SWIFT is widely floating its new Supply Chain offering – Bank Payment Obligation or BPO – as a new service for member banks to offer to corporate customers, to assist the banks in oiling the wheels of international trade.
BPO supports Open Account trade, where buyer and seller have agreed to do business without a Letter of Credit or Documentary Collection, operations in which the banks acts as an intermediary holding documents of title to the goods. BPO is a guarantee of payment to the seller, issued by the buyer’s bank, and it is unconditional and irrevocable when it goes “on risk”, and no bank is involved in holding documents of title.
Five issues arise:
- When does the BPO go “on risk” during the transaction cycle?
- What is the performance that the seller has to demonstrate in order for the BPO to go “on risk”?
- Does that give the buyer sufficient comfort for them to furnish the seller with a guarantee of payment from that point on?
- What is the price that the buyer has to pay for the guarantee?
- Can that be factored back into a discount off the invoice price or, put another way, should a buyer henceforth factor a BPO fee into any supposedly “Open Account” purchase?
BPO is not presented as an unconditional guarantee of payment to the seller, valid and irrevocable from the time at which the buyer places a Purchase Order with the seller.
Instead it appears to be a guarantee of payment to a seller under an Open Account sale once the seller has completed a Performance that is specified in the Purchase Order.
BPO uses the facilities of the SWIFT Trade Services Utility (“TSU”) to enable the checking of the performance against the Purchase Order. Documents proving performance of the underlying trade transaction can be created, stored and viewed in TSU, giving all parties greater comfort, but without parties having security.
The BPO is irrevocable, but its going “on risk” is conditional upon the buyer accepting that the goods have been delivered in good order, meaning in compliance with the Purchase Order. The “on risk” trigger is firstly the matching of the Purchase Order with the Invoice in TSU, but a key issue is whether an approval by the buyer is needed as well. That would give the buyer the same level of control as in “complete” Open Account, and much less control for the seller than under an L/C.
The BPO, once issued by the buyer’s bank, can be confirmed by the seller’s bank so as to transfer commercial and political risk away from the buyer’s bank and country
As such the BPO does not alleviate the seller’s risks under Open Account trade other than the post-delivery payment risk. The seller would have to be happy to run – and/or should have obtained insurance cover – for all the risks up to that point, including specious refusal by the buyer to accept delivery.
If the seller is covered on that side, BPO should on the face of it be a popular product, both for sellers and for their banks. The point of Bolero, TSU and now BPO was to reintermediate banks into the Open Account space, the Trade Letter of Credit space being in decline.
The operational costs of BPO should be lower than L/C because of electronic processing and matching through the TSU. The tracking of a transaction through TSU and the electronic matching of documents should deliver material benefits of in risk management, data accuracy, and more efficient management of the supply chain. For a bank, then, the pricing for Operational Risk should be low, since there will be less manual work in document checking and matching, issuance of hard guarantees, and accounting.
Furthermore the maturity period of a BPO would be lower than a Trade L/C if it can be measured only from when it goes “on risk” and not for the entire Order-to-Delivery cycle.
Nevertheless, while it is “on risk”, it could prove expensive for banks.
There is no certainty that BPO will be looked upon by regulators as anything other than a fully risk-weighted financial guarantee, similar to a Stand-by Letter of Credit. This is at a time when capital markets are closed to banks, capital buffers need to be strengthened, and banks are deleveraging.
BPO on that measure is unattractive to banks as the mechanism of re-intermediation into the Open Account space.
Under the first Basel Accord there was a simple computational difference between a Trade L/C and a Stand-by L/C or financial guarantee: the bank got an 80% discount off its capital adequacy for the Trade L/C.
Under Basel II and Basel III many banks use Internal Risk-Based Approaches that take account of other risk-mitigating factors beyond whether the bank is allowed to seize goods, and the capital adequacy is then not based on 20% or 100%.
However, the Basel I approach persists as the Basel II “Standard” approach, and prevails outside the OECD – since “Trade Services” frequently have a non-OECD country at one end of the deal, this massive disparity of capital allocation remains a factor.
Even for more sophisticated banks there is a long way to travel between an 80% discount (often referred to as a Product Recovery Rate) for Trade L/C and a 0% one for Stand-by L/C and BPO: no amount of mitigating factors could bridge that divide without a finding by regulators that BPO differs fundamentally from Stand-by L/C.
Without that, the importer’s fee payable to their bank to issue a BPO will inevitably be far higher than for issuing a Trade L/C. Whether the usance of the BPO can be held down to 60 days when the L/C might have been available for 60 days and against a 60-day draft, is a moot point: that would at least reduce the number of days for which the higher fee is payable.
Unless the risk on BPO can be sold to regulators as in some way being mitigated by its linkage to a sale of goods without necessitating the BPO-issuer having title to them, the BPO offering can only fly at the banks in the current environment if the fee is as high as the margin on a loan to the same BPO applicant. Will such a fee be regarded as good value by the applicant? How will the fee for the 100% instantly-callable BPO guarantee compare to insurance alternatives, which include a deductible, a delay and certain support on the claim process by the applicant?
Admittedly the terms and conditions of BPO are unconditional once issued, whereas insurance policies generally carry many twists and turns, and conditions and processes for claim settlements.
Nevertheless the Price+Performance = Value equation applies. We know BPO’s Performance (or business proposition) but in the absence of clarification of capital allocation and therefore the Price, its Value cannot be determined. The benchmarks for comparison will be the existing markets for insurance and for Trade L/C, and BPO needs to clearly distinguish itself in order for it fly higher and more sustainably than its banking parents and grandparents – Bolero and TSU.