The EBA has released a report on the risks and opportunities arising for institutions from FinTech.
Among other hot topics such as bio-metrics, robo-advisors, big-data and digital wallets, one subject stood out which is proving a particularly controversial battle for the pro's and con's it has to offer - Distributed Ledger Technology (DLT) and Smart Contracts.
Logistically, it makes sense.
Having a shared view - a one touch point - could rationalize the manual effort and reconciliation processes currently facing international transactions, with consequent savings in time, money and resources.
To break it down currently a trade transaction could hold up to 9 or 10 stakeholders for a simple process. In the world of trade finance these stakeholders could be; the exporter; the importer; banks; insurance companies; carriers; stevedores; custom offices; shippers and controllers; each one having its own ledger, with the consequent need to reconcile their registries. In addition, tracking the status of each transaction may require querying a number of stakeholders.
Using a DLT puts all of these eggs into the same basket:
- From the moment the importer applies for a letter of credit, the application could be registered in the ledger.
- Once the importer’s bank approves the letter of credit, the seller could receive a notification triggered by a smart contract, being able to initiate the shipment of goods immediately, saving days or even weeks compared with the previous procedure.
- Every step along the supply chain could also be registered in the ledger, as well as any event or data related to the process, including invoices, shipment data, payment status, photos or any other useful information.
SO, what are the risks?
- For some, it is merely the immaturity of the tech that gives reason for regulators, insurers and adopters to raise a red flag - but this surely will be overcome with time and further industry adoption.
- A lack of jurisdiction - if a transaction is made internationally a third party must traditionally oversee it done and to a degree decide on the jurisdiction of the transaction as this legally has to be accounted for. But what happens when you remove that overseeing, all powerful third party - who accepts liability if something goes wrong then?
- Data protection
- If all users and participants of the DLT rely on the same system, the damage caused if that one system went down could be catastrophic. System failure would be of a huge concern from a risk management point of view.
- Lastly, a potential poor service, poor user experience and fines for non-compliance could negatively affect the overall reputation.
It is worth noting that the EBA's report followed news that a group of EU banks had conducted a series of live cross-border trades using a jointly-developed blockchain platform.
It's coming home.
"A number of opportunities emerge from the use of DLT and smart contracts for trade finance. The most promising are the potential efficiency gains, cost reduction, and lower risk of duplicate financing and loss or manipulation of documents." That said, the EBA also noted the emerging technology still faces potential risks as applicable law remains uncertain at the moment. As such, conflict of interests may occur among DLT nodes that are located in different jurisdictions. The EBA went on to explain: "For example, a digitally signed contract might not be enforceable in all the jurisdictions. It is essential to establish the applicable jurisdiction, in case of conflict, and the dispute mechanisms, when a dispute arises. "