Innovation

Via TXF

Is the temperature dial turning on global trade digitization with the latest moves in the U.S. for UCC amendments that can be adopted at a state level? How is this moving global trade digitization forward? A comprehensive approach is proving vital, but there’s no magic switch.

Digital Trade in the US Took What is Being Described as a Big Step Forward

The summer heat is not a time when you expect things to move rapidly. Move fast and break things only applies to my fridge freezer, which has chosen this season to swoon and expire. Somewhat surprising then to recount that this summer things are moving relatively fast for some parts of trade digitization regulation in the U.S. 

Digital trade in the U.S. took what is being described as a big step forward on July 13 when the Uniform Law Commission (ULC) passed several amendments to the Uniform Commercial Code (UCC) addressing digital assets, terminology to account for digital records, electronic signatures, and distributed ledger technology, providing rules for electronic negotiable instruments, and clarifying the rules for UCC applicability to hybrid transactions involving both goods and services. The measures still need to be taken up by state legislatures. And that’s the key – it’s a federal solution. 

Why is this development important, and how does it move the dial for trade digitization in the US and globally? “The UCC in the U.S. already permits electronic documents of title, but promissory notes and bills of exchange must be in written form,” Edwin E Smith, Chair of the Drafting Committee on the UCC and Emerging Technologies tells TXF. “The 2022 amendments would in effect permit electronic promissory notes and electronic bills of exchange, something that trade finance parties have been looking for. The amendments would also give effect to a governing law clause in the electronic promissory note or electronic bill of exchange.”

The issue in the U.S. has been that there has never been a federal solution to the handling of commercial trade documents in digital form. “The breakthrough was really last year where the UK secured G7 ministerial commitment to digitalize commercial trade documents, which of course includes the US,” says Chris Southworth, Co-Chair of the Legal Reform Advisory Board of the ICC Digital Standards Initiative (DSI). “The breakthrough is that the US government has now identified a solution which is the UCC and is now actively progressing on reforming the law to enable those documents to be handled across state boundaries.”

“It’s a great development,” says Alisa DiCaprio, Chief Economist at R3 & Co-Chair of the BAFT Innovation Council. “BAFT and R3 actually started this process in the UCC with a paper ‘Code is Not Law’ in 2018 in which we included [UCC] in the drafting.” There’s a footnote that she is particularly proud of. “It talks about how long it took to update the UCC in the previous time (I think it was eight years), versus how long we could expect this to take (three to five years). You could compare this to how long it actually took (four years).” 

Tod Burwell, BAFT President & CEO, explains the context: “The two biggest obstacles (currently) to trade digitization are interoperability of disparate technology platforms and consistent legal frameworks that support digital trade. BAFT outlined the rationale for why both of these are central in ‘Code is Not Law’. Though that paper focused on blockchain, which is where much of the digitization energy was focused at the time, the legal framework issue applied to digitization more broadly. The United Nations Commission on International Trade Law (UNCITRAL) produced the Model Law for Electronic Transferable Records (MLETR) in late 2017 and that became the reference point for how the industry could solve the legal framework problem. 

BAFT was a member of the ICC Trade Digitisation Working Group that outlined a roadmap to drive digitization, and adoption of MLETR became a core component. We are now active in the ICC Legal Reform Advisory Board, which is a collection of organizations committed to driving the legal framework change in various jurisdictions, so this is clearly an important step toward our goals.”

As Smith also points out, electronic versions of LCs had already been legal under an earlier update to the UCC rules, it was just electronic negotiable instruments that were left out. “It’s illustrative of the fact that no one actually knows what rules and regulations are limiting the expansion of digitalization. There’s no one list (although the UK has done a great job identifying theirs),” DiCaprio notes. 

What Should We Expect to See Next in the US?

The catch of course with the U.S., as in any federation, is that this still needs adopting at state level.  “We examined several different paths for change in the US and amending UCC was one of the most direct and comprehensive,” says Burwell. “The ULC undertook the heavy lifting of drafting actual language that would amend the UCC and approved the package of amendments last week.”  

