Paperless Trade

In a world that is becoming increasingly digitalised, trade is no exception. Especially in the area of trade finance (especially guarantees and letters of credit), technology and innovation are having a transformative effect. The transition to paperless trade processing is an essential step that increases efficiency, reduces costs and improves transparency. In the area of guarantees and letters of credit, however, paper is still often the number one information carrier and the term digitalisation, when applied, is found in very different degrees. This makes it all the more interesting to ask what degree of digitalisation is already possible in trade finance today - the keyword here is paperless trade.

In the following, we will therefore take a closer look at the technical aspects in addition to the legal aspects (in accordance with the current regulations of the International Chamber of Commerce).

Digital guarantees

• Digital guarantees (sureties)
  Let's start with sureties and guarantees. According to the German legal understanding, a surety is a contract in the sense of Section 765 (1) of the German Civil Code (BGB) by which the guarantor undertakes towards the creditor of a third party to vouch for the fulfilment of the third party's obligation. The special feature of the surety lies in the accessoriness of the principal claim. This means that the surety itself stands or falls with the principal claim. As soon as the principal claim has been fulfilled, the claim against the guarantor under the guarantee agreement also expires.
  Pursuant to Section 766 sentence 1 BGB, a guarantee must be in writing. § Section 766 sentence 2 BGB expressly prohibits the electronic form. However, this provision only applies to B2C transactions. In commercial business transactions, this strict written form requirement is modified by Section 350 HGB, which allows merchants within the meaning of the HGB to use any form, including electronic form.
• Digital guarantees
  It is precisely this strict accessoriness that is lacking in guarantees. Under the guarantee contract, the guarantor also undertakes to vouch for the claim of a third party. However, the guarantor's obligation to pay does not automatically expire upon fulfilment of the principal claim. In practice, guarantees on first demand (demand guarantees) are common. In this case, the guarantor undertakes to pay upon the assertion that the guarantee case has occurred (the so-called first demand). The assertion by the original guarantor or assignee that the guarantee case has occurred, which triggers the guarantor's payment obligation, must be made in the form, language and wording prescribed in the guarantee contract and thus in conformity with the guarantee. A large number of documents play a major role here, which must be submitted in the event of the first request. These first demand guarantees are standardised internationally by the "Uniform Rules for Demand Guarantees, URDG 758" of the International Chamber of Commerce.
  URDG 758 authorises the use of electronic documents in two respects. Firstly, the guarantee promise, i.e. the guarantee itself, can also be issued in electronic form. This follows from the interaction of the definition pair "guarantee" and "signed" within the meaning of Art. 2 URDG 758. Accordingly, guarantee means any signed obligation to pay, however named or designated, upon presentation of a compliant request. Signed means, in relation to a document, guarantee or counter-guarantee, that an original is signed by or on behalf of the maker by electronic signature, which may be authenticated by the party to whom such document, guarantee or counter-guarantee is presented, or by hand, facsimile signature, perforated signature, stamp, symbol or other mechanical method. This form also extends to the requirement of the guarantee within the meaning of Art. 15 lit. a) URDG 758.
  In addition, Art. 14 lit. c) URDG 758 states that the document submission can be made by means of electronic documents. However, the specific format of the electronic documents should be determined beforehand in order to avoid problems with the submission.
• Digital letter of credit
  The ICC's UCP 600 ("Uniform customs and practice for documentary credits") has established itself as the standard set of rules for the letter of credit business. These have been extended by the eUCP v. 2.1. The eUCP were deliberately designed as a mere supplement. The intention was not to create a new instrument, but to extend the existing letter of credit to include the use of electronic documents. The eUCP apply if their validity has been expressly noted in the documentary credit (Art. e1 eUCP). However, this does not mean that electronic documents must also be submitted at a later stage. It is still permissible to submit only paper documents or even a "mixed presentation" of paper and electronic records.

Conclusion

From a legal perspective, the use of guarantees and letters of credit can already be mapped completely digitally today, so that a paper-based form is no longer considered necessary.

