Navigating Change, Trends and Developments in Trade Finance

George Fong

Regional Head of Trade Product Management and FI Advisory, Asia Pacific Global Trade & Loan Products J.P. Morgan

The World in 2016

Political Change • Brexit and US elections

Strong emerging ideologies • China & Russia question existing international infrastructure for settlement

Continued dispute and unrest in Middle East • Fall of Eastern Aleppo & attack on Mosul • Failed coup in Turkey

Uncertainty with North Korea Impeachment of presidents in Brazil and South Korea Future of the Trans-Pacific Partnership remains unclear Banking sector de-risking

• Rationalization of correspondent banking relationships arising from cost / complexity of anti-financial crimes regulatory compliance has slowed down

Commodity Pricing • Oil prices halved from peak in 2014 and metal prices have also fallen

sharply • Drop in demand for commodities, in particular hard commodities • Surplus liquidity and increased competition

Political / Macroeconomic

Trade Growth in 2016: 1.7% (vs average 5% since 1990)1

• 5th consecutive year growth in global trade < growth in global GDP growth • Developing markets: 42% merchandise trade • Intra-developing markets trade: Increase 41% 52%

SWIFT Traffic fell for 5th year1

• MT700 message volumes as low as 2009 levels Markets reliant on primary commodities have headwinds

• Prices fell up to 50% in 2016 (priced in USD)1

• China – Africa trade corridor receded since 2014 Anti-financial regulatory compliance

• Trade finance gaps and strict compliance SMEs were hit the hardest • Lack of compliance harmonization between jurisdictions viewed as

impediment Other Trends

• Trade finance gap being filled by multilateral development banks and Fintechs

• Increasing trends observed in:- - Claims under BGs and SBLCs - Court injunctions from trade disputes - Allegations of fraud

Global Trade Trends

Sources: 1 ICC – Rethinking Trade & Finance 2016

The World in 2017

Trade Protectionist2 Brexit: The impact on UK and EU2 Monetary policy reaches its limits2

• 8 years of Quantitative Easing since the Global Financial Crisis increased 4 largest central banks balance sheet: $6tn $18tn

• Reduced returns tapering Tighter fiscal policy weighs2

• Despite calls for increased government spending Commodities recovery reverses2

• Commodity prices expected to recover modestly China continues to slow3

• Target growth: 6.5% over next 5 years • Need to re-balance economy to consumer spending from less productive

investments • Re-focus on maintaining RMB’s position in the global economy (RMB

payments via SWIFT dropped 29.5% in 2016) Spotlight on Trade3

• Freer Trade: Global Policy for past 70 years • Electorate of development economies no longer tolerate policies seen to

reduce their income in lieu of cheaper products & higher pay for select few

Political / Macroeconomic

Trade Growth in 2017: 3.6%4 • Still lower than the average 5% since 1990 • Risks remain from slowing emerging economies and financial volatility

Rise of the Fintechs • SMEs flight to alternative financing still at early stages

• Companies unfamiliar with digital financing (Peer to Peer lending, Debt-based securities and Crowd funding)

Embrace disruption • Banks are exploring ways to work with Fintechs to reach those least linked

with traditional trade financing • Digitization in banks can promote transparency, efficiency and equality

Asia remains primary market for trade finance4

• Despite challenges, trade continues to be an important factor for GDP growth

A New Hope5

• WTO’s Trade Facilitation Agreement (TFA) was ratified by 2/3 acceptance on Feb 22, 2017. Reduce red tape at borders, add $1tn global trade flows & create 20MM jobs

• Consider a new e-commerce agreement under WTO

Global Trade Trends

Sources: 2 The National Interest – The 5 Biggest Challenges in Global Economy (2017) 3 FORTUNE Finance – These 5 trends will shape the Global Economy (2017) 4 WTO – Trade Statistics & Outlook Press Release 2016 5 World Economic Forum article (https://www.weforum.org/agenda/2017/02/this-new-trade-agreement-will-add-1-trillion-to-the-world-economy/)

US and Europe

US economy heating up • Peak in labor market & financial markets in frenzied state • Inflation pressure increasing • Federal Reserve raised interest rates 3 times since 2015 with benchmark

rate between 0.75 – 1% • Yellen expecting more interest rate hikes (in face of expansionary fiscal

policy) Fiscal stimulus policy

• Cut tax rates (everyone & reduce tax brackets) • Increase infrastructure & defense spending (potential struggle between