“Next this needs to get taken up and passed by the American Bar Association, which we are hopeful will take place in the next few months,” Burwell explains. “Ultimately, each individual state in the U.S. must then adopt the amended UCC articles within their own local law. We understand that this is already in scope for the 2023 legislative agenda for many of the states. So far, there has been positive support for advancing amendments for digitizing trade, however, there are other aspects of the amendments that address digital assets, which is being looked at with more scrutiny given recent developments. At this point, we are cautiously optimistic but excited that the first hurdle has been crossed.”

Is there likely to be traction for state adoption? Smith for the ULC is also optimistic. “We anticipate that the 2022 amendments will be presented to states in the 2023 legislative sessions,” he says. “There is already momentum behind the amendments. Several states, anxious to be leaders in the digital asset space, have already enacted prior drafts of the amendments.” 

Patchworks Don’t Work: Moving Together

How does Smith see the ULC’s move on UCC in the wider global context? For instance, with developments in the UK trade digitization legislation and some (slow) momentum on MLETR adoption after it was championed by the G7 last April? “Much of the 2022 amendments are consistent with the UK trade legislation, UNIDROIT principles and the like,” says Smith. “There was close coordination between our drafting committee and these other groups.” 

Importantly, a comprehensive, rather than piecemeal approach is key. “There has always been a risk when governments take a patchwork approach. We’ve seen several governments take this approach, for instance Germany, Japan and Korea, and in the end it doesn’t deliver the outcome we need. In the case of Germany, they are now introducing new legislation to address the gaps. For trade transactions to go digital, all documents need to be digitalized or the system reverts back to paper. In the case of the U.S., a federal solution will still need to be adopted at state level but this is a big step in the right direction,” says Southworth.

As Southworth points out, we are talking here about commercial documentation, which governments often don’t understand so they need industry groups to help them point out the legal barriers and solutions as well as ensuring laws are aligned to MLETR. “Once the legal framework is in place, we can start getting into practical cross-border pilots to test systems and consistently implement interoperable standards.”

The U.S., of course, is a very important to global trade. And that’s one major reason why the move is so significant. “The big economies are now all working on legal reform through the G7. China is also actively moving forward as well,” Southworth notes, pointing to China’s rapid adoption of UNCITRAL Model laws and the ICC China’s industry task force up and running. The Chinese government is actively looking at what the legal barriers are in Chinese law and what the solutions are. 

“We don’t know what the solutions are yet, but the most important thing is they are engaged and they’re actively working on it. We also have a funded technical assistance projects with help from the Multilateral Development Banks via the DSI. The Asian Development Bank (ADB) will be supporting China and Georgia with other countries to follow across the region. We also have a legal assistance taskforce in the UK to help low to middle income countries across the Commonwealth. These assistance projects are crucial in making sure no one gets left behind and all SMEs are able to benefit from the initiative. They will task in lawyers to go in and help work through the legislation, identify the barriers then build a roadmap to reform,” he says.

The EU is also concerned about fragmentation with G7 members reforming laws so are also actively trying to find a pan EU solution. “That means the big three blocks are all moving forward and the G7 economies, which is game changing news. It was only 18 months ago when none of this was happening. We shouldn’t also forget to mention that the WTO Ecommerce Agreement, currently under negotiation, includes an MLETR commitment which will bring another 86 countries into the initiative,” Southworth says.

Inspiration of Article 7 UCC 

Let’s go into the weeds a little. The good news remains that the alignments are already working. “Article 7 UCC [which governs documents of title covering goods and usually concerns commercial shipment and storage of goods] has been a major source of inspiration when drafting the MLETR and therefore the two texts are already largely aligned,” says Luca Castellani, Legal Officer at UNCITRAL. “The amendments to Article 7 UCC are rather minor and they bring Article 7 closer to MLETR. Moreover, other relevant US legislation, such as UETA and e-SIGN, is also closely aligned to UNCITRAL texts such as the UNCITRAL Model Law on Electronic Commerce, which brings U.S. law and UNCITRAL law even closer.” 

“So far, Article 7 UCC has been broadly applied to electronic warehouse receipts, which are, however, issued only for the domestic market. It has not yet been used extensively for electronic bills of lading, possibly because of lack of technical infrastructure or readiness, including in other countries. EssDOCS has issued negotiable electronic bills of lading (eBL) under Article 7 UCC but limited to inland waterways,” says Castellani. 

