CiTF Chapter 15.pdf

Chapter 15

Bank payment obligations (BPOs)

Learning objectives By the end of this chapter, you should have an understanding of: u what is meant by a bank payment obligation (BPO); u how BPOs work and what tools are required; u the benefits of BPOs to sellers and buyers; u the International Chamber of Commerce Uniform Rules for Bank Payment Obligations (URBPO).

In Chapter 7 and Chapter 8 we looked at documentary collections and at documentary credits respectively. These provide more security to sellers than selling on open account terms where, for example, the buyer may not be well known or may not be financially sound. As the names suggest, both of these settlement terms rely on the physical transmission of documents, with the inherent risk of increased cost and time delays. This chapter looks at a new type of payment instrument: the bank payment obligation (BPO).

15.1

How was the concept of the BPO developed?

The finance of trade is a long-established, highly specialised branch of banking that is critical to the successful and efficient flow of commerce. Traditional mechanisms and instruments, such as documentary collections and documentary credits, are so well established and trusted that there has © ifs University College 2014

269

15: Bank payment obligations (BPOs)

been limited innovation in this domain over the last several decades, if not hundreds of years. While technology has evolved to enable faster and more efficient processing, the fundamental nature of traditional trade finance has remained largely unchanged. Continuing evolutions in technology, together with shifting priorities and preferences of buyers and sellers, have to some extent driven a move away from traditional instruments, underpinning a search for new business models and new solutions in support of trade. The widespread adoption of trade on open account terms is a direct consequence of the changes in global sourcing and supply chains, challenging banks to deliver more creative and cost-effective solutions for the mitigation of risk and financing. If industry forecasts for growth prove correct, by 2020 not only will the value of world trade have doubled but there will also be an additional USD17 trillion worth of business, all being conducted on open account. In the face of these changing market dynamics, the effective management of credit and liquidity is of growing importance as a powerful strategic tool, not only in the context of risk mitigation and payment assurance but also in having ready access to cost-effective working capital finance. To achieve these goals, it is recognised that there needs to be enhanced process efficiency, enabling clear visibility into the physical supply chain (the movement of goods from one place to another), linking to the financial supply chain (the movement of money in the opposite direction) and facilitating the fast exchange of data and speedy resolution of disputes. The International Chamber of Commerce (ICC) Banking Commission is the trusted rule-making body for the banking industry. SWIFT is the trusted platform for banks around the world to exchange structured messages securely, not only in support of traditional trade but also in related payments, foreign exchange and financing. Given these trusted positions, the ICC and SWIFT have been able to collaborate closely with a broad range of industry stakeholders, including leading members of the banking and corporate communities, to develop the bank payment obligation, backed by new technology, new messaging standards and a new set of industry rules that together provide a fresh response to the evolving needs of businesses engaged in international commerce. It should be noted that the BPO is not a product, but rather a framework, complete with processes, rules, standards and practices aimed at the provision of solutions in trade and supply chain finance. It can be used by financial service providers, to enhance a broad range of financial supply chain product offerings.

270

© ifs University College 2014

How does a BPO work?

15.2

How does a BPO work?

A BPO is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after a successful electronic matching of data according to an industry-wide set of rules. The successful establishment and completion of a BPO transaction require the close interaction of three critical components: 1. the transaction matching application (TMA), which provides the platform for the exchange of messages; 2. the ISO 20022 TSMT messaging standards (see section 15.2.2 below), which enable the data to be presented and matched in a structured way, according to accepted industry practice; 3. the ICC Uniform Rules for Bank Payment Obligations (URBPO), providing a framework for BPO transactions in much the same way as UCP 600 provides a framework for documentary credits (see Chapter 8). If we consider a documentary credit as placing an obligation on an issuing bank to pay, subject to the physical presentation of compliant documents, then the BPO places a similar obligation on an issuing bank (known as the ‘obligor bank’) to pay, subject to the electronic presentation of compliant data. These data are presented (and matched) through a central transaction matching application (TMA). To develop new products based around a BPO, a bank must: address its product positioning relative to existing open account and documentary solutions; and deploy a technology platform that can support communication not only with the corporate client but also with a central TMA, such as SWIFT’s Trade Services Utility, while interacting with the bank’s own accounting, credit, capital reporting and payment applications. To make these products successful, a bank must also develop its own commercialisation plan. A BPO is made up of the following data elements: u the bank that must make payment under the BPO (the obligor bank); u the bank that receives payment under the BPO (the recipient bank); u the maximum amount that will be paid under the BPO; u the date of expiry of the BPO; u the amount of charges to be taken by the obligor bank; u the country whose law governs the transaction; u payment and settlement terms (at sight or deferred). © ifs University College 2014