White House & Capitol Hill) Elimination of regulations Trump’s Policies to Trade

• TPP • NAFTA • Import tariffs on China & Mexico • Other trade deals

Trump Administration

European economy heating up • Factory orders surging, economic confidence high & inflation pressure

increasing Contagion of Brexit

Populism and anti-European sentiment on the rise Upcoming elections in Netherlands, Germany and France

(Initial results in Netherlands voted against far-right) UK

• Parliament voted to trigger Art 50 to formally start withdrawal process – BREXIT date: 29th Mar

• Looking to secure new free trade agreement with EU (not EEA membership)

• Trade negotiations with US, China, Canada, HK, Australia, Korea & India (need to reaffirm all agreements under umbrella of EU with respect to WTO

Impact beyond EU • APAC treasurers need to deal with new FX volatility • Credit & counterparty risks also changing with economic impact for many

UK and European companies unclear • Impact to Asian MNCs:-

- Tax & regulatory regime location of supply chain HQ - Labor market location of shared service centres

• Impact to Banks & financial sector : ??

Europe Continues to Unwind?

And 3 ½ years for Facebook

38 years for Radio

13 years for TV

4 years for the Internet

To Reach 50 Million Users, It Took:

75 Years for the Telephone

And 3 ½ years for Facebook

38 years for Radio

13 years for TV

4 years for the Internet

Disruptive Digitization has shaped the evolution of the Trade landscape too

Source: Greenwich Associates – Large Corporate Trade Finance study 2014 Based on 400 respondents for Asia (excluding Indonesia), 297 for Europe and 168 for the United States

Even though the adoption of e-channel is

increasing, Asia continues to lag European and

US markets in terms of trade business managed

electronically

Share of Trade business initiated and managed electronically

23%

44%

53%

Asia

Europe

United States

1980s Mid 1990s Early 2000s 2010s

Client Drivers for Trade Digitization and Standardization

Trade Digitization

More efficiency in conducting their business model

E-invoicing & doc fulfillment platforms that

connect all parties including buyer & suppliers

Advanced bank agnostic trade software solutions

Solutions have customizable workflows & based on industry standards messaging

Reduced Receivables to Cash Cycle (DSO)

Mitigate risks inclusive of credit, fraud and physical document loss

Trade Standardization

Digitize & automate their processes

Consolidated MIS across banks Increase efficiency through

improved internal workflow & control

Reduce cost through standardizing interfaces

with their banks

Accelerate trade processing to be more competitive

Banking Industry’s Response

SWIFT for Corporates

BPO & e-B/L

Electronic Document

Presentment

3rd Party Doc Prep Providers

Blockchain Cybersecurity

Standardization through Multi-Banking (MT798) J.P. Morgan partners with third party document preparation provider to provide doc prep services to our clients on a referral

basis. (Trade Technology Inc.)

J.P. Morgan will be able to log into the doc prep provider website and print the documents prepared by the service provider

Partnering with Doc Prep Providers

Client presents documents directly to Issuing Bank or Remitting Bank while electronic images of the document set is sent to J.P.

Morgan

J.P. Morgan will check documents, handle incoming payment and discounting the export bills if required

Electronic Document Presentment

Blockchain and Trade

Why are Banks so interested in Blockchain for Trade • Under Basel III, regulatory conditions aim to:- 1. Mitigate banks using short-term assets to fund long-term liabilities (One-Year Minimum Maturity Provision) 2. Ensure sufficient cash & liquid assets to meet all their short-term obligations (LCR) increased cost to trade finance • Risk of disintermediated by NBFI – not subject to same tight regulatory rules

Reduce costs by removing all inefficiencies & waste invest in technology 75% of European treasurers are focusing on investing in trade finance technology

Avoid Past Mistakes (Bank-to-Corporate Model) To adopt Blockchain in supply chain / trade finance, need to move beyond Bank-to-Bank Model In order for Blockchain to work, there needs to be an industry-wide effort towards implementation

Banks need to:- • Create awareness among corporate clients around blockchain features and technology enhancements • Map bank-to-corporate blockchain applications with real-case trade finance business processes

Corporates need to:- • Provide use cases to test the assumptions and establish true potential of blockchain in trade (address requirements & concerns)

