HSBC: Facilitating Trade Finance using Blockchain

Group 1
Assignment Questions

1. What are the key steps in the trade finance process? What is the role of banks in the trade finance
process? How is risk apportioned?
A) Key steps in the trade finance process
1. The buyer's bank issues a letter of credit in the seller's favor.
2. The buyer's bank forwards the original letter of credit to the seller's advising bank.
3. The seller's bank then authenticates and approves the credit and sends it to the seller 4. The
seller examines the letter of credit and proceeds to make the necessary arrangements for the
goods.
5. The seller prepares and submits export documents to his bank.
6. The letter of credit is verified by the seller's bank (the negotiating bank).
7. The bill is negotiated by the seller's bank.
8. The bill and paperwork are received by the buyer's bank from the seller's bank.
9. The buyer authenticates and accepts the bill issued by his bank.
10. The buyer completes the transaction.
11. The buyer receives shipping documentation including the details of the products he ordered
after making the payment.
12. The buyer's bank reimburses the seller's bank.
13. The amount is paid to the seller.
Banks manage various financing instrument in Trade financing. The documents include
• A bill of exchange is a non-interest-bearing legal order that binds a seller's foreign customers to pay
a certain amount to another party at a later date.
• A letter of credit: A letter of credit is a document issued by the seller's bank to the buyer's bank
stating that the seller is entitled to payment if certain delivery criteria are met. It reduces the
seller's risk by guaranteeing payment from the buyer's bank. Simultaneously, the buyer is protected
against risk and fraud because payment is not made until the vendor meets the requirements.
• Bill of Lading: A bill of lading is a document produced by a shipping agency for commodities
being transported from the seller's location to the buyer's location, and it is signed by authorities of
the carrying vessel.
• Letters of credit reduce the risk associated with international trade because the buyer's bank
guarantees payment to the seller for the items shipped. The buyer, on the other hand, is protected
because payment will not be made until the seller complies with the terms of the LC. Both parties
must follow the conditions of the agreement in order for the transaction to be completed. Factoring
is the practise of paying a percentage of a company's receivables to them. Exporters may be given
export credit or working capital.

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 • Insurance can be used to cover the costs of shipping and product delivery, as well as to protect the
exporter from nonpayment by the buyer.

2. How does blockchain work? What are its strengths and weaknesses compared to the traditional
process of trade finance? Why is it thought to be a good platform to move to for trade finance?

A) Blockchain is connected on a peer-to-peer database for mentoring that is maintained across a network
of computers. It's a list of records that each transaction documents as a block. Each new transaction
resulted in the building of a new block, which in turn resulted in the establishment of a permanent
information chain. Each block included two components: data and a hash reference. The hash pointer was
used to record the address of the previous block as well as the hash of the data within the block.

A blockchain chain smart contract was employed to communicate the sales agreement between the seller
and the buyer with the buyer's bank once a purchase contract was signed.The buyer's bank then assessed
the contract and prepared loan terms in real time. After the seller's bank evaluated and accepted payment
responsibilities, a smart contract was designed to address the terms and circumstances offered. The seller
confirmed and accepted the smart contract's blockchain-based letter of credit. When the predetermined
prerequisites were met, the agreement was automatically enforced. As a result, a smart contract aided in
contract agreement facilitation, verification, and negotiation. The same procedures were utilised at each
stage until the transaction was completed.

It has the following strengths: -

● It enables network participants to share and maintain identical, cryptographically secure records in a
decentralized manner, without relying on a central authority.
● When a transaction was completed, the blockchain was updated, eliminating the need for several copies
of the same piece of information to be maintained across various databases and organizations.
● Members of the trade ecosystem might lower their trade finance operational costs by 50% to 80% if
they employed blockchain technology effectively.
● It may also result in a three- to four-fold reduction in turnaround times, depending on the trade
financing product.
● Benefits include more transparency, improved traceability, increased efficiency, and cheaper costs.

Its drawbacks include: -

● While blockchain had no transaction costs, it did have a continuous infrastructure cost.
Blockchain designs are extremely hard to build, deploy, and maintain.

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 3. What are the key challenges in implementing and commercially rolling out blockchain-based
trade finance services for HSBC to its clients?
a. From a governance viewpoint
b. From a technology standardisation viewpoint
c. From a regulatory standpoint

Ans. From a governance viewpoint

Although it was clear that it provided transparency for banks, it was uncertain whether externalising the
entire system at once was appropriate. Integrating existing systems was also difficult because they couldn't
be totally removed. Before banking systems adopted blockchain, the technology had to prove that it could
manage large amounts of data and that the energy consumption issue had been handled.

Establishing a governance system that enabled the use of platforms was necessary for managing consortia.
In addition, the mechanics of the governance structure must be worked out.

From a technology standardisation viewpoint

From a technological sense, blockchain may speed up the transfer, but integrating it with existing systems
was difficult because they couldn't remove the entire external system at once. Before financial institutions
implemented blockchain, it had to ensure that it had adequate capacity to handle massive volumes of data
and that the energy consumption issue was resolved. Scalability was also a major challenge, as was a lack
of industry standardisation, which slowed the adoption of blockchain.

It would also necessitate the digitisation of the trading system's parties, which would necessitate a
considerable expenditure to develop utility and then integrate with existing systems.

From a regulatory viewpoint

The lack of laws around blockchain was a major issue from a regulatory aspect, making the bank open to
both profits and losses. As a result, banks would require legislation to deal with the resulting
misunderstanding in the event of a loss. Participation in different networks by HSBC might make the bank
interoperable, but connecting various platforms is a hurdle.

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 4. How has the nature of the service that HSBC offers to its trading clients changed between the
traditional process and the blockchain-based process? What are some critical differences for HSBC
and for its customers in the entire process?

Ans.

1. From a regulatory standpoint, the lack of rules around blockchain was a huge issue, leaving the bank
vulnerable to both gains and losses. As a result, banks would need legislation to cope with the
misunderstanding that would arise in the event of a loss. HSBC's participation in numerous networks
may make the bank more interoperable, however linking various platforms is a challenge.

2. Since May 2018, HSBC has utilised Contour to complete 18 commercial transactions totaling more
than USD35 million in commodities. The platform is now in commercial usage, and they want to start
transacting routinely across the network in the near future.

3. To settle these payments instantaneously, HSBC FX Everywhere uses distributed ledger technology,
which improves the customer experience by increasing efficiency, lowering processing costs, and
lowering risk.

4. This method was used by HSBC to successfully complete cash settlement in a trial digital bond issue
in Singapore, which was a first for both HSBC and Singapore.

5. We successfully simulated a completely digitalised bond issue on SGX's DLT-enabled platform – in

tandem with a traditional issuance – on SGX's DLT-enabled platform, which lowered overall
settlement time from five days to only two days and made the process more efficient.

6. HSBC's Digital Vault is a blockchain-based custody platform that allows worldwide custody clients
to access details of their private assets – including equities, debt, and real estate – immediately and in
real time via a web browser, rather than having to request a search of paper-based record. HSBCnet is
our internet banking platform. There are currently tens of thousands of users on this blockchain
network.The total value of the assets is USD13.5 billion.

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