The digitisation of guarantees and letters of credit is a very inhomogeneous field and depends heavily on the contractual partners. In general, the degree of digitisation mainly consists of the following four steps:

Applying for a guarantee/letter of credit
The first step - once the terms and conditions have been successfully agreed between the contracting parties - is the application process for the instrument within a company. The scope of this process ranges from submitting the application to approving or revising the application within the company and communicating it to the bank. Today, all steps prior to communication to the bank often take place via one or a combination of the following channels:

• Paper circulation
• Telephone
• chat
• e-mail
• Trade Finance Systems

Kommunikation mit der Bank
Die Kommunikation mit der Bank bzw. einem Finanzinstitut ist der nächste Schritt, nachdem der Garantie-bzw. Akkreditiv-Antrag innerhalb des Unternehmens final freigegeben wurde. In diesem Prozessschritt verlässt der Antrag das Unternehmen und wird von einer externen Partei weiterverarbeitet. Die Kommunikation erfolgt üblicherweise via:

• Telephone
• e-mail
• Digital communication channels, such as SWIFT

Issuing a guarantee/letter of credit
Once the application has been sent to the bank or financial institution, the certificate or corresponding documents are processed and issued there. This also includes sending the original document to the beneficiary. This dispatch usually takes place via one of the following channels:

• Paper via post / courier
• Digital communication channels, such as SWIFT

Inventory management
Once the guarantee or letter of credit has been successfully issued and received by the beneficiary, inventory management begins on both sides. Among other things, the debtor of a guarantee aims to pay the fees incurred only for guarantees that have been issued and not drawn. For the beneficiary of a guarantee, on the other hand, it is relevant to know when a guarantee becomes invalid and how it can be drawn in the event of a guarantee event occurring. The key elements in the management of letters of credit are therefore the fees and the options (manner) for managing the required documents.

The following options are often used to manage the portfolio, fees and maturities:

• Paper-based filing structures
• MS Excel
• Treasury management systems
• ERP systems
• Trade Finance Systems

Conclusion
It is already possible to fully digitalise all of the steps mentioned above. Dedicated trade finance systems are often predestined for this, as they can map all the steps of the workflow described above (from application to issuance to management). In addition, many treasury management systems also offer the option of mapping individual aspects.

When guarantees and letters of credit are fully digitalised, we speak of paperless trade.

There are a number of challenges that often arise in connection with paperless trade. Below are some of the most common challenges that are mentioned after considering the above legal and regulatory framework:

• Standardisation of data formats
  The standardisation of data formats is a key aspect in ensuring that digital guarantees and letters of credit can be processed easily by different systems and inconsistencies can be avoided.
• Interoperability
  It is also important that the data exchange between the various systems, for example on the corporate and banking side, functions smoothly and seamlessly
• Acceptance and trust
  The trust of all market players involved and acceptance of paperless trade is one of the main factors that will enable digital guarantees and letters of credit to become the standard. In particular, this requires broad acceptance of the processes, the systems used and the security mechanisms on the part of applicants, beneficiaries and banks.

In addition to the challenges just mentioned, the use of paperless trade also offers a number of advantages that make trading more efficient, secure and transparent. The most striking advantages are

• Time saving
  The digitalisation of guarantees and letters of credit enables transactions to be processed significantly faster. The electronic transfer of documents and data enables immediate processing and significantly reduces the time required for the exchange of paper-based documents.
• Increased flexibility
  By using paperless trade, the parties involved are no longer bound by courier deadlines and delivery times and can therefore request and process transactions around the clock. Transactions can also be adjusted quickly if conditions change.
• Cost savings
  The use of digital guarantees and letters of credit can lead to significant cost savings. By eliminating the need to print and send paper documents, several types of costs are saved.
• Increased transparency
  The use of digital guarantees and letters of credit leads to increased transparency for all parties involved. All relevant information and the current status can be viewed by the parties involved at any time and any anomalies can be rectified immediately.

Conclusion
Both technically and legally, it is already possible to process guarantees and letters of credit digitally and even paperlessly. If the technical possibilities that are often already available but not yet utilised are exploited and the number of convinced market participants grows, paperless trade will increasingly find its way into trade finance. The advantages of fully digitalised guarantees and letters of credit are already decisive arguments for addressing the issue and setting the course for a digital present in trade finance.

Source: KPMG Corporate Treasury News, Issue 143, May 2024

Authors:
Nils Bothe Partner, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG

Maximilian Gschoßmann, Manager, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG

Guest author:
Lawyer Dr David Saive, LL.M., Managing Partner of Tug & Tow® UG (haftungsbeschränkt)