“I believe it is important to promote awareness of the close relationship between Article 7 UCC and MLETR. Many bills of lading are issued under New York law, which may already allow for their digitization: an in-depth discussion of this issue should be promoted,” he adds. 

Internationally, digital adoption of instruments such as eBLs remains vanishingly small. Last week, BIMCO, a large international shipping association which represents shipowners, published BIMCO eBL standard for bulk shipping. It pointed out that less than 2% of world trade is carried using the instruments. The Digital Container Shipping Association (DCSA) has also recently announced phase two of its eBL platform interoperability proof of concept (PoC). Meanwhile, the Maritime & Port Authority of Singapore (MPA) has set up two project consortiums to develop and trial eBL solutions across two cargo segments and cites that fewer than 0.1% of bills of lading have been issued digitally since 1990. 

The Big Push? Get Ready to Move Quickly?

With better frameworks in place, standards evolving and laws changing, it will be incumbent on industry to take the next steps to adopt. Needless to say, there will have to be a big push. 

The passing of UK Electronic Trade Documents Bill is scheduled to come into force by the middle of 2023 on current plans. In anticipation of the changes, the priority now is to inform the market and support companies to get ready to go digital. The ICC Centre for Digital Trade & Innovation has just launched its ‘Get ready to go digital’ campaign for this reason with more support coming in September including training for SMEs.

“With legal, standards and rules frameworks now in place, the priority now is to work with industry to invest in the digital systems we know will deliver a cheaper, faster, simpler trading system,” says Southworth. “The big point around English law is it’s not about England, this is about English law and it’s role in trade worldwide.” With the Commonwealth countries using the same pieces of centuries old foundational law, the Bills of Exchange Act and Carriage of Goods by Sea Act, they should, theoretically be able to adopt the new bill wholesale or with minor changes. The potential is there to accelerate legal reform faster than any other global network.”

“That point is not lost on the rest of the Commonwealth, where Australia, Canada, New Zealand, Singapore, Caribbean and African nations continue to gear up. There’s potential for 53 countries to move very quickly. Low to middle income countries will need technical assistance which is why the DSI and UK support programs are so important if we want trade to work for everyone. We need to send clear signals to the market that this is coming and it’s coming much faster than anybody would have previously believed two years ago. And so that means we need to work together to help the market prepare,” Southworth says.

“The news of the UK bill is welcome as it aims at being compatible with MLETR while building on the significant English commercial law tradition,” adds Castellani. “That may help in reaching the network size needed to kick off trade digitization on a major scale. The legislative work in Germany is likewise significant.”

Burwell at BAFT is cautiously optimistic that the UK and U.S. digitization efforts will have much wider ramifications. “Until now, there have been seven countries that have formally adopted MLETR, and several other countries are either considering it or have similar legal frameworks under consideration. Though they have made high level commitments, none of the G7 countries are quite there in having the legal frameworks. The UK and the U.S. moving forward would be game changing for a couple of reasons:  

• The U.S. dollar and sterling have outsized importance in international commerce and settlement 

• U.S. and UK law has outsized importance as a basis for contractual trading terms.  

We are hopeful that if/when the U.S. and UK move forward with legal frameworks to support digital trade, that will also have a domino effect on other jurisdictions and we can trigger the process to put the legal frameworks in place across other significant trading jurisdictions.”

But, Like My Defunct Fridge Freezer, There Is No Magic Switch

“I think we have to be realistic in understanding that trade digitization won’t be achieved with the flick of a magic switch: it is a long and complex process,” cautions Castellani. “MLETR removed one major stumbling block but we need a lot of other components, including a robust ecosystem and onboarding regulators. At the same time, Article 7 UCC and its underlying notions shared with MLETR such as control have significantly influenced other new Articles of the UCC (for example on digital assets), and UNCITRAL is starting work on a new project, on a legal instrument on negotiable multimodal transport documents, that will build significantly on MLETR. In short, the impact of MLETR on trade digitization may be deeper than it seems, but at the same time may also be less immediate and apparent than one may wish.”