Proposed “Electronic Trade Documents” law in the UK may spur global regulatory push towards Trade Finance and Insurance digitization

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English Common Law is not only at the root of the 54 Commonwealth countries’ legal systems. It is also the source of de-facto globally accepted guidelines on working practices and expected standards in cross-border commercial transactions for major economic sectors such as Banking, Insurance, Asset Management and Shipping. 

For example, Brexit notwithstanding, a high percentage of Investment Banking transactions globally are based on contractual documents (from Master Level Agreements to Annexes and Confirmations) that have been^[1] and are still being written under English Law and London Arbitration^[2]. Of course, there are already ways to transfer legal certainty to a purely EU setting (for instance, ISDA responded^[3] in-time before Brexit took effect to include standardized amendments allowing counterparties to transfer existing Master Agreements to versions^[4] valid under Irish Law or French Law^[5], addressing concerns^[6] on both sides^[7] of the English Channel). Legal commentary usually mentions a few recurring reasons^[8],[9] why this preponderance of English law should continue, but expert opinions (or convictions …) aside, it is rather difficult to expect that long-established working practices and contractual frameworks in global firms will change dramatically going forward. 

Major important Commodity Trading participants (producers – such as Australia, Canada, Kenya, New Zealand, Nigeria and South Africa – and trading hubs such as Hong-Kong and Singapore) are either in the Commonwealth or following common law in commercial matters. Import/Export, Commodity Trade Finance, Shipping and Chartering laws and contracts (templated and/or arbitrated by industry bodies such as the International Chamber of Commerce^[10],[11] and BIMCO^[12]) still contain significant common law input, to the extent that London is still considered a “safe” seat of arbitration for shipping and trade disputes and English law the “safely” applicable one^[13]. 

Significantly, the final court of appeal for a number of British Overseas Territories^[14] continues to be the Judicial Committee of the Privy Council^[15], sharing premises and staff with the UK Supreme Court. It^[16] “generally has the power to reverse the decision of the lower court in the country from which the case was referred”. Among these territories are Bermuda (Re-/Insurance), Cayman Islands (Commercial Trusts and Capital Markets), the British Virgin Islands (Private Trusts and SPVs).

With this context in mind, a recent policy document containing proposals for reform and draft legislation issued by the UK Law Commission titled “Digital assets: electronic trade documents”^[17],[18] may have far-reaching consequences for Trade Finance and Insurance houses globally. The issuing organization^[19] has the statutory role of advising the UK parliament on necessary changes to ensure that “law is as fair, modern, simple and as cost-effective as possible”^[20]. Communication of the proposals was originally made on April 30, 2021 under the uncharacteristically ambitious title “Proposals to allow electronic documents would revolutionize trade”. 

In this case, the ambition might well be justified. 

The document in effect proposes to legislate in the UK the legal equivalence of physical and electronic trade documents of the following types (“Bill”, Section 1, Sub. (2) – page 177 in reference18):

• Bill of exchange
• Promissory note
• Bill-of-lading
• Ship’s delivery order,
• Marine insurance policy
• Cargo insurance certificate
• Warehouse receipt

This list betrays the scale of the ambition. Next to “Bill-of-lading” please read “Negotiability”, “Title transfer”, “Trade Position Securitization”. Without further ado, let us make a corresponding list of industries that might well be disrupted by the practical implementation of this draft law:

• Banking, Asset Management
• Credit Insurance, Reinsurance
• Banking, Asset Management, Subscription Trading Facilities
• Vessel Operators, Quality Assurers
• Vessel Operators, Marine Insurance, Reinsurance
• Cargo Insurance, Reinsurance
• Banking, Collateral Agents, Insurance

If one considers alone the role that warehouse receipts played in recent prominent fraud cases^[21],[22] around collateral due diligence, borrowing base valuation, dispute resolution and litigation that would be enough to ask how different would the risk management and control processes in all the industries mentioned be (and several risk & compliance units less stressed out) had this law been in place globally. 

