Paperless trade - KPMG Germany (2024)

As the world becomes increasingly digitalized, trade is no exception. Especially when it comes to trade finance (especially guarantees and letters of credit), technology and innovation are proving transformative. Transitioning to paperless trade processing is an essential step that increases efficiency, reduces costs and improves transparency. However, for guarantees and letters of credit, paper is still often the number one information carrier and the term digitalization, where used, has very different meanings. All the more interesting is the question of what degree of digitalization is already possible today in the trade finance sector – cue paperless trade.

In the following, we will therefore take a closer look at the legal aspects (as per the current regulations of the International Chamber of Commerce) as well as the technical aspects.

Digital guarantees

• Digital sureties
  We begin with sureties and guarantees. Under the German understanding of the law, a surety is a contract within the meaning of §765(1) BGB by which the guarantor undertakes towards the creditor of a third party to vouch for the fulfillment of the third party's obligation. What is special about the surety is that it is accessory to the principal claim. In other words, the surety itself stands or falls with the principal claim. So as soon as the principal claim has been fulfilled, the claim against the guarantor arising from the guarantee agreement also expires.
  A surety must be in writing in accordance with §766 sent. 1 BGB. §766 sent. 2 BGB explicitly prohibits the electronic form. However, this provision applies solely to B2C business. This strict written form requirement is modified in commercial business transactions by §350 HGB, which allows merchants within the meaning of the HGB to use any form, including electronic form.
• Digital guarantees
  With guarantees, the strict accessory nature described above is not present. Under the guarantee contract, the guarantor also undertakes to be liable for the claim of a third party. However, the guarantor's obligation to pay does not automatically expire upon fulfillment of the principal claim. For practical purposes, guarantees on first demand (demand guarantees) are common. In such cases, the guarantor undertakes to pay upon the assertion that the guarantee case has occurred (the so-called first demand). Any assertion by the original guarantee holder or assignee that the guarantee case has occurred, giving rise to the guarantor's payment obligation, must be made in the form, language and wording prescribed in the guarantee contract and thus in compliance with the guarantee. In this respect, there is a large number of documents that must be submitted in the event of the first demand. These guarantees on first demand are governed internationally by the “Uniform Rules for Demand Guarantees, URDG 758” of the International Chamber of Commerce.
  There are two ways in which URDG 758 permits the use of electronic documents. On the one hand, the guarantee promise, i.e. the guarantee itself, can also be created in electronic form. This follows from the interplay of the definition pair “guarantee” and “signed” within the meaning of Art. 2 URDG 758. Hence, guarantee means any signed obligation, however named or designated, to pay upon presentation of a compliant request. Signed means, in relation to a document, guarantee or counter-guarantee, that an original is signed by or on behalf of the issuer by electronic signature, which may be authenticated by the party to whom such document, guarantee or counter-guarantee is presented, or by handwriting, facsimile signature, perforated signature, stamp, symbol or other mechanical method. This form also extends to the requirement of the guarantee within the meaning of Art. 15 lit. a URDG 758.
  In addition, Art. 14 lit. c URDG 758 states that documents may be submitted in the form of electronic documents. To avoid problems with the submission, however, the specific format of the electronic documents should be determined in advance.

Digital letter of credit
The ICC's UCP 600 (“Uniform customs and practice for documentary credits”) have become established as the standard set of rules for the documentary credit business. These have been extended by the eUCP v. 2.1. These eUCP were deliberately designed as a mere supplement. Rather than creating a new instrument, the intention was to extend the existing letter of credit to include the use of electronic documents. eUCP are applicable if their validity has been expressly indicated in the documentary credit (Art. e1 eUCP). However, there is no obligation to submit electronic documents at a later stage. It remains permissible to submit only paper documents or even a “mixed presentation” of paper and electronic records.

Conclusion
From a legal perspective, the use of guarantees and letters of credit can be fully mapped digitally today, which means that a paper-based form is no longer considered necessary.

