Supply Chain 2020 Report Regulation and innovation as drivers of change Does regulation hinder innovation or can it be the catalyst that feeds it? 1 Introduction The nature of global trade is constantly evolving. The world’s population continues to increase, emerging markets are maturing and developed economies’ appetite for materials, goods and services shows no signs of slackening. As trade becomes increasingly globalised, supply chains are growing ever more complex. They face increasing risk from quality control issues and compliance requirements, to the management of unforeseen events such as natural disasters. The August 2015 explosions at Tianjin, the fourth largest port in the world for cargo throughput, has caused those involved to claim an average of USD 1 million per claim for business interruption due to the impact on their global supply chains. With these growing challenges, innovation is gathering pace. Businesses are looking to sharpen their competitive edge and minimise risk through their supply chains. The way raw commodities and manufactured products are extracted, produced, processed, traded and delivered is becoming increasingly automated. Also, the Cloud, Big Data analytics and the Internet of Things (IoT) look set to play an increasingly key role in changing supply chain dynamics. The correlation between innovation and regulation - the extent to which one influences the other - is the subject of this report. Does regulation hinder innovation or can it be the catalyst that feeds it? A growing compliance burden can push up both cost and risk. This often has the effect of making supply chains less efficient, but can it also force innovation? In the following pages, we look at legislation and regulation in the context of the supply chain. We investigate some of the ways in which businesses are responding to this frequently challenging trading and regulatory environment, through innovation. Should you require any further information on the issues covered, please do not hesitate to contact us. Trade & Commodities Team Clyde & Co E: firstname.lastname@example.org 2 Supply chain trends Regulation The flood of new regulation continues to be a major focus, as government agencies encourage businesses to behave in a transparent manner. Funding Trade finance in any form is proving more difficult to access, with many now searching for newly developed alternatives. Supply Chain 2020 Report 33 A changing global marketplace Over the past 10 years, there has been a significant shift to Asia, with China a key player. Pivotal new trading locations such as the Middle East, Africa and South America could start to emerge. Technology Technology developments are transforming how companies view and manage their supply chains. True supply chain end-to-end visibility is now a real possibility. Efficiency Product and process innovation that improves supply chain efficiency and security will become a competitive differentiator. 4 Supply Chain 2020 Report The impact of regulation Politically driven legislation can have a significant impact on global supply chains. Companies dependent upon Government related contracts are the most exposed as those governments seek the best return from the exploitation of their resources. With companies increasingly operating across a number of challenging jurisdictions, this risk requires careful handling. 5 Sanctions Used as a tool by states, they are intended to influence a country politically and economically. The sheer complexity of multi-sector, multi-regime sanctions across a company’s global operations creates a level of concern that may shut down certain trades or relationships. The impact of sanctions prohibitions on the financial services sector has stifled trade more effectively than any regulatory body could hope to achieve. As has been apparent through the recent use of Iranian sanctions, even the relaxation of sanctions can bring pitfalls. Following the announcement of ‘Implementation Day’ many were excited to access Iran’s untapped and diverse economy. However, it soon became clear that the situation was more complex that it first seemed. After years of sanctions, Iran has some way to align itself with developments on the global stage, to shore up its capital adequacy and comply with international regulations. Today, certain individuals and entities are still excluded from dealings in the country, and banks may be prohibited from, or refuse to, engage in clearing payments or providing finance for activities linked to Iranian trade. This is a prime example of how legal restrictions can hamper supply chain operations. It also shows how companies can innovate in response to these challenges. Reports suggest1 that several smaller international banks have spotted an opportunity and are entering the Iranian market. In fact, the first EU-approved, Iran-focussed alternative investment fund was given the go-ahead late last year2 . Global Sanctions Most extensive sanctions regime DPRK (aka N. Korea), Syria Additional extensive US sanctions Cuba, Iran, Sudan List based regimes Afghanistan, Belarus, DR Congo, Egypt, Eritrea, FRY (former Republic of Yugoslavia) and Serbia, Republic of Guinea, Guinea-Bissau, Iraq, Iran, Ivory Coast, Lebanon, Liberia, Libya, Russia, Somalia, Tunisia, Ukraine, Zimbabwe Arms based embargoes Angola, Argentina, Armenia, Azerbaijan, Benin, Bosnia and Herzegovina, Burkino Faso, Burundi, Cape Verde, China/Hong Kong, Gambia, Ghana, Guinea-Bissau, Haiti, India, Iran, Macao, Mali, Moldova, Montenegro, Namibia, Niger, Nigeria, Pakistan, Rwanada, Sierra Leone, Senegal, Taiwan, Togo, Uganda, Uzbekistan, Russia 1. Source: Reuters http://www.reuters.com/article/iran-banks-idUSL8N19637F 2. The Turquoise Variable Capital Investment Fund. Source: Legal Business http://www.legalbusiness.co.uk/index.php/country-profiles/6241-picking-up-the-pieces 6 Bribery & corruption The UK Bribery Act exposes companies liable for bribery committed by their employees or agents in order to gain a business advantage. For example, a third party such as an agent operating on a company’s behalf in its supply chain could cause problems if they engage in bribery to facilitate a deal. The penalties are high, with unlimited fines and the prospect of imprisonment. The UK Act’s reach is extensive, stretching far wider than just British companies - UK staff wherever based could fall under its scope. Its