Jesse Chenard, CEO at fintech MonetaGo, looks at why the risk of trade fraud is higher than ever and analyses how the landscape is changing. Jesse outlines the reasons why trade fraud thrives in even the most prosperous of industries and discusses how technology could provide the solution.
The recent scandals in Singapore were just some of the many cases last year where fraud could have been mitigated if governments and financial institutions worked together to implement better trade fraud prevention practices.
As economies across the world begin to recover from the pandemic, we will see a flurry of activity in trade across the globe. While the economic benefits of this are inarguable, another direct consequence of an uptick in activity is an increase in trade fraud.
This correlation has stood true for as long as trade has been carried out and is an almost inevitable by-product of the benefits increased trading activity will bring.
Fraud flourishes where confusion reigns
Fraud flourishes amid uncertainty, chaos and outdated processes, which tend to be those that are paper-based. Over 80% of global trade relies on trade finance, yet many financial institutions still rely on paper-intensive documentation and clunky legacy systems, leaving trade finance susceptible to fraud.
Trade finance encompasses invoice financing, purchase orders, warehouse receipts and bills of lading – all of which come with their own set of standards, systems and the inevitable stack of paperwork. In 2018 the global invoice factoring and finance market alone was worth $2.9 tln. It’s time for government and financial institutions to come together and provide innovative solutions for trade fraud prevention.
A key example of the type of confusion that allows trade fraud to flourish is the UK’s exit from the EU. Uncertainty on rules and paperwork following the eleventh-hour Brexit deal has created the perfect petri-dish of conditions that make it easier to execute trade fraud.
Fraudsters will be looking to take advantage of any ambiguity or loopholes in regulatory frameworks, as the UK pulls out of a vast web of EU regulations. This is on top of reduced and increasingly complex UK-EU co-operation in criminal matters, often crucial in the multi-jurisdictional issues sophisticated frauds entail.
Looking to a digital solution
Many of the challenges outlined above could be solved through industry-wide co-operation and digitization of trade finance.
From trade finance to customs clearance, transportation and logistics, trade in goods involves multiple actors and remains paper-intensive.
Distributed ledger technology, commonly referred to as blockchain technology, is one of the most powerful solutions which would enable financial institutions and governments to mitigate trade fraud. With blockchain, huge amounts of paperwork could be verified and processed automatically. An immutable blockchain ledger could provide transparency over the transportation and processing of physical and online goods. Double financing could be eradicated.
Another area of trade that can significantly benefit from the use of blockchain is enforcing VAT compliance by combating ‘carousel fraud’, also known as ‘missing trader fraud’. VAT is vulnerable to fraud because it relies on self-reporting and a disjointed system of rules and enforcement among individual countries.
Blockchain could solve many of the system’s weaknesses by creating a registry of digital invoices that would allow tax authorities both domestically, and in some cases internationally, to see and verify the taxes paid when a product changes hands.
Blockchain’s intrinsic features of immutability and transparency mean that trading counterparties have the assurance that ‘what you see is what I see’. The Economist calls blockchain a ‘trust machine’.
Co-operation at the industry-level and digitization of fragmented legacy systems through new technologies is the key to mitigating fraud in trade finance. Cross-border flows could be tracked from start to finish, and the need for paper could be eliminated entirely. With the right technology, we can learn and evolve from the lessons of trade fraud, mitigate future occurrences, and allow all countries to prosper through safe and secure trade.
HOW DO YOU ADAPT YOUR INSURANCE PRICING STRATEGY IN THE FACE OF INCREASED PRICE COMPETITION?
By Ketil Kristensen, Senior Advisor, Insurance, SAS
Many countries in Europe have in previous years experienced increased price competition for general insurance products. Especially in Southern Europe, the competition has been very fierce, fuelled by online price comparison websites. In Spain, Portugal and Greece, there has been a substantial drop in average premiums for products like motor, home and health insurance. This poses a real threat to the profitability of property and casualty insurers.
While some insurance products are highly specialised and almost impossible to compare, most common products have increasingly become commodities. Consumers can now easily compare them online.
When comparing insurance policy prices and details becomes as effortless as getting quotes for airline tickets or hotel accommodation on price comparison sites, more insurance companies will eventually enter the market. And thus price competition will increase.
