De-risking with technology
With ongoing globalisation and the emergence of new markets, the shift in world trade towards East Asia and the ASEAN region, both of which have a growing middle class and surging economies, will continue apace. This changing reality of global trade flows places new demands on the shipping industry as the economics of doing business require companies to adopt better control, risk management and reporting processes to satisfy the requirements and regulations of a global marketplace. None of this can be achieved with the 20th century risk tools used by the industry today.
When referring to risk in shipping the focus is most often on price risk. While the industry has come a long way with FFAs, systems and formalised processes around managing price risk, the reality is that any physical contract for delivery is subject to many more risks than just price fluctuations. Surprisingly, there are few systems in place which give visibility to the diverse and numerous risks associated with the industry; those systems are, for the most part, not real-time, which is why companies find themselves limited in their ability to get a high-level and complete view of risk, manage it efficiently or indeed optimise the business. The management of contracts within the freight industry, by and large, relies on 20th century tools to manually create, issue and manage freight agreements. We would find this unacceptable in our personal financial management, so why do we accept it when this approach might put our business at risk?
The processes built around the creation of contracts are to a large extent manual and time-consuming. The complexity of the trade places great demands on individual employees, who need to have the ability and the up-to- date knowledge to identify risks and, more importantly, react to them.
Changing, slowly but surely
The good news is that contract management is at last changing: slowly, but surely progress is being made. When an industry is slow to adopt new ways and new technologies there is usually a surprisingly significant and positive effect on the business when it finally makes the leap to modernise. This is now beginning to happen in contract and risk management. When an industry such as banking, which prides itself on constantly implementing new technology, implements new practices or processes, the expected gain versus cost is usually minimal. But with global shipping and contract management, in particular, the benefits from implementing new technologies are significant in terms of efficiencies, risk management, dispute resolution and fraud reduction. As with any good system, the foundation of better contract management is accurate data, which is securely accessible to both parties in real-time.
When contract information is captured at the source and made securely available to parties in the trade, there is a big improvement in the management of the contract lifecycle for fixture recaps, charter parties, and other fixture-related documentation. This includes document creation, review, validation, archiving and retrieval. But where does this information come from? How accurate is it? How can you ensure that everyone who needs it has access to it – when they need it?
Organisations in the shipping industry have not historically been good at sharing information across the business; this is rarely automated and extracting useful information from a sea of data, on an ad-hoc basis, becomes very expensive and time-consuming, assuming it’s even possible. This approach is prone to errors and mistakes are easily inherited and unwittingly propagated. Resolving this is time-consuming at best, but, at worst, exposes the company to costly resolutions and various risks: contract, reputational, political, execution, etc. In an attempt to identify contractual risks and get a complete overview of these risks, companies are having to resort to multiple reporting tools, spreadsheets and manual processes, which limits the ability of these companies to proactively identify and manage risk.
What do these risks amount to? Well, according to the LCIA, their caseload of contracts being referred to arbitration increased by 54% in 2013. Of those referrals which had financial settlements, and where the claimant specified an amount, more than 60% were resolved for sums in excess of $1 million; 25% of these were over $10 million.
So contractual risks alone can be very costly. As a result of the recent Qingdao Port scandal, banks, traders, lawyers and companies have been reviewing their contracts, which make up part of the $4.5tn China import/export market. Currently, according to Reuters, banks and traders are locked in $3bn of lawsuits as a result of this review. Significant to these lawsuits will be the contracts themselves and the master agreements they refer to. The recent decision involving an oil trader and a bank was for $270m, and while no payment was forced, it highlighted the size of the potential problem.
In addition, new regulations place more demands on the industry: the ICC Global Trade and Finance survey notes that 193 new trade restrictive measures were introduced by the G20 between December 2013 and November 2014. How do you ensure that your staff are aware of these new measures and understand the effects on your business? If you do manage this, how do you ensure that the information you need is available when issuing contracts?
The solution is technology. The solution is processes. The solution is to empower staff by giving them all the information they need to spot and act on risks. Companies which recognise the potential of integrating technology into their contract management process will be quick to reap the benefits across their businesses. According to PWC, companies which implement strong control systems and develop standards are in a much better position to detect and eliminate weaknesses and gaps in their businesses at an early stage. A PWC risk management report from April 2015 states that companies which put a premium on risk management see better growth than companies which do not.
Emphasising the importance of a well-structured process around the management of commercial and contractual information creates great opportunities for improvement and efficiency gains. However, the technology which is being used must be cost-effective and easily scalable. The right technology gives companies tools which help them to be more efficient, dynamic and to make better-informed business decisions by having the right information with the right people at the right time.
The solution is technology-led but it also requires having the right processes. The industry increasingly recognises that the ability to effectively manage, mitigate, and monitor risk is a source of competitive advantage.
Embedding corporate learning means incorporating the lessons learnt by the organisation into operations in order to avoid being dependent on the experience and knowledge of individual employees. When this is applied to contract creation it ensures that everyone involved in the process has real-time access to relevant, centralised information and can make an active and informed decision about any possible risks.
Risk profiles change during and after contract issuance; assessing open contracts for emerging risks can be very problematic and costly. Being able to identify contracts which have become more, or less risky, allows you to take the appropriate measures to manage emerging risks. This can give you an early warning system for all contracts against a variety of risks – even if it is just one line in one clause that causes the change.
Technology is the most effective route for companies to achieve real 21st century contract management, with all it has to offer: real-time decision-making, collaboration, connectivity and visibiility. As a wise man once said: “Knowledge is power ”.