INDUSTRY OPINION: Unblocking the paperchase in international trade

(This post originally published by Lloyd's List Australia. The opinions are solely those of the author)

NEARLY every report on risks in trade faced by importers and exporters refers to those risks associated with paperwork needed to complete transactions and then the risks of actually making or receiving payments properly. In my practice I am regularly faced with scenarios where an importer has paid for goods to an overseas supplier – who then refuses to release the bill of lading without additional payment or who claims it does not have an export permit and refers the importer to a colleague party who actually has such a permit but who then demands that the importer make additional payments to have the goods transported or to secure the bill of lading. These are nightmare scenarios in which a nasty letter from an Australian lawyer is not enough; proceedings here are of limited use and we often need help from lawyers in the supplier's jurisdiction or other parties who can exert legal and commercial pressure to require the suppliers and their colleagues to honour the agreements.

The system is also open to other risks of human error which interferes with the contract being honoured properly – let alone fraud where the lack of security and closure in the commercial deal where one party can effectively sell or finance the same goods through a number of different parties.

There are also other little known consequences associated with the reliance on paper to complete transactions. For example, during the time that the Icelandic volcano and the related ash clouds stopped many commercial flights in the northern hemisphere, that also stopped the shipping trade as the necessary hard copy bills of lading could not be delivered and presented.

For some time there has been agreement, in principle, on what could reduce or even eliminate risks which would act to the advantage of all parties. That would be the combination of building a secure chain between the actual parties to the transactions themselves (a form of "blockchain") to provide for the transactions to be effected including stages for payments and release of goods, secure encrypted contracts (smart contracts) recorded and limited to action by the actual parties in the chain themselves (avoiding unilateral or third party interference), together with payments triggered by independently determined events such as the loading of goods and containers arrival of vessels in port, the unloading of relevant goods and containers and confirmation on their contents. All of this is effected through a combination of electronic contract and payment combined with the physical passage of goods. The intent is that once the chain and the contract are established then the payment flows automatically due to digital ledger technology encrypts and stores the terms of the contracts, allowing parties to operate off the same version of the same contract which could not be unilaterally altered or manipulated.

The certainty in the contract allows the stages of the contract to be "coded" into the "smart contract" which are triggered automatically when certain conditions are met, eliminating the long paperchase and intervention by humans.

In recent times, there has been some media coverage of what appears to be the first real time transaction relying on blockchain and smart contracts associated with the sale and transfer of 88 bales of cotton travelling from Houston to Qingdao. Reportedly, as the bales arrive and are scanned then the electronic contract would be actioned, transferring ownership and allowing payments to be made. Certainly, there is some real attraction to such a transaction, funded by external financiers and effected through electronic means which would have been a welcome extension to the current "e-commerce" agenda.

However, at this stage there is no one agreed framework for such transactions as they will depend on many things such as the numbers of parties in the relevant "blockchain", the nature of the contract itself depending on the goods themselves and the supply chain and the approval of external parties such as financiers, insurers and regulators. The "scalability" of such a process will depend on the ability to have a common process which is accepted and adopted by all parties in the supply chain.

There is also the feeling that it may be confined to more sophisticated parties in the supply chain who understand and can afford the transactions and have a like-minded set of counterparties who accept the same parameters and are prepared to play by the same rules including the acceptance of the forms of contract and actions under those contracts. It will also be limited by the technology involved and its security and reliability. Clearly, the ability of parties to "hack" websites and electronic communications can also create similar risks for electronic "blockchains" and payment processes. After all, even the sophisticated technology associated with share trading can also be manipulated and that has been in operation for many years.

While the proposed arrangements offer some prospect of reduced risk and increased certainty, it is probably also true to say that for some time its success will be limited by these practical, commercial constraints, let alone the necessary legal framework and the goodwill of the parties. In addition there is also the issue of the one, intractable, necessarily conservative body which is many ways is the most vital party in the supply chain – the border regulators who still require separate and independent reporting of different stages of the transaction – whose approval is still required for the movement of goods and who heavily penalise any failure to comply with regulatory obligations. In the absence of the regulators engaging with such transactions and incorporating their reporting and payment requirements into the same system, then while the parties to the contracts may see the electronic payments and contracts as an advantage, that advantage will still be limited by the obligations to the regulators. Hopefully this topic becomes one which is taken up and advanced at the National Committee on Trade Facilitation although to do so it would require the admission of financiers and insurers to that body which has yet to happen.

As always we look forward to developments which will advance and enhance the supply chain and reduce the risks to the parties engaged in that supply chain.

Andrew Hudson is a partner with Gadens who practices extensively in international trade and customs issues.