Industry

What is Blockchain – A Recap

Is an immutable & consistent transaction protocol and data store shared by all nodes of a distributed network

Provides the ability to record and transfer ownership of digital assets, such that all nodes automatically agree on ownership rights at any given time

Sources: Study of European treasurers (C2FO – 2017)

Trade Finance on Blockchain – Case Studies

Digital Trade Chain (DTC)

Jan 2017 : 7 European-bank consortium deliver trade finance on blockchain through DTC platform

Quicken / streamline order-to-payment process Aim to bring more business opportunities to banks

- lending money, selling guarantees, managing cash & handling payments

7 European Banks Logistic Companies

SME clients of 7 Banks

- Track & trace - Mobile access

Texan Cotton Trade

Chinese Importer US Cotton Merchant

1. First global trade transaction between 2 unrelated banks 2. Uses blockchain technology with 2 other emerging technologies (i.e. smart

contracts and internet of things) 3. Involved international physical shipment ■ Open account trade using physical supply chain trigger & digitized bill of lading

(Oct 2016)

J.P. Morgan Global Trade’s Response Review projects in the market - No clear transformative efforts yet Possible opportunities

1. Documentary Trade 2. Supply Chain

Sources: Seven-bank consortium to deliver trade finance on blockchain this year (Euromoney) Sources: CBA, Wells Fargo and Brighann Cotton pioneer landmark Blockchain trade transaction (Fintech)

Cyber Crime and Global Trade

Early movement towards targeted regulation on how banks need to take action Shared platforms for providing information have emerged – similar development to AML In several jurisdictions, FIs are collaborating and sharing information to prevent cybercrime at the industry level Some vendors are working with FIs to create consortium-based detection approaches and models More needs to be done:-

Can consider reviewing scope of GATT with regard to issues like cybersecurity including the use of national security exception While data protection and privacy requires legal protection but information & communication technology moves faster than national regulations can control

them recognize that different approaches to regulating cross-border data transfers and differing mechanisms can be used delineate between issues of government access to data & cross-border data transfer in commercial context

State-sponsored cyber-theft and the failures of governments to prevent cyber-theft should be addressed through international rules of intellectual property Information sharing needs to become more real-time in the face of real-time technology

Development and Next Steps

Cyber Crime - Background

Cyber attacks are becoming increasingly more sophisticated and high valued in nature Attacks on global trade makes cyber security measures more challenging given the barriers to sharing information cross-border

Concerns of reputational damage by banks / institutions subject to attacks Strict privacy rules across jurisdictions (national security) Compounded by countries which are reluctant to share data outside their borders

Accusations of state-sponsored cyber-theft co-mingled with trade regulations

Sources: Barriers to information sharing impact cyber security measures – Euromoney (2017) What cybersecurity means for global trade – World Economic Forum (2015)

How to mitigate Trade Fraud using Cyber Security

Identify – What are the risks? Need recognize the changing threat environment

Control – How do we Protect?

Identify Detect Protect Respond Recover Implementing controls for email exchanges (public domain, maker / checker, email risk exposure through call-

back procedure and email encryption)

Assess – How effective are the controls? Top threats: Cybercrime & fraud, disruption of IT, Integrity Top controls: Continuous monitoring, access control, recovery planning

Treat – How do we reduce risk exposure?

Investments, Build & deliver, Adopt & consume, Evaluate control

Trade Based Money Laundering

Enormous volume of trade flows, which obscures individual transactions and provides abundant opportunity for criminal organizations to transfer value across borders

The complexity associated with (often multiple) foreign exchange transactions and recourse to diverse financing arrangements

The additional complexity that can arise from the practice of co-mingling illicit funds with the cash flows of legitimate businesses

The limited recourse to verification procedures or programs to exchange data between countries

The limited resources that most customs agencies have available to detect illegal trade transactions

Why Trade Based Money Laundering?