271

15: Bank payment obligations (BPOs)

The BPO allows for a variety of features and commercial scenarios, including the acceptance of mismatches and amendments, the engagement of multiple banks in one BPO transaction, the ability to handle partial shipments, and the option to share risk among banks through the distribution of obligations under the BPO. The BPO transaction life cycle formally begins with an ISO 20022 message called an ‘Initial Baseline Submission’. The counterparty bank must resubmit an identical version of the baseline in order for the transaction to become established. The transaction cannot be established, and therefore the BPO cannot be established, unless both sides agree. As soon as the two baselines match, the BPO becomes an irrevocable undertaking conditional on the matching of the specified data.

15.2.1 BPO workflow From a corporate perspective we can think of a BPO transaction in four distinct stages (see Figure 15.1). 1. The buyer and seller contract to use a BPO as the method of payment. 2. The relevant purchase / sales order data are passed to each bank. 3. After shipment, the seller provides commercial and transport data to its bank. 4. When the commercial and transport data have been matched to the purchase order data, the BPO is due and payment (or an undertaking to pay at an agreed future date) will follow. All of these steps involve interactions between buyers, sellers and their respective banks without touching the TMA. These steps are therefore outside the scope of the TMA service and outside the scope of the URBPO. There are no rules governing the way in which data are exchanged between a corporate customer and a bank. This is purely a matter for negotiation between the customer and its selected service provider. From a bank perspective, we can also think of a BPO transaction in four stages (see Figure 15.2). 1. The buyer’s bank uses the purchase order data to submit a baseline, and the seller’s bank uses the purchase order data to resubmit the baseline. This enables the transaction to become established. 2. Both the buyer’s bank and the seller’s bank receive a baseline match report, to confirm that the two baselines match.

272

© ifs University College 2014

How does a BPO work?

Figure 15.1

Interactions outside the scope of the URBPO

Source: SWIFT

3. Once the goods are shipped, the seller’s bank submits the invoice and transport data to the TMA. 4. The data set match report confirms that the invoice and transport data match the baseline and the BPO is due.

15.2.2 ISO 20022 standards The International Organization for Standardization (known as ISO) is the world’s largest developer and publisher of International Standards, with a membership of more than 160 national standards bodies. ISO 20022 is a set of standards developed by ISO for use in the financial industry. Usage of ISO 20022 messages results in consistency and uniformity of format and terminology through use of a common data dictionary. The adoption of structured ISO 20022 TSMT messaging standards is mandatory to support the exchange of BPO data through a recognised TMA. © ifs University College 2014

273

15: Bank payment obligations (BPOs)

Figure 15.2 Interactions inside the scope of the URBPO where the buyer’s bank is the only obligor bank

Source: SWIFT

ISO 20022 standards are the methodology established by ISO for message development and specify the format for commercial, transport, insurance and certificate data sets to be submitted by a bank in relation to an underlying BPO transaction. ISO 20022 organises financial message definitions by business area, each one of which is uniquely identified by a four-character business area code. In the case of trade services management, the business area code is TSMT. As is the case with other ISO standards in the area of financial services, ISO 20022 standards for TSMT messages are publicly available and are not proprietary to any technology provider or financial institution. The Initial Baseline Submission message can be submitted either by a bank acting on behalf of a buyer or by a bank acting on behalf of a seller. The BPO is an optional part of a baseline, which can be established from the outset or added later by way of an amendment. The baseline contains all of the details of the data-matching terms and conditions that must be met in order for the BPO to be enforced. In order to establish a baseline − and in so doing to establish the BPO − the counterparty bank must resubmit the baseline to the TMA as a confirmation 274

