Payment Commitment on the Marco Polo Network: The Past, Present, and Future of Trade Settlement Methods

By Dave Sutter
Chief Product Officer at TradeIX, the developers of Marco Polo

This is the first in a two part series in which the ‘future of trade’ is discussed through an overview of current trade settlement methods, specifically, the Bank Payment Obligation alongside an introduction to the newly available Payment Commitment solution on the Marco Polo Network.

Looking Back – The Bank Payment Obligation

The Bank Payment Obligation (BPO) was launched in 2013 as an attempt to answer a question that is just as relevant, if not more relevant today than it was during its inception. That question is, in short: 

“How can we offer buyers and sellers a solution that provides the risk mitigation benefits of documentary trade finance and the advantages of open-account trade and supply chain finance namely simplicity, cost, speed, and working capital optimization?”

Traditionally, buyers and sellers have been forced to rely on Letters of Credit and other forms of Documentary Credit issued and advised by banks to provide non-payment and performance risk mitigation in trade transactions. A typical Letter of Credit, the most common form of Documentary Credit, requires the physical presentation, manual checking and exchange of large quantities of paper documents between a convoluted web of intermediaries around the world, which makes them notoriously complex, slow, costly, and prone to error and fraud.

Outside of Documentary Credit, the only other option available to buyers and suppliers was to trade on open account terms. An open account trade transaction is one where goods are shipped and delivered before payment is due, which is typically within 30, 60 or 90 days, with no bank or intermediary involved in guaranteeing due payment. While trading on open account terms benefits the buyer in terms of delivery, it can be a risky option for a supplier, especially in newly established trading relationships. Moreover, open account terms can force the supplier to bear the working capital burden from buyers with long payment terms.  Over the past two decades, payment terms have been continually stretched in many industries and countries beyond 60, 90, 120, and 180 days. Indeed, a common KPI (Key Performance Indicator) for Treasury and Account Payable departments is the length of payment terms. Not only does this put significant stress on the supplier’s balance sheet, it also creates significant risk for the buyers, as the financial health of their suppliers is critical to sustainable, healthy, and robust supply chains.

BPO attempts to mitigate these inefficiencies by providing risk mitigation that is dependent on digital trade data being electronically submitted by the buyer and seller to their banks. This digital trade data is automatically matched on a platform, as opposed to relying on slow, costly Letters of Credit for risk mitigation.

In essence, BPO is a digital trade settlement instrument used to mitigate non-payment and performance risk in trade transactions. As per the Uniform Rules for Bank Payment Obligations (URBPO), it represents an irrevocable payment undertaking by the buyer’s bank to pay the supplier’s bank a certain amount, in a certain currency, on or before a specific date. BPOs are issued by the buyer’s bank in favor of the seller’s bank upon the successful matching of digital trade data such as purchase orders, invoices, and logistics information. 

Looking Back - The Bank Payment Obligation

Earlier this year, SWIFT announced the end of BPO and Trade Services Utility (TSU), the centralized matching and workflow engine that operates as the backbone for BPO. Reasons for this decision are primarily the lack of adoption among banks and their corporate clients resulting in low transaction volumes. Faced with the need to invest in enhancements and upgrades to the underlying technology to ensure its relevance in today’s digitally focused market, SWIFT ultimately decided to switch off TSU/BPO in December 2020, which will allow for a transition period to other solutions.

(Source: GTR, Exclusive: SWIFT calls time on TSU, 2019).

Fortunately, leading banks have already been working on the next generation of the BPO. The solution? Marco Polo’s Payment Commitment. Already piloted extensively with great success between banks and corporates such as Daimler, LBBW, Commerzbank, Bangkok Bank, MAN, and BNP Paribas, the solution’s production release has just occurred in March 2020 with participants hoping to go live in the coming months.

Looking Forward – the Marco Polo Network

Not coincidentally, the 13th-century Italian explorer named Marco Polo is frequently credited as a driving force behind the emergence of Letters of Credit as the primary instrument for trade settlement over the past several hundred years. Marco Polo’s two decades of exploration in China and the East, the knowledge and relationships built during the trip, writings about the journey and the opportunities he found in the East inspired a new wave of exploration. They helped precipitate an explosive growth in East-West trade.

Looking Forward - the Marco Polo Network

This newfound globalization of trade and commerce created an acute need for financial instruments and intermediaries that could help mitigate the risk between buyers and sellers. 

Nearly 700 years later, following on a similar path along the achievements of Marco Polo the explorer, a widely innovative approach towards trade known as the Marco Polo Network is born.  Its goal is to accelerate a paradigm shift in the way that buyers, sellers, and banks conduct, facilitate, de-risk, and finance global trade transactions. And to achieve that, a series of trade finance solutions, including Payment Commitment is launched on the Marco Polo Network.

What is the Marco Polo Network?