application is even broader than the US Foreign Corrupt Practice Act, meaning that companies affected by it have even more issues and pitfalls to take into consideration. In high risk sectors or locations, where corruption and bribery are widespread, companies need to ensure their policies and procedures are robust. Conducting due diligence to satisfy compliance teams that agents are genuine and trustworthy is important. Contracts must include proper anti-bribery provisions and conducting thorough audits to ensure adequate checks and balances are in place should prove a vital defence should any allegations arise. Money laundering Money laundering looks set to become an increasingly hot topic in the years ahead. Enhanced regulation requiring companies to verify the source of counterparty funds may soon to be implemented. In the commodities sector, where many companies have trade links to low tax jurisdictions or locations where transactions can often be opaque, this could pose a substantial compliance burden. However, failure to comply with regulations could result in criminal liability. Modern slavery The UK’s Modern Slavery Act includes landmark transparency provisions to incentivise organisations to take responsibility for eliminating modern slavery in their supply chains. It requires large organisations to outline publicly what steps they are taking to ensure that modern slavery (slavery, servitude, forced and compulsory labour and human trafficking) is not taking place in their global business or supply chains. While the Act does not currently provide for any fines or penalties, in reality, it is more than a Corporate Social Responsibility box-ticking exercise. An organisation’s reputation and the value of its shares are most at risk if it fails to actively engage with the issue, particularly if it operates in a sector that is already under scrutiny in relation to labour issues. The primary drivers for compliance are intended to be customers, activist shareholders, trade unions, civil society and the press. NGOs such as the Business and Human Rights Resource Centre and KnowTheChain have been active in publicly shaming non-compliant companies under similar Californian legislation. Many organisations are now engaging with the issue, developing modern slavery procedures and policies, mapping their supply chains and interacting with suppliers to ensure the required standards are implemented3 . The cumulative effect of these legislative measures could well cause a re-think of the supply chain footprint, perhaps resulting in a shift towards using suppliers in lower-risk, but potentially higher-cost countries. For those that do continue to do business in high-risk geographies, the compliance burden is also likely to increase. Whatever happens, endusers will need to ramp up innovation to offset rising costs across the supply chain. 45.8 million trapped in modern slavery globally 2016 Global Slavery Index 3. Tackling Modern Slavery – Are You Ready? Source: Clyde & Co: http://www.clydeco.com/insight/article/tackling-modern-slavery-are-you-ready Supply Chain 2020 Report 7 The impact of tightening financial regulation on the commodities market In addition to broader geo-political legislation, the regulatory framework governing financial markets has profound consequences for the supply chain. As the distinction blurs between physical commodities trading and derivatives trades in futures, swaps and options, both are subject to increasing regulation intended to deliver more transparent, efficient and robust markets. • Dodd-Frank and EMIR: The Dodd-Frank Act in the US, and the European Market Infrastructure Regulations (EMIR) in the EU, which tighten the regulation of derivatives trading also impose heavy disclosure requirements. Both seek to channel derivatives trades through major exchanges, and companies (including financial and non-financial participants) have to monitor and report their positions frequently. Though the reporting timeframe under EMIR is not quite as strict as it is under Dodd-Frank (which requires disclosure in real time), trades still need to be reported promptly and trades must be marked to market daily and portfolios reconciled regularly. • MIFID II: Under the next phase of the Markets in Financial Instruments Directive, regulatory technical standards are currently being developed outlining how “position limits”, which set the maximum net position an entity can hold in commodity derivatives, should be applied. The practical ramifications for market participants are significant. Since these limits will apply at group level, parent companies will be required to determine and report the group’s overall net position across all trading arms trading on EU trading venues - and ensure that they are always compliant with the rules in real time4 . Trades by non-financial companies to hedge risk will be exempt, but they may need to submit a raft of applications to various different authorities in order to secure the necessary exemptions and this remains an area of some contention. In addition, concerns remain about regulatory bodies’ ability to set appropriate limits on hundreds, even thousands, of different commodity contracts. The consequences of getting it wrong could be serious: liquidity could be reduced, trading disrupted and, ironically, market distortions could occur considering one of the purposes of such comprehensive legislation was to reduce the risk of market distortion. 4. Impact of Position Limits on Commodity Trading. Source: Clyde & Co. Clearly, such onerous reporting requirements require significant investment in systems and processes to speed up information sharing and data analysis and increase transparency and visibility. Whether businesses can successfully realise any business benefit from these increased costs is questionable. 