© ifs University College 2014

How does the BPO compare with existing tools?

that both banks agree on what the baseline looks like. This also confirms that both banks agree on the data-matching terms and conditions. As soon as the two baselines match, the BPO becomes an irrevocable undertaking conditional on the matching of the specified data. Later in the transaction life cycle, the goods will be shipped and the physical documents sent directly from the seller to the buyer (as in a conventional open account environment). At the same time, the seller will provide to its bank the relevant data elements that have been extracted from the underlying documents. The bank acting on behalf of the seller will submit those data sets into the TMA for matching.

15.3

How does the BPO compare with existing tools?

The closest comparable tool to a BPO is the documentary credit (see Chapter 8), which guarantees payment by the issuing bank or confirming bank, as long as certain documentary conditions are met. However, promoters of BPOs are keen to differentiate the two instruments and do not wish BPOs to be seen as an electronic form of a documentary credit. It is emphasised that, although BPOs and documentary credits are both conditional payment instruments, with the BPO the payment is triggered by presentation of electronic data, rather than hard-copy documents such as invoices and bills of lading. It is important that BPOs are perceived to be a more secure alternative to pure open account trading, requiring (possibly) less use of credit insurance. Another advantage is the speed of the transaction. The BPO has the potential to remove several days from the seller’s ‘days sales outstanding’ (DSO), thus improving its cash flow and working capital positions. In this context, it should be noted that a common measure of management effectiveness is the cash conversion cycle, combining activity ratios related to accounts receivable, accounts payable and inventory turnover. The cash conversion cycle is based upon a combination of DIO (days inventory outstanding) plus DSO (days sales outstanding) minus DPO (days payables outstanding). In other words, it calculates the number of days working stock is held as part of inventory plus the number of days it takes to collect payment from debtors whilst taking away the number of days taken to pay creditors. The lower the net result, the more efficient the organisation is in its deployment of cash. Some retailers are able to work to a negative cash conversion cycle by selling stock before paying suppliers. One material difference between a BPO and a documentary credit is that the BPO is given by a bank (the obligor bank) in favour of another bank (the recipient bank), whereas a documentary credit is issued by a bank in favour © ifs University College 2014

275

15: Bank payment obligations (BPOs)

of a corporate client − the seller and ultimate beneficiary. Consequently, it is not technically possible for a BPO to be ‘confirmed’ in the traditional sense. Hence, the role of a ‘confirming bank’, which is commonly used in documentary credit transactions, does not apply in the case of a BPO transaction. When and how value is passed to the seller is outside the scope of the URBPO, and will form part of a separate agreement between a recipient bank (the seller’s bank) and its customer. Included in the terms of such an agreement, the recipient bank can issue another contingent obligation towards the seller, based on the BPO received. This can have the same effect as a silent confirmation of a documentary credit, whereby a beneficiary can enter into a separate arrangement with a negotiating bank to commit to negotiate the documentary credit on its due date.

15.4

What are the benefits of BPOs?

15.4.1 Benefits for the seller The following sections outline the benefits of using BPOs for the seller.

15.4.1.1

Assurance of payment

A BPO provides an assurance of being paid in full on the due date, according to the terms of the contract, provided the requisite data are presented and matched.

15.4.1.2

Cash flow forecasting and working capital management

Day-to-day cash flow can be managed in an efficient manner, as can treasury forecasts, anticipating in advance any opportunities to invest or requirements to borrow.