The Marco Polo Network is the largest and fastest growing distributed trade and supply chain finance network in the world. It is a joint undertaking between technology firms TradeIX, R3, and some of the world’s leading financial institutions, corporations, and technology providers.

Launched in 2017, the Marco Polo Network provides an open platform for trade and supply chain finance that enables users to streamline, automate trade and supply chain finance transactions. Marco Polo is a blockchain-based network which enables key stakeholders in global trade and supply chains – banks, corporates, logistics companies, insurers, service providers to connect, exchange data, and transact in a highly-automated, real-time, and secure manner.

Within the Marco Polo Network, it is supported by the Marco Polo Platform, which provides a suite of trade finance solutions that allows corporate users to better manage their supply chains, optimize working capital, and mitigate trade risk. Marco Polo can be accessed from one single interface which can be connected directly and securely from the corporate’s ERP (Enterprise Resource Planning) and other systems of records. On the other end, Marco Polo is enabling banks to streamline their operations, improve their cost-income ratio, offer new and improved solutions to their clients, access new sources of origination and drive revenue, as well as better manage their risk.

The Marco Polo Network is open – meaning it is designed from the ground up to support a rich ecosystem of third-party service providers and developers who build, deploy, and commercialize a wide variety of applications, services, and solutions on the Marco Polo Network and Platform.

What is Payment Commitment?

The Payment Commitment is a solution built and deployed on the Marco Polo Platform which builds on the same core tenets of BPO – primarily its original mandate, conceptual value proposition, and ability to bring the banking industry together to develop, deploy, and scale new and innovative solutions.

Payment Commitment takes these core tenets of BPO and transforms them from a standalone product and closed digital island into a natively digital instrument for trade settlement called an IPU (Irrevocable Payment Undertaking).

How does it work

Imagine a typical business transaction, on the physical supply chain layer, goods are purchased and shipped from the supplier to buyer. At the same time, information is exchanged via a blockchain-based network and a 3-way-match is performed on the Marco Polo Platform taking into account purchase order (PO) data from the buyer, invoice data from the supplier, and shipment data from the logistics provider.

Upon successful matching of the trade data, the buyer’s bank provides an IPU in favor of the supplier to mitigate the non-payment risk. Going further, suppliers can elect to sell their IPU to a bank in exchange for early payment. This means suppliers can achieve both risk mitigation and the ability to accelerate cash flow, enabling them to optimize their working capital.

The cost of financing an IPU is typically low compared to the supplier’s borrowing costs because the funder who purchases the IPU is not taking a risk on the supplier but on the buyer’s bank, which is typically an organization with a sound credit profile.

Irrevocable Payment Commitment with financing in favour of the supplier

Why is it different?

The Payment Commitment solution provides many advantages compared to traditional trade finance instruments.

  • It is part of a holistic and integrated trade and supply chain finance offering for banks and their corporate clients. The IPU can be managed from the same user interface, platform, network, and workflows as their procure-to-pay and order-to-cash activities.

  • It offers users the data custody and privacy they expect and require in today’s digital environment by allowing each network participant to control and retain custody over their data and deploy their systems in any way they deem fit. This allows multi-party transactions across jurisdictions and between participants with wide variety of legal and regulatory requirements for data residency and custody. 

  • It provides an open, API-driven architecture that enables connectivity to any data source and/or service from internal and third-party sources. This provides greater flexibility, richer data sets, and others to build and deploy solutions which integrate IPU, expanding the scope and reach of the instrument dramatically.

  • The modular platform and network provide extensibility and flexibility, allowing the instrument to be integrated into a wide range of trade workflows and meet differing requirements. This means each network participant can tailor the solution to fit their needs in terms of trading parties and trade flows.

  • It enables asset portability, meaning IPU digital assets can be moved to and from funders and their respective financing systems seamlessly, securely, and in real-time. This enables more dynamic funding structures including participations and distributions, expanding funding capacity, and better risk and balance sheet management.

  • It is built on a technology infrastructure that can support a wide range of user-defined workflows and configurations outside of the happy-path SWIFT BPO/TSU, including payables finance, pre-shipment finance, payment commitments for risk mitigation, promissory notes, bills of exchange as well as any future products and workflows that involve an irrevocable commitment to pay, triggered by completion of pre-configured criteria agreed on by the counterparties. 

  • It lays the foundation for the adoption of legally enforceable, entirely digital, and self-executing smart-contracts for digital payment commitments. Simply put, this capability can provide trading parties with much needed trust, in a more efficient and secure way. 

It lays the foundation for integration with cash-on-ledger and other DLT-based payment networks. In the future, digital payments associated with financing and settlement of IPUs can be tied programmatically to the asset itself, which means payments can be real-time, automated, peer-to-peer, and require little to no reconciliation.

Find out about the Marco Polo Payment Commitment Solution here.

For more information about how your organization can get involved, register your interest here.