When it comes to the digitalization of guarantees and letters of credit, the field is very diverse and depends heavily on the contractual partners. As a general rule, there are four main steps involved in the digitization process:

Applying for a guarantee/letter of credit
The first step – once the conditions have been successfully agreed between the contracting parties – is the application process for the instrument within a company. This ranges from submitting the application to approving or revising the application within the company and communicating it to the bank. All steps prior to communication to the bank are now often carried out by one or a combination of the following channels:

• Paper-based circulation
• Telephone
• Chat
• Email
• Trade finance systems

Communication with the bank
Communication with the bank or a financial institution is the next step after the guarantee or letter of credit application has been finally approved within the company. At this step in the process, the application leaves the company and is processed further by an external party. Communication usually takes place by:

• Telephone
• Email
• Digital communication channels, such as SWIFT

Issuing a guarantee/letter of credit
Following transmission of the application to the bank or financial institution, the certificate or corresponding documents are processed and issued there. It also involves sending the original document to the beneficiary. This dispatch usually takes place via one of the following methods:

• Paper via post / courier
• Digital communication channels, such as SWIFT

Inventory management
Once the guarantee or letter of credit has been successfully issued and is in the hands of the beneficiary, inventory management begins on both sides. A debtors' aim is to pay the fees only for guarantees that have been issued and not drawn. By contrast, the beneficiary of a guarantee is interested in knowing when a guarantee expires and how to draw on it in the event of a guarantee event. This means that when it comes to managing letters of credit, the key elements are the fees and the options (i.e. the way in which) the required documents are managed.

Often the following options are used to manage the inventory, fees and due dates:

• Paper-based filing structures
• MS Excel
• Treasury Management systems
• ERP systems
• Trade finance systems

Conclusion
For all of the above steps, there are already options for fully digitalizing them. Often, the company's own trade finance systems are predestined for this, as they can map all the steps in the workflow described above (from application to issuance to management). In addition, many treasury management systems also allow individual aspects to be mapped.

When we talk about the complete digitalization of guarantees and letters of credit, we are talking about paperless trade.

In this context, there are a number of challenges that often arise in connection with paperless trade. A few of the most common challenges that arise when the above-mentioned legal and regulatory framework is taken into account are listed below:

• Standardizing data formats
  Standardizing data formats is an essential aspect of ensuring that digital guarantees and letters of credit can be processed by different systems without any problems and that inconsistencies can be avoided.
• Interoperability
  Another important factor is the seamless exchange of data between the various systems, for example between the company and the bank, which needs to function perfectly
• Acceptance and trust
  One of the main factors that will enable digital guarantees and letters of credit to become standard is the trust of all market players involved and their acceptance of paperless trade. It is particularly important that the processes, systems and security mechanisms used are widely accepted by applicants, beneficiaries and banks.

Alongside the challenges mentioned above, the use of paperless trade also offers a range of advantages that make trade more efficient, secure and transparent. The most significant advantages are:

• Time savings
  Thanks to the use of digital guarantees and letters of credit, transactions can be processed significantly faster. By transferring documents and data electronically, it is possible to process them immediately, significantly reducing the time needed to exchange paper-based documents.
• Increased flexibility
  With paperless trade, the parties involved are no longer bound by the deadlines and delivery times of couriers and can therefore request and process transactions at any time of day or night. Also, transactions can be quickly adjusted if conditions change.
• Cost savings
  Making use of digital guarantees and letters of credit can lead to significant cost savings. By eliminating the need to print and send paper documents, several kinds of costs are saved at once.
• Increased transparency
  All parties involved benefit from the increased transparency that the use of digital guarantees and letters of credit brings. As a result, all relevant information and the current status can be viewed by the parties involved at any time, and any irregularities can be rectified immediately.

Conclusion
Even today, a paperless and digital processing of guarantees and letters of credit is possible from both a technical and legal point of view. To the extent that the already existing but as yet unused technical possibilities are tapped and the number of convinced market participants grows, paperless trade will increasingly find its way into trade financing. Already today, the advantages of fully digitalized guarantees and letters of credit are convincing arguments for dealing with the topic and setting the course for a digitalized present of trade financing.

Source: KPMG Corporate Treasury News, Edition 143, May 2024
Authors:
Nils Bothe Partner, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG
Maximilian Gschoßmann, Manager, Finance and Treasury Management, CorporateTreasury Advisory, KPMG AG
Guest Author:
Lawyer Dr. David Saive, LL.M., Geschäftsführender Gesellschafter der Tug & Tow® UG (haftungsbeschränkt)