A Banking Payment Obligation (BPO) is a trade finance instrument related to an underlying transaction that promises that one bank will pay another bank on a specific date after effectively confirming that a transaction has happened. That process happens when data related to that transaction is matched by something called a Transaction Matching Application (TMA). The revolutionizing feature of BPOs is that data (and not documents) is being exchanged. There are four parties to a BPO: the buyer, the buyer’s bank, the seller and the seller’s bank.
Technically speaking, BPOs actually sit between a letter of credit (LOC) and an open account operation (OAO). This serves to keep the trade finance “pipes” open between banks the corporate customers they serve. BPOs provide the risk mitigation and access to liquidity of a LOC while bringing operational efficiencies related to managing the OAOs. Additionally, BPOs are used when LOCs are not practical due to costs, timing or sophistication of the underlying transaction. Although the main advantages of a BPO are that they are electronic and only passes data, and is an irrevocable promise between banks to settle a transaction, its use is still limited in spite of an increase in the level of global trade volumes.
According to José Ignacio Echevarría of the International Chamber of Commerce’s (ICC) Banking Commission, BPOs are especially suited for short-term one-time recurrent operations but could also be tailored to fractioned or single payments and used for domestic or international operations. André Casterman, head of corporate and supply chain markets at SWIFT, adds that industries where BPOs could prove useful are those that involve long-term relationships and standard items such as auto manufacturers, energy and petrochemicals.
The main advantage of BPOs is that they don’t require document management since they’re an electronic reconciliation of data. This reduces processing costs and time, eliminates the need to open a LOC, physically sending and handling the information and the request for paper use. LOC volumes have been on the decline given the costs of compliance in light of Basel III Standards.
BPOs also assure data accuracy, which prevents discrepancies and thus reduces administrative and litigation costs. Finally, it allows for financial innovation in areas such as loans and insurance. For example, the Bank of China has developed special products for financing orders under TSU (SWIFT’s centralized matching application). Electronic handling of data helps in different areas, for example production cycle, inventory handling and logistics.
Notwithstanding its advantages, adoption of BPOs aren’t widespread. The ICC developed standards in July of 2013 to increase its adoption last year, primarily focused on promoting transparency and hopefully stimulating its widespread use. Specifically, it issued a standard rule, which requires trade service messages (TSMT) to be sent following standardized norms, ISO 20022. Before ISO 20022, there was not a standard for TSMTs, which cover messages supporting procurement, trade finance products and services, forecasting, reconciliation, accounting, remittance information and more.
While there is a large opportunity in reaching potential customers who are using OAOs, BPOs have been mainly used to replace LOCs. Many banks are not proactively seeking to end LOCs in favor of BPOs even if their clients may be willing to, causing the classic chicken/egg dilemma in the payment industry. Usually, trade operations involving banks have three parties: the seller, the buyer and the buyer’s bank which back-ups the operation.
The problem with this scheme is on-handling of suppliers which can be overcome with the four-corner model enabled by BPO. The seller’s (who already knows and has a relationship) and the buyer’s bank collaborate, sharing risks and rewards.
As of 17th April 2014, only 8 banks, primarily in in the Asia-Pacific, already used BPO operations while 17 more are ready to carry transactions and 56 are working on implementation.