Of course, the devil is in the details. Equivalence of legal force between physical and electronic documents will not make the former disappear overnight. First of all there is the small problem of document standardization. As the proposal document itself explains (p. 21, point 2.62):

• We recognise that allowing for electronic trade documents in law is not the end of the matter. There are practical considerations which parties will have to take into account … It will also be for industry to facilitate interoperability between different systems. We hope, though that this will be made easier by the legal recognition of electronic trade documents. 

and further (p. 149, point 7.77):

• It will be to the advantage of all stakeholders, however, if different platforms for electronic trade documents can be made interoperable and standardised (as far as technologically possible). It is perhaps not surprising, therefore, that work is already underway to establish international technical standards and documents which conform to them, in particular the Digital Trade Standards Initiative run by the International Chamber of Commerce. A recent WTO paper tracks a significant number of technical projects aimed at using blockchain and DLT in international trade. It notes that “a natural year’s worth of progression has been both accelerated and, in some areas, stunted by the forces of the COVID-19 pandemic”, and that while some projects have fallen by the wayside, others have been realised.

Then, there is the problem of supply chain and financial participants not having the willingness or the means to install requisite infrastructure to support Straight-Through-Processing possible under the legislation. Why would Software providers oblige to design and implement such capabilities if the funding is not there?

This is where reading the entire policy document pays off. The permeating theme appears to be: “We know that this is simply a legal option that we are creating in the UK. But, if some organizations and countries implement it first, then their competitors will not be able to afford not to follow”. 

Viewed as a call to arms of sorts by UK policy makers, this legal initiative is nothing short of a major endorsement for Trade Finance and Insurance digitalization at a high level of UK policy decision-making. 

Several respected trade publications already commented in similar terms. For example, in an interview^[23] with proposal authors and industry experts, the latter opined precisely that the expected influence on both jurisprudence and industry practices globally (common-law following countries are specifically mentioned) would be significant. Interestingly, expressed strong arguments for the need of such a change in the law were not only legal but also avowedly political. Given that the Law Commission is a statutorily independent body, this fact might indicate a consensus among UK policy makers and economic actors of its necessity. If that is the case, then voting of the draft law through the UK parliament may be simply a formality. 

Will there be an actual need for non-UK (or non-Common-Law) market participants to take this legal development into account? Will EU corporates (Banks, Insurers, Vessel Operators, Freight Forwarders, Asset Managers and Assurers) in particular need to plan for process disruption?

The post-Brexit frictions in trade, supply chains and energy and commodity markets along with the societal costs of the pandemic have probably led to a realization in the highest levels of British decision making that without a societal alignment along new business models the short-term fiscal impacts might become permanent. The UK needs to mobilize every single one of its many competitive advantages to create a better financial picture. As the service sector currently generates 80% of the UK GDP and 82% of its jobs^[24], it needs to at least protect its profits and reduce its cost base. Trade digitalization is both a way to achieve these targets and a stated policy decision of the UK Government^[25]. The UK is perfectly able (post-Brexit) to orchestrate and incentivize private sector action in this direction. 

Practically speaking, imagine any of the major UK Trade Finance and Credit/Marine/Cargo Insurance houses forming a consortium with similar houses in common-law jurisdictions such as Singapore and Australia to agree common data standards as per the upcoming legislation. Then any EU bank with significant UK operations (say, in Corporate and Investment Banking) will simply have to follow this local initiative – should it keep dealing in physical documents only, then it will be a matter of time before either its clients or its profits disappear. Once new digital-only operations are accepted in its UK operations, then the non-UK ones will have to adapt as well (the success of the technology will be too obvious to ignore and the internal trading, risk management, compliance and operations units will simply press for replication). So, our prediction is that the globally active EU banking, insurance, and shipping houses will have to keep pace with the UK. Importantly, EU regulators may also feel the need to follow the example of the Law Commission and at least begin examining the need to advise similar trade-specific^[26] initiatives on the continent. 

Once the major EU financial and transport corporations have implemented electronic trade documents, the rest will either follow or lose the market to the majors. Investments will be probably front-loaded for everyone but pay-back (as in most compelling digitalization use cases) assured. 

How soon will an implementation effort start?

In the UK and in major common law trading jurisdictions we predict that the standards-setting work may begin in Q3 2022. There are parallel developments in other trade-related as well, which we will explain in subsequent opinions. 

How can IBM help EU Banks in their Trade digitalisation journey?

IBM is a proven supplier of capabilities at all stages of trade transactions. Let our:

• Regulatory and business process experts formulate your precise functional and non-functional requirements for a digital Trade Finance target operating model.
• Business process and technical consultants execute your vendor selection and due diligence for Trading, Core-Banking, Transaction Processing, Transaction Surveillance and Reporting solutions.
• Pre-tech consultants match your requirements to scaling and secure Trade Finance and Risk Management applications from among IBM’s own or from our vast Partner ecosystem offerings.
• Technical experts install, integrate and configure your chosen applications either on premise, on hybrid cloud or on public cloud.
• Business process outsourcing unit take on the actual, day-to-day operation of your Trade-Finance and Risk middle- and back-office.
• Legal and regulatory experts adapt and future proof your risk & compliance frameworks around Trade Finance, from the Risk Appetite Statement all the way to Policies and procedures, to granular controls, to management and regulatory reporting.
• Regulatory and audit experts assess the robustness of your internal controls framework (both business and technical) to inform your representations towards external auditors and regulators worldwide.

