June 2019

Digitalising trade finance has been a rather tough climb, with the joy of reaching the summit some way off. International Trade and Forfaiting Association Chair Sean Edwards explains how the United Nations, with the Model Law on Electronic Transferable Records, gives cause for optimism

This is a short article about a very big solution. It is also an article about hope and vision and those things that don’t help bankers create budgets in the short run, but do change the world in the long run for them and their customers − if only someone would invest in that.

The powerful solutions offered by fintech have the capacity to completely change the way we do banking business. We have been told this often enough by the tech pioneers and messiahs. From the author’s own experiences, finding a technological alternative to almost anything we do is rarely the problem. To the tech companies’ intense frustration, we start to run into the awkward little problems created by that alternative to the virtual world, namely the real one. In banking, this demon takes many forms: legacy systems, budgetary constraints, lack of customer interest, lethargy, vested interests and, to cut the list short and get to the point of this piece, legal validity – or certainty.

Model laws

Fortunately, we do not start our journey to resolve this problem in a complete vacuum. For many years now, the United Nations Commission on International Trade Law (UNCITRAL) has published documentation to assist and inform the passage of legislation securing digitalisation at a global level. This effort began in 1996 with the Model Law on Electronic Commerce. Model laws on electronic signatures and electronic communications followed. Underlying these laws are a few fundamental and critical concepts:

  • Non-discrimination – no digital document or instrument is to be denied effect solely because it is in electronic form.
  • Technological neutrality – no one technology is to be favoured over any other.
  • Functional equivalence – legislation must provide and validate digital equivalents to those aspects of paper that are integral to that medium, such as signatures.

It is important to realise that model laws, or indeed conventions, are not automatically ‘global law’, and for good reason. Model laws can be plug-and-play or simply a list of ingredients to pick and choose from (although the need for consistency and a level playing field for all favours the former approach). And sometimes they are not needed. National common law can be surprisingly favourable to electronic commerce (as is the case in the UK), so there may be no need to pass new laws, or only limited legislation may be required. Passing new laws is also time-consuming, even if the effort is limited to key jurisdictions.

The favoured approach has therefore been to promote club or closed-loop arrangements, as has happened with the electronic bill of lading providers essDOCS and Bolero, which are essentially private contractual arrangements. The obvious disadvantage here is that, to be effective, everyone involved in the relevant supply chain must subscribe and agree to these conditions. Like Groucho Marx, some just don’t want to belong to any club that will have them as a member. Even when they do join, ensuring effectiveness against third parties such as courts can be difficult. And it is a moot point whether or not trade finance tools such as negotiable instruments, which derive their existence from specific laws, could ever be reproduced through a contractual arrangement.

Electronic transferable records

A comprehensive and optimum solution therefore requires that an effort be made to encourage the adoption of these laws, even as we try to make a living from interim solutions. The International Chamber of Commerce (ICC), and others, now spend more time than ever lobbying for such legislation. And all these lobbyists and promoters (including your author) have become excited by a new kid on the block: the Model Law on Electronic Transferable Records (MLETR).

First impressions are that UNCITRAL should have employed a public relations firm to come up with a better name. But let’s look beyond that, because the MLETR is seriously good stuff.

Like all UNCITRAL model e-commerce laws, the MLETR espouses the three principles set out above. These are so important that they bear repetition; it includes provisions on non-discrimination and recognition of electronic formats, electronic writing and electronic signatures. But the MLETR goes, as it has to, beyond this to deal with the particular issues facing electronic transferable records.

But first, what are these records? The MLETR approaches them with functional equivalence in mind, and the definition therefore covers all paper documents or instruments that entitle a holder to claim performance and pass on that entitlement to another person through a transfer of the document. The potential scope and importance to trade transformation of the MLETR is therefore readily apparent, as this definition will include both negotiable instruments, such as bills of exchange and promissory notes, and documents of title, such as bills of lading. The MLETR thus opens up the possibility of creating combinations of existing instruments and digitalising these as well. Currently, tokenisation initiatives look at this possibility but tend to focus more on settlement and payment legs; a more holistic ‘cradle to grave’ financing instrument could be envisaged, starting at the pre-production phase and ending with settlement.

"Control produces uniqueness by preventing competing claims to ownership of the same instrument"

 

It then requires that the electronic or digital tool used to move from paper to virtual existence is reliable enough to identify the electronic instrument as the single instrument in existence, submit it to control (more on this below) and retain integrity. Further details are given as to how to measure that standard, such as adequate security compliance with industry standards. Although the MLETR does not say so, this is a call for governmental intervention, as has already happened in Europe. Private initiatives, such as that being proposed through the Universal Trade Network, are an equally legitimate response, provided they have widespread adoption, which will be harder to achieve without legislative help at some level.

Reliable control of ownership

Critically, it is the same ‘reliable’ tool that must ensure exclusive control of the electronic instrument by a single owner in order to give rise to a unique instrument that cannot be held by any other person until transfer. Control produces uniqueness by preventing competing claims to ownership of the same instrument and has the same function as physical possession in the paper environment. The method used must also enable control to be transferred to another holder in the same way as a bill or note is currently endorsed to transfer title.

The vocation of blockchain to produce that reliable method is clear. Benefitting from a high degree of security, and combining data in a form that ensures its integrity, it also permits exclusive control by an owner, with the ability to easily transmit that data.

The law is not always exciting; digitalisation may be the exception to that rule. Let’s all help it fulfill its potential and reach the pinnacle.

Sean Edwards is Head of Legal and Special Adviser to the Global Trade Finance Department at Sumitomo Mitsui Banking Corporation Europe Limited and Chairman of the International Trade and Forfaiting Association (ITFA). He sits on the Executive Committee of the ICC Banking Commission and leads a workstream on the ICC Working Group on Digitalisation in Trade Finance

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