliance and risk procedures enabling greeted transparency and visibility i.e. by reading ESG standards or by reducing fraud risk.

Finally, digitalization is proven to reduce barriers to entry to international trade and promote more inclusive business practices; this is especially beneficial for small businesses and emerging markets.

What are Voltron and Contour?

Voltron was the first Letter of Credit blockchain platform founded by eight banks i.e. Bankgok Bank, BNP Paribas, CTBC Holding, HSBC, ING, NatWest, SEB and Standard Chartered and produced by R3’s Enterprise Corda in 2016. In September 2019, the Voltron blockchain was commercialized and re-branded “Contour” by securing more than fifty partners, member banks and external investors.

As of today, a Countor blockchain LoF is available on the network. In practice, the issuing of a digital LoC is a two-step process. Firstly, during the buying stage, the parties to sales contract create, edit and agree to a draft of the LoC between them. Then, the chosen bank advices, issues and confirm the LoC on the platform commencing a real-time tracking process. Secondly, at the selling stage, other digital documents e.g. BoL can be integrated in the system. The latter shows discrepancies and provide opportunity to fix errors. Subsequently, the seller gets instructions from the bank e.g. confirmation, acceptance, bills and loans directly on the Contour blockchain.

It must be noted that the system used to issue digitalised LoC can potentially be open to any other exchanging trade document, that is initiated externally and then verified by the platform.

To conlcude, a Letter of Credit (LoC) is a widely used payment mechanism in international trade that involves a bank's guarantee to ensure secure transactions between buyers and sellers. The lengthy and expensive process of issuing an LoC requires significant paperwork, making digitalization highly desirable to ensure cost-efficiency and speediness. Voltron and Contour are blockchain platforms that have been developed to facilitate the digitalization of LoCs and other trade documents, offering real-time tracking and transparency to improve compliance and risk procedures while promoting more inclusive business practices.

Sources:

United City Merchants (Investments) Ltd v Royal Bank of Canada (The American Accord)[1983] 1 AC 168

I Carr, International Trade Law [Fourth Edition], (New York: Routeledge-Cavendish, 2010)

ROY GOODE, HERBERT KRONKE & EWAN MCKENDRICK, Transnational Commercial Law: Texts, Cases and Materials [Second Edition], (Oxford: Oxford University Press, 2015)

Ledger Insights, ‘Letter of Credit Blockchain Launches with Eight Banks’ (Blockchain for Banks, 23 October 2018) < https://www.ledgerinsights.com/blockchain-letter-of-credit-trade-finance-voltron/> accessed 16 March 2023

Global Trade Review, ‘Industry Perspectives: Rethinking trade finance digitisation’ (GTR, 15 March 2023)<https://www.gtreview.com/news/sponsored-statement/industry-perspectives-rethinking-trade-finance-digitisation/> accessed 18 March 2023.