Preparing for a price war
Once the price war starts, there is no way to avoid it. And insurers need to meet their competitors head-on.
To win a price war, insurers need to be meticulous when they set the premium levels. They might also need to rethink the definition of “profit” when they are making pricing strategies for the future. In a market where premium levels are volatile and the competitive situation may change rapidly, insurers also need the capability to evaluate potential future scenarios in a short period of time.
Setting the premiums right
In the fast-paced digital era, customers expect insurance prices to be easily available online. They will make inquiries for insurance covers for their cars or homes on price comparison websites and expect the prices to be available immediately. From an insurer’s point of view, the premium customers will see on their screens when comparing insurance policy prices is the sum of the insurer’s technical premium and the commercial loading.
The technical premium represents the break-even price that the insurance company would charge for the policy if it had no costs and no desire to make a profit. Commercial loading represents the sum of the insurance company’s costs and the profit it expects to make on the policy. Technical pricing is the subject of many actuarial textbooks. But as machine learning algorithms make their way into actuarial departments, we will need to rewrite those books. Modern pricing techniques that include machine learning algorithms are a notable improvement compared to traditional models. If applied properly, ML models will result in more accurate technical pricing given the same data.
But what about commercial loading? How much profit should the insurer aim for?
Every one of us has a different tolerance for how much we would pay for, e.g., a car insurance policy. Some customers don’t consider price to that important. Others will try to search for a better deal elsewhere, regardless of how much time the process would take. Most customers are somewhere in between.
Being able to price the insurance products analytically based on the “willingness to pay” is, for many actuaries, seen as the holy grail of insurance pricing.
Most insurers already do personal pricing to some extent today. For example, they give different discounts to policyholders with equal risk. However, there is often a great potential to do segmentation and price calculations in a more analytical manner. Ideally, insurers would like to set the premiums as high as possible, but not so high that customers move their policies to another insurer.
On the other side, insurers would like to move customers away from their competitors by offering low premiums – but not too low. The insurer must first determine the price sensitivity of insurance customers and then price each insurance policy so that it maximises the profit for the insurer.
Insurers that can quickly reoptimise changing prices in the online market will also quickly identify customers that are at risk for churn. They can then perform the appropriate actions to prevent this from happening.
When insurers think “profit,” they usually mean the income statement for next year. This is about to change. The concept of Customer Lifetime Value (CLV) is becoming more and more common in the insurance industry. And many insurers are now refining their pricing strategy based on a maximisation of the CLV of all its customers, thus not focusing solely on the profit definition in the income statement. The CLV of an insurance customer is the net present value of this customer for the insurer, where behavioural effects like renewal, cancellation and cross-selling of other insurance products are considered for the entire lifetime of the customer.
To accurately compute CLV for a customer, the insurer will need data that describes the behavioural patterns of the customer. Most insurance companies have quite a lot of such data available – the problem is usually that it is not adequately structured. In practice, to quantitively identify the customer lifetime value, insurers need to integrate both actuarial and customer behaviour models. Once a system for this is in place, insurance companies will have a strong quantitative foundation to compute the customer lifetime value of their policyholders.
Competitive insurance pricing
When a customer determines where to buy insurance, the price is the most important factor. Thus, to stay competitive and still run a profitable business, insurers need to set their premium levels just right. The evolution of price comparison websites – which provide real-time quotes on competitor prices and increased access to data that contains information about the customer’s insurance risk – has made the actuary’s job of calculating the premium more complicated.
Over the years, SAS has worked together with insurers to ensure that strong system support is in place to compute premium levels down to an individual policy level. These pricing systems have been put through the test in some of the most competitive insurance markets in Europe. They have turned out to be a valuable strategic tool for insurers to balance the desire for profit against the desire for market share. And maybe most important of all, they have enabled these insurance companies to effectively join the price war, fight it and still make a profit.