Financial Action Task Force (FATF) Money launder & trade finance in diamonds

• In 2011, trade in rough diamonds - $51bn • In 2013, trade in polished diamonds - $214bn

Financial Conduct Authority (FCA) / Financial Services Authority (FSA): 2013 • About ½ of banks had no clear policy or procedures document for

dealing with trade-based money laundering risks • Many banks were unable to demonstrate money laundering risk had

been taken into account when processing trade transactions • Trade processing staff in most banks made inadequate use of customer

due diligence information gathered by bankers Australian Crime Commission (2011)

• Trade based money laundering and bulk cash smuggling are international concerns that have been identified as emerging or possible threats

Joint Money Laundering Steering Committee (JMLSG) • Trade finance can be used in the layering and integration stages of

money laundering

Industry / Regulatory Concerns

Trade Based Money Laundering

IMF & UNDOC estimated that criminal enterprises launder between 2-5% of global GDP annually using a range of strategies (2011)

Global Financial Integrity (2013) estimated 80% of illicit financial flows from developing countries are accomplished through trade based money laundering

US State Department’s Bureau of International Narcotics and Law Enforcement Affairs report : annual estimates of trade based money laundering reached into hundreds of billions of dollars

UN (2012) - the global merchandise export trade is $18.3tn business – challenge is to identify the needle in the haystack

Magnitude of Risk

Governance Roles & responsibilities for managing financial crime risks are clear and documented

Policies and Procedures Identify customers & transactions with highest risk Screen all relevant parties and counterparties

Due Diligence Clear procedures on when and what checks for non-client counterparties

Training and Awareness Raise awareness and understanding through tailored training Raise awareness through industry publications

Dual-use Goods Identify dual use goods in transactions Confirm whether government license is required

AML / Investigation procedure Use of third party data sources, analysis of pricing and regular quality assurance work is conducted

Sanctions procedure Validate shipping container numbers Potential sanctions matches are screened for several key stages of transaction

Best Practices

Increasing number Asian regulators have published guidance papers for banks to adhere to trade based money laundering standards - HKMA (Hong Kong), MAS (Singapore) and FIU (India)

Regulatory Response

Where Next?

Despite political uncertainty, economic headwinds and rising Fintechs, banks in Asia need to embrace disruption and trade is still source of growth

Completely paperless transaction processing – broader adoption of Electronic Bill of Lading through platforms such as Bolero / essDOCs (eliminate the risk of lost or fraudulent documents and reduced sales cycles)

Continual need for alternative option for risk mitigation and financing - BPO? What else?

Drive for multi-banking standardization continues - SWIFT for corporates?

Broader and more sophisticated mobile / tablet based solutions using Apps (improved transparency and MIS)

Blockchain Trade Finance – J.P. Morgan and handful of banks already developing trial projects (need to resolve critical tech challenges such as scalability, privacy, latency & ecosystem development)

Banks and regulators need to work together to tackle trade based money laundering

Trade fraud in the digital space becoming increasingly more complex (J.P. Morgan spends > 20% of tech budget on security & controls, 7% on cyber capabilities)

Where is Asia heading with Trade

Only 8% can see Trade going completely digital in the next 1-2 years

4-10 yrs 67%

Others 20%

1-2 years 8%

Never 5%

“How long before Trade to become mostly Digital?”

Disclaimer

This presentation was prepared exclusively for the internal use of the J.P. Morgan client to whom it is addressed (including the client’s affiliates, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, certain products or services that may be provided by J.P. Morgan. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by J.P. Morgan. It may not be copied, published, disclosed or used, in whole or in part, for any purpose other than as expressly authorized by J.P. Morgan.

This presentation is confidential and proprietary to J.P. Morgan and is not intended to be legally binding. In preparing this presentation, J.P. Morgan has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. Neither J.P. Morgan nor any of its directors, officers, employees or agents shall incur any responsibility or liability whatsoever to the Company or any other party in respect of the contents of this presentation or any matters referred to in, or discussed as a result of, this presentation. J.P. Morgan makes no representations as to the legal, regulatory, tax or accounting implications of the matters referred to in this presentation.

The products and services described in this presentation are offered by JPMorgan Chase Bank, N.A. or its affiliates subject to applicable laws and regulations and service terms. Not all products and services are available in all locations. Eligibility for particular products and services will be determined by JPMorgan Chase Bank, N.A. or its affiliates.

J.P. Morgan is a marketing name for the businesses of JPMorgan Chase Bank, N.A. and its affiliates worldwide.

J.P. Morgan is licensed under U.S. Patent Numbers 5,910,988 and 6,032,137.

© 2017 JPMorgan Chase & Co. All rights reserved.

Q & A