If you would like to discuss your strategic vision or tactical needs in Trade-Finance Digitalization, please feel free to contact the authors.

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Authors

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References

^[1] A 2009 European Commission staff working paper (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52009SC0905) reported that of 151,000 collateral agreements in place at that time, 28% were concluded under English law. Similarly, that Credit Default Swaps contracts under ISDA Master Agreements on European reference entities were „usually transacted under the English law“. Finally, that the FX market wasstandardised in terms of contract specifications, whereby „the big institutions typically trade out of one jurisdiction (predominantly London) thereby centralising their OTC FX business on one type of contract (ISDA MA, English law).“. Using the prevalent Continuous Linked Settlement (CLS) system for cross-currency settlement risk also implied accepting the fact that „CLS Bank’s rules are governed by English law“.

^[2] Under the auspices of the London Court of International Arbitration (https://www.lcia.org/LCIA/introduction.aspx)

^[3] Brexit and the ISDA Master Agreement, ISDA, 2018 (https://www.isda.org/2018/01/08/brexit-and-the-isda-master-agreement/) asserts “As it currently stands, virtually all of the ISDA Master Agreements entered into between counterparties based in the EU or EEA are governed by English law.”

^[4] https://www.isda.org/book/isda-amendment-agreement-english-law-to-irish-or-french-law/

^[5] https://www.isda.org/books contains all versions of ISDA documents under Irish and French law, along with their Common Law equivalents. 

^[6] https://www.shearman.com/Perspectives/2018/07/New-ISDA-Documentation-On-Brexit-Will-English-Law-Remain-Even-If-The-UK-Does-Not

^[7] Three EU member states (Ireland, Cyprus, Malta) have legal systems significantly following Common Law in the commercial space. All three have close economic dependencies on UK economic sectors. 

^[8] https://www.qlts.com/blog/why-english-law-governs-most-international-commercial-contracts

^[9] https://www.cogencyglobal.com/blog/the-benefits-of-choosing-english-law-in-cross-border-financial-transactions

^[10] https://iccwbo.org/, 

^[11] https://iccwbo.org/dispute-resolution-services/

^[12] https://www.bimco.org/contracts-and-clauses/

^[13] The UK Supremce Court held in Enka Insaat Ve Sanayi As v OOO Insurance Company Chubb [2020] UKSC 38 (reported in https://www.supremecourt.uk/cases/uksc-2020-0091.html) that, under the facts of the case, the law applicable to a dispute relating to the contract for the construction of a power plant in Russia, involving a Russian appellant and a Turkish respondent was not the law of the contract (Russian law) but the law of the seat of arbitration (English law). 

^[14] https://en.wikipedia.org/wiki/British_Overseas_Territories

^[15] https://www.jcpc.uk/about/judicial-committe.html

^[16] https://www.jcpc.uk/about/powers.html

^[17] https://www.lawcom.gov.uk/project/electronic-trade-documents/

^[18] https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2021/04/Electronic-trade-documents-CP.pdf

^[19] https://en.wikipedia.org/wiki/Law_Commission_(England_and_Wales)

^[20] https://www.lawcom.gov.uk/about/

^[21] https://www.bailii.org/ew/cases/EWHC/Comm/2019/3163.html

^[22] https://www.globaltrademag.com/the-biggest-warehouse-fraud-cases-in-recent-history/

^[23] “Assessing the impact of new English law on electronic trade documents”, November 1, 2021 (https://www.txfnews.com/News/Article/7281/Assessing-the-impact-of-new-English-law-on-electronic-trade-documents)

^[24] https://commonslibrary.parliament.uk/research-briefings/sn02786/

^[25] Digital trade objectives, published September 20, 2021 (https://www.gov.uk/government/publications/digital-trade-objectives-and-vision/digital-trade-objectives).

^[26] In its current form, the EU Digital Finance Package does not appear to offer specific guidance in the trade documents area (https://ec.europa.eu/commission/presscorner/detail/en/IP_20_1684).