8 Supply Chain 2020 Report 9 Limits on banks’ trading activities As a consequence of Dodd-Frank’s “Volcker” rule, which imposes limits on banks’ proprietary commodity trading activities, many banks have now exited the market. As the number of market participants has decreased, liquidity has reduced and transaction costs have been pushed upwards. In addition, the impact of new US Federal Reserve proposals requiring banks to hold additional capital against commodity trading activities could be significant5 . This is likely to make physical commodity trading more expensive, potentially hastening the exodus of banks from the commodities arena. These factors, together with continuing constraints on banks’ capacity to lend as capital adequacy and customer compliance regulations continue to bite, have a major effect on access to funding. This has resulted in traditional trade finance arrangements becoming comparatively elusive. To fill the gap, innovative alternative finance sources are growing in prominence, with emerging market lenders and large commodity trading houses stepping into the breach. New products and techniques such as supply chain finance are continuing to gain ground. Peer-to peer (P2P) lending, warehouse receipt financing and shadow banking are innovations which are now becoming popular in the Middle East and Africa. In fact, shadow banking, where credit is provided by non-regulated financial intermediaries, was worth USD 75 trillion in 2014. As laws affecting the supply chain proliferate, the ability to adapt in order to ensure compliance and remain competitive is vital. In such an environment, it will be interesting to see whether the UK will seek to differentiate itself postBrexit by introducing lighter touch regulation to try to attract businesses as it forges a new position for itself on the global stage outside of the EU. To fill the gap, innovative alternative finance sources are growing in prominence, with emerging market lenders and large commodity trading houses stepping into the breach. 5. Source: Bloomberg. http://www.bloomberg.com/news/articles/2016-09-23/fed-commodity-rules-seen-speeding-trader-exodus-from-wall-street 10 Innovation as a driver of change Supply chain efficiency is critical. Any supply chain must be agile enough to respond to fluctuating demand, yet resilient enough to withstand ranging levels of disruption. As the regulatory burden increases, so too do costs on businesses. Maximising efficiency of production and delivery from source to customer is crucial. Powered by innovation, businesses are responding in a variety of ways. 10 Supply Chain 2020 Report 11 Digital dynamics Radical innovations such as the Cloud, Big Data analytics and the Internet of Things (IoT) look set to play an increasingly key role in taking supply chain dynamics to the next level. This is likely to manifest itself in very specific ways as companies identify previously hidden patterns and synergies across commodities, geographies and time zones to gain a competitive advantage. For example: • Collaboration and the Cloud: the Cloud has the potential to facilitate the drive for greater collaboration between producers, clients and distributors. Greater information sharing can improve visibility and transparency, enabling supply chains to forecast more accurately and respond more quickly. This can speed up time-to-market, help solve problems faster, reduce the risk of disruption and make it easier to identify new growth opportunities. • IoT: The transformational impact of the Internet of Things, whereby objects communicate wirelessly with each other, is quickly becoming realised. Developments where robotics anticipate demand and place orders automatically when supplies are running low are now a reality. In fact, research6 among third party logistics providers suggests that more than a quarter are already using machine-to-machine technologies, and almost half plan to do so in the future. • Leveraging Big Data: Big Data analytics can be deployed in many ways, from understanding where underlying logistical inefficiencies lie, to creating a picture of how macro global trends could impact future demand. There is an untapped mine of new data illustrating insights and patterns of behaviour in the supply chain, which has previously been impossible to understand. Collating and leveraging this information could be the key to unlocking major growth. • Blockchain: Has the potential to show what happens to an asset throughout its life, providing transparency in the supply chain. Traditional registries of these assets may be under threat from this disruptive distributed technology. • Machine learning: Machine learning when combined with ‘Big Data’ analytics will help supply chain decisions to be made in faster and more accurate ways without human intervention. The above may be inter-connected, and together set the stage for many supply chain developments outlined in the following pages. 6. Source: Eye for Transport 2015 3PL Selection & Contracting Survey Report By 2020, at least a third of all data will pass through the cloud. 11 As digital channels and communication platforms proliferate, protecting intellectual property assets and confidential or sensitive information are clearly vital considerations. Cyber-security breaches and theft of IP, proprietary data and customer details are all too common. Breaches cost in financial terms but also in terms of damaged customer/partner relationships, negative brand impact and counterfeit or copied goods or services. Having well-designed systems and safeguards in place – and ensuring that suppliers do too – is increasingly vital as technology advances and new markets develop. Evolving manufacture, storage and delivery patterns New technologies are improving container packing techniques, dramatically increasing speed and efficiency. There has been a steady increase in automation in ports to improve efficiency since the first automated stacking cranes were installed in Rotterdam in 1990. Today, the use of automated equipment in ports is widespread, while software is continuously optimising the flow of goods through ports. Developments in inexpensive sensors have also improved the movement and storage of goods. Purfresh is using this technology to collect real-time data on the atmospheric conditions inside a refrigerated container. Sensors send automatic alerts if the temperature moves outside the required range, allowing remote logistics managers to take mitigating action. Technological developments are resulting in supply chain distribution networks becoming increasingly sophisticated. Keeping inventory low and located at different levels of the chain is dramatically increasing the flexibility and agility of the supply chain. By removing many of the traditional steps in the supply chain, the travelling distances required for distribution are minimised and cross-border issues are reduced. This trend is particularly driven by internