Whitepaper 2.0 on Distributed Ledger Technology

1 Table of Contents 1 Whitepaper on Distributed Ledger Technology Annex Table of Contents2 Table of Contents Annex A Trade Finance Contribution by Deloitte Consulting.. 4 Annex B Digital Identity Management on DLT by Hong Kong Applied Science and Technology Research Institute Company Limited .. 20 Annex C BOCHK Mortgage Loan Application by Bank of China (Hong Kong Limited) .. 33 Annex D Six Control Principles for Financial Services Blockchains by Deloitte .. 38 Annex E Distributed Ledger Technology Security by PwC Hong Kong.. 57 Annex F Innovative Application of Law to Facilitate DLT by Technology Committee of The Law Society of Hong Kong.

2 73 Annex G Blockchain & Liability by Dirk A. Zetzsche, Ross P. Buckley and Douglas W. Arner.. 97 Trade Finance Contribu on 4 Annex A Trade Finance Contribution Author Deloitte Consulting Trade Finance Contribu on 4 Proof-of-Concept Trade Finance After considering the benefits of deploying DLT in trade finance in the first Whitepaper , the HKMA formed a working group involving five leading banks in Hong Kong, namely Bank of China (Hong Kong) Limited ( BOCHK ), the Bank of East Asia Limited ( BEA ), Hang Seng Bank Limited ( HASE ), the Hongkong and Shanghai Banking Corporation Limited ( HSBC ), and Standard Chartered Bank (Hong Kong) Limited ( SCB ).

3 The working group commissioned Deloitte Advisory (Hong Kong) Limited ( Deloitte ) to develop a DLT prototype with the goal of visualising the target operating model and evaluating the feasibility of the Technology and its commercialisation potential. Under the leadership of the HKMA, the working group deliberated on issues of regulatory uncertainty in relation to the operating model, and spearheaded efforts to solve real business problems. Given the scale of the participating banks within the global trade finance market, the working group was able to adopt a global perspective. The Proof-of-Concept ( PoC ) work has not just involved the development of a Technology prototype, but also a thorough investigation of how DLT can potentially address a wide range of business, regulatory, legal, and technical issues related to trade finance.

4 1 Introduction Reportedly, US$16 trillion worth of global trades take place annually, but only one quarter of that amount (US$4 trillion) is financed by banks. Despite this, the World Trade Organization (WTO) has estimated that 80% to 90% of trades actually need financing. Two major reasons for trades not being financed are, first, a lack of trust among participating parties, and second, issues relating to the provenance of the relevant goods. In today s world, a company can use the same purchase order ( PO ), usually in the form of paper documents, to obtain financing from multiple banks by using forged trade-related documents, which are hard to detect.

5 A recent case involved an invoice being fabricated for invoice financing in which a bank lost US$700 million. With banks facing the threat of such enormous fraud losses, many corporates, especially small and medium enterprises ( SMEs ), are unable to obtain financing for their normal operations. This in turn is reducing the total volumes of production and trade in the market. Additionally, trade finance processes today remain very labour-intensive, involving large amounts of paperwork and a non-standardised workflow. The process of the transfer of assets is opaque, and payments are frequently delayed and error-prone, resulting in very high costs for operating a trade finance business.

6 Those involved in international trade are eagerly looking for breakthroughs that could enable them to cut time and costs in such transactions. DLT offers a revolutionary solution to improve trade finance fundamentals and boost trade in general. As mentioned, DLT allows all players in the ecosystem to share customer information and transaction histories securely over a Distributed data infrastructure, without compromising customer privacy or sensitive business information. The ecosystem participants can be certain of the digitised trading documents being real, and are informed in a timely manner of the progress of the manufacture, delivery and arrival of the goods.

7 Banks can therefore provide working capital financing appropriately along the supply chain. Trade Finance Contribu on 5 DLT comes with a feature called smart contracts. Smart contracts allow for the automatic execution of business logics based on specified events. Many events occur throughout the trade finance process, such as the delivery of goods, the issuance of an invoice, and the receipt of payment. These events are currently followed by manual reconciliations and other operational tasks. Smart contracts offer the potential for automating these processes, reducing human error and increasing efficiency.

8 At the beginning of 2017, the working group formed by the five leading banks and the HKMA decided to ascertain both the business value and the technical feasibility of developing a DLT platform for trade finance. Deloitte was then selected by the banks to be their Technology partner. The Proof-of-Concept project was completed in March 2017. The research project was structured into two streams, a business analysis stream and a Technology development stream. The business analysis stream focused on developing the case for business, studying the commercialisation options, and resolving various legal, compliance, data privacy, and governance issues.

9 The Technology stream focused on developing an end-to-end prototype using an agile software development methodology. Intensive discussions were then conducted to collect the key requirements from the major banks. As suggested in the first Whitepaper , the PoC work covered the financing of trade under open account terms, including both pre-shipment and post-shipment financing. Goals included the achievement of the following features leveraging the data distribution nature of DLT: To share the status of each transaction along the process to all trade participants in the ecosystem, in order to prove the authenticity of all trade documents, POs, bills of lading and invoices; To create alerts on duplicated financing to reduce fraud loss; To automate selected manual processes with smart contracts and reduce the human effort required for invoice reconciliations.

10 And To protect customer privacy and sensitive business information from other players in the network, and allow only authorised access to privileged data. The five banks actively participated in both the business and technical streams in order to resolve issues relating to data standardisation, process flow differences, interoperability of different technologies, etc. The enthusiasm of the working group members, the capabilities of the consulting partner, and strong support from the HKMA resulted in the great success of the project in a short period of time. Within eight weeks, a trade finance platform was developed with two layers: a presentation layer that illustrated the end-to-end user experience with the platform, and an underlying DLT layer that Distributed data across nodes while protecting data security and integrity.