15.4.1.3

Dispute resolution

The BPO process for handling mismatches and other data issues presents an attractive alternative to the often time-consuming and expensive business of resolving discrepancies in physical documentation. Data mismatches are identified and reported quickly, providing the opportunity for such mismatches to be accepted or rejected without delay. The definition of a 276

© ifs University College 2014

What are the benefits of BPOs?

data mismatch is less subjective than a discrepancy in a paper document, since in the case of a data element it either matches or does not match.

15.4.1.4

Amendments

The terms and conditions attached to a BPO transaction can be amended quickly and easily by mutual agreement between the involved banks. This includes the ability to: create a transaction without a BPO but then add the BPO later by way of an amendment; or change the due date of the payment. Such flexibility can provide additional advantages in relation to the cost of capital and hence the cost of financing.

15.4.1.5

Risk mitigation

A BPO establishes a baseline agreement, so that everyone involved can share a common view and level of comfort, hence facilitating the mitigation of risk. Having multiple BPOs for a single transaction creates a wider opportunity for trade asset distribution, for example in a lead bank model where one bank may invite other obligor banks to participate in a risk. If multiple obligor banks are involved in a single TMA transaction, the amount due by each obligor bank is proportional to its share of the total of all BPO amounts. No joint and several obligations are created.

15.4.1.6

Finance

In the absence of a documentary credit, sellers lack the collateral to obtain finance under open account. Available options may be limited to factoring or invoice discounting. With a BPO, a comprehensive range of financing options can be made available, including pre-shipment and post-shipment finance.

15.4.2 Benefits for the buyer The following sections outline the benefits of using BPOs for the buyer.

15.4.2.1

Securing the supply chain

The BPO allows the buyer to provide key suppliers with an assurance of being paid on time according to the agreed payment terms. This assurance of payment comes from the obligor bank (or banks) being legally committed to pay on the due date, provided the data submitted by the seller’s bank are compliant with the agreed terms.

© ifs University College 2014

277

15: Bank payment obligations (BPOs)

From a cash management point of view, this is beneficial to both buyers and sellers alike, since it delivers certainty on cash flow in and out. The ability to provide such an absolute level of payment assurance clearly strengthens the buyer−seller relationship, possibly resulting in the opportunity to negotiate improved terms and conditions. Buyers who engage in a BPO contract with one or more sellers will contribute to the streamlining of supply chain processes, resulting in enhanced risk mitigation and improved efficiency. This may be turned into a competitive advantage over other buyers, resulting in improved payment terms.

15.4.2.2

Finance

From a buyer perspective, a BPO is obviously safer than pre-payment. It allows the buyer to confirm that the goods have been shipped on or before the due date according to the required specification, before committing to pay. Because the electronic processing of data is faster, the buyer can potentially get quicker access to banking services, including financing where required. Because the BPO provides banks with greater visibility into the trade transaction, the buyer can also benefit from specific financing services (eg extended payables finance), tailored to working capital needs at any stage of the transaction life cycle. This feature is similar to what is available through the existing documentary credit practices, but offers a wider spectrum of financing opportunities in a more timely fashion. Because it can be created at any time during the life cycle of a transaction, and for an amount that can differ from the total value of the goods, the BPO offers greater flexibility than a documentary credit. It can also help to spread payment risk across several obligor banks, for example by instructing a lead bank to allocate the risk according to a trade asset distribution model. This flexibility could result in lower financing costs as well as reduced costs for the seller, creating more value in the supply chain and potential opportunities for higher degrees of accuracy and objectivity. For critical suppliers, a buyer may decide to offer a BPO in order to ensure that the goods ordered continue to be delivered on time and that there are no interruptions to the supply chain. A seller can get financing from its bank at different stages in the transaction life cycle. The BPO can be used to sustain the seller’s working capital in support of, for example, production (pre-shipment finance, inventory finance), product shipment (packing and distribution loans) or business development and growth. Failure to have access to these facilities could prove detrimental to the seller’s continued ability to trade.

278

© ifs University College 2014

In what circumstances should a BPO be considered?