FROM EFFICIENCY TO NEW INVESTMENTS – WHY BLOCKCHAIN IS MORE THAN MEETS THE EYE
Thomas Borrel, chief product officer at Polymath
Blockchain has been an extremely hot topic in 2021. With companies and financial institutions internationally having to adapt to an increasingly digital world, the true potential of blockchain is becoming increasingly clear. We have seen hospitals using the technology to track vaccine distributions, major blue-chip companies floating digital assets or ‘stablecoins’, even progress made by central banks in piloting and adopting digital currencies
When it comes to the world of finance, much of the attention has focussed on the booming price of Bitcoin, and there has been much excitement around using cryptocurrencies as an alternative investment. However, the real potential of blockchain technology stretches far into traditional finance and beyond.
Improving access to investment options
Security tokens created and issued on the blockchain are already being used to improve efficiency in a variety of more traditional asset classes, ranging from real estate to green bonds. The Sustainable Digital Finance Alliance (SDFA) and HSBC Center of Sustainable Finance recently joined forces to highlight how security tokens for green bonds can reduce management costs and increase operational efficiency by up to ten times. And in early 2020, RedSwan CRE Marketplace tokenised $2.2B in commercial real estate, making it one of the biggest tokenisations we’ve seen so far.
However, the potential of tokenisation does not only stand to improve the process of trading traditional assets; blockchain can also open up the pool of investors able to participate. To date, the focus has been on how fractionalisation brings benefits to retail investors by lowering the bar to entry. However, the retail regulations are still very stringent, which is important to protect non-professionals from disproportionate losses.
Tokenisation can be used to enable large institutional investors to buy into smaller projects. Referred to as aggregation, this process can be used to bind assets together so that they meet an institution’s minimum investment threshold. Because of the transparency of blockchain, the investor is still able to inspect each individual offering and ensure each element meets their quality and risk requirements, but by packaging it into one larger token, an institution can diversify with assets that would have otherwise flown under its radar.
Optimising efficiency and minimising risk
Risk management and operational efficiency are usually at the core of any financial institution’s wider strategy. However, no matter how much firms optimise their own processes, there are a range of financial instruments that are still very prone to issues in these areas, especially those that are traded ‘over the counter’ (OTC). The best example of this is likely the bonds market – a multi trillion-dollar market, where OTC trades are still common practice.
When an OTC trade is conducted, it is often so over the telephone – one person calling another to make a deal. This introduces significant information risk with securities operations teams reporting error rates as high as 40%. When instructions for the trade are passed on to the custodians, they will spot the discrepancy. They then have to investigate and find out what has gone wrong, often resulting in very long delays to settlement times.
Blockchains go a long way to solving this problem, providing transparent access to trade and clearing information so that operational issues can be caught earlier and help mitigate settlement risk (i.e. settlement failure). For example, on Polymesh settlement instructions must be affirmed prior to settlement, in a case where an OTC trade has been improperly captured by one counterparty, the counterparty which has affirmed the instruction can see that the other counterparty has not affirmed the instruction within a defined period. In this way, the affirming counterparty can reach out proactively prior to the settlement date to rectify the situation and avoid settlement failure.
Trading on blockchain also generates an easily accessible, secure ledger of trading information. When it comes to reporting in traditional asset classes, the process is highly manual and often expensive. But, with a blockchain solution, reporting is built into the ecosystem from the ground up. There are no significant additional costs or resources required to extract this data and share it where necessary, and the number and complexity of the steps required to complete reconciliations between different entities are reduced and simplified.
Is tokenisation a ‘cover all’ solution?
Fundamentally, certain traditional asset classes are not right for the blockchain yet. Instruments with well-established frameworks, like publicly traded stocks, already have very well-formed, rigorous rails in place, and so transferring to a blockchain could cause disruption and incur unnecessary costs.
It is very common to hear blockchain advocates claiming that blockchain technology should be introduced into every corner of the finance space, which is misguided. Blockchain should be introduced where it brings value to investors or institutions. It should be about augmenting and supplementing the marketplace – not overhauling it, or at least not until the incumbent systems no longer keep up with demand.
The costs and infrastructure associated with capital markets have made some assets – like green bonds or real estate – too expensive to bring to market and service, or too difficult to invest in. These use-cases are examples of where tokenisation can really shine.
Blockchain is an extremely powerful tool, with a range of exciting applications and potential benefits for businesses and financial institutions, ranging from risk management and efficiency through to enabling new investments. However, as with any product, it isn’t the answer to all problems, and must be treated as a powerful enabler – not as an agitator.
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