15.4.2.3

Process efficiency

While the manual documentary credit process implies a detailed verification of documents, including a line-by-line examination of some of the shipping documents, the BPO requires only the matching of a limited number of relevant data elements to guarantee the payment or to support a proposition for financing. At the same time, there is the added flexibility that in the event of data mismatches being found, the buyer has the immediate discretion to accept or reject such mismatches, so reducing the risk of extended disputes and delay. Buyers trade with multiple sellers across the globe, often in different jurisdictions resulting in a variety of payment terms, and potentially using more than one supply chain finance platform. These platforms use different exchange mechanisms, from electronic proprietary data formats, to fax and email. The cost of integration with corporate back-office applications becomes prohibitive, when the number of trading players grows or varies over time. It also implies significant on-boarding costs (ie the process of bringing suppliers ‘on board’ to participate in the financing scheme) and lengthy ‘know your customer’ processes. The BPO is designed for a four-corner business model, involving a buyer, a seller, a buyer’s bank and a seller’s bank. The goal is to help buyers to reach multiple suppliers through selected banks in the existing correspondent banking network.

15.5

In what circumstances should a BPO be considered?

The following are some of the circumstances where the use of a BPO in international or domestic trade may be considered appropriate. Where: u a buyer and a seller wish to trade on open account terms, but seek bank assistance to help with the mitigation of risk; u a buyer and a seller wish to trade on open account terms, but the seller additionally seeks an assurance of payment from the bank; u a buyer and a seller wish to trade on open account terms, but bank assistance may be required to support short-term working capital financing arrangements; u a buyer and a seller wish to trade on open account terms but to keep open the possibility of obtaining bank assistance for financing at any time during the transaction life cycle; © ifs University College 2014

279

15: Bank payment obligations (BPOs)

u the costs associated with alternative forms of trade or supply chain finance are unacceptable to one or both parties and threaten to compromise the trading relationship; u the exchange of paper documents is mandated as between buyer and seller, but such documents are not required to be physically presented through the banking system.

15.6

ICC Uniform Rules for Bank Payment Obligation (URBPO)

The ICC Banking Commission has adopted BPOs as an accepted market practice, in the same way that documentary credits became accepted under the ICC Uniform Customs and Practice for Documentary Credits rules (UCP − see Chapter 8). Having worked jointly with SWIFT on the development of the rules, the ICC approved the Uniform Rules for Bank Payment Obligations (URBPO), publication no. 750, version 1.0 in April 2013 with an implementation date of 1 July 2013. While some banks have already conducted transactions with the use of a BPO, others are currently involved in developing their own solutions and have clients trying to identify potential counterparts. The foreword to the URBPO states clearly that the use of BPOs is aimed as a solution to supply chain financing problems. It is hoped that banks and non-bank providers will respond with financing services to complement BPOs and meet their clients’ needs, whether in international or domestic trade. There are 16 articles in the URBPO, and the areas covered are outlined below.

Article 1 Article 1a defines the scope of the URBPO as follows: The ICC Uniform Rules for Bank Payment Obligations (URBPO) provide a framework for a Bank Payment Obligation (BPO). A BPO relates to an underlying trade transaction between a buyer and seller with respect to which Involved Banks have agreed to participate in an Established Baseline through the use of the same Transaction Matching Application (TMA).

Article 2 Article 2 describes the applicability and binding nature of the URBPO subject to specific version numbering and mandatory use of ISO 20022 messaging standards.

280

© ifs University College 2014

ICC Uniform Rules for Bank Payment Obligation (URBPO)

Article 3 Article 3 provides a list of general definitions and how these should be interpreted in the context of the URBPO. For example: u an ‘involved bank’ means a seller’s bank or recipient bank (depending upon its role at any given time), a buyer’s bank, an obligor bank or a submitting bank; u the recipient bank is the beneficiary of the BPO and will always be the seller’s bank; u the buyer’s bank may or may not act as an obligor bank; u a submitting bank is a bank whose only role is to submit data.

Article 4 Article 4 provides a list of message definitions, describing all such ISO 20022 TSMT messages as may be used in a BPO transaction.

Article 5 Article 5 provides specific interpretations within the scope of the rules, eg that branches of a bank located in different countries are considered as separate banks.

Article 6 Article 6 indicates the separate nature of a BPO from the underlying contract.

Article 7 Article 7 describes how BPO data may be extracted from the physical documents which, in the majority of cases, may still exist. Banks involved in a BPO transaction deal in data, not documents or the goods, services or performance to which the data or documents may relate.

Article 8 Article 8 covers the expiry date for the submission of data sets. The use of Universal Time Co-ordinated (UTC) allows for the adoption of a consistent and standard timing protocol on a global basis. UTC is recognised as the primary standard by which world time is regulated: it is commonly used in the synchronisation of computer systems and the internet.

Article 9 Article 9 covers the role and responsibilities of an involved bank, including the obligation to act without delay on receipt of a message from a TMA.

© ifs University College 2014

281

15: Bank payment obligations (BPOs)

Article 10 Article 10 covers the undertaking of the obligor bank, including those scenarios in which there may be more than one obligor bank.

Article 11 Article 11 covers the subject of amendments, again including scenarios where there may be more than one obligor bank.

Article 12 Article 12 covers the use of a disclaimer clause, consistent with other ICC rules.

Article 13 Article 13 addresses the concept of ‘force majeure’, also consistent with other ICC rules.

Article 14 Article 14 specifies that an involved bank cannot be held liable if a TMA is unavailable.

Article 15 Article 15 specifies applicable law (being that of the country where the branch or office of the obligor bank is situated).

Article 16 Article 16 confirms that a recipient bank has the right to assign any proceeds under a BPO.

Chapter summary This chapter has looked at the subject of bank payment obligations (BPOs) and the ICC rules covering them: u BPOs are designed to enable faster, cheaper payments and enhanced working capital management. They are an addition to the existing toolkit of solutions available to buyers and sellers engaged in ongoing trading relationships. u BPOs have been created in response to the changing nature of international trade, particularly the growth of open account trade.

282

© ifs University College 2014

Chapter summary

u The BPO transaction life cycle formally begins with an ISO 20022 message called an ‘Initial Baseline Submission’. The counterparty bank must resubmit an identical version of the baseline in order for the transaction to become established. The transaction cannot be established, and therefore the BPO cannot be established, unless both sides agree. As soon as the two baselines match, the BPO becomes an irrevocable undertaking conditional on the matching of the specified data. u Benefits of BPOS to the seller include: − assurance of payment; − cash flow forecasting and working capital management; − dispute resolution; − amendments; − risk mitigation; − finance. u Benefits of BPOs to the buyer include: − securing the supply chain; − finance; − process efficiency. u There are a number of situations in which buyers and sellers wishing to trade on open account terms might consider use of BPO, for example risk mitigation or support for working capital financing arrangements. u The Uniform Rules for Bank Payment Obligations (URBPO) have been effective since 1 July 2013. Appropriate situations for the use of a BPO have been examined. A summary of the ICC URBPO rules has been provided.

References ICC (2013) Uniform rules for bank payment obligations. ICC Publication No. 750E.

© ifs University College 2014

283

15: Bank payment obligations (BPOs)

Review questions The following review questions are designed so that you can check your understanding of this chapter. The answers to the questions are provided at the end of these learning materials.

1.

In the world of trade finance, what does the term ‘BPO’ mean? a. Business process outsourcing

b. Bank payment obligation

c. Broker price opinion

d. Bank payment order

2.

What are the three components that must interact with one another to facilitate the successful completion of a BPO transaction?

3.

How can a BPO become established?

4.

Who is the beneficiary of a BPO?

284

© ifs University College 2014

Review questions

5.

How can a BPO be confirmed?

6.

If a transaction contains multiple BPOs, what is the obligation of each obligor bank?

© ifs University College 2014

285

15: Bank payment obligations (BPOs)

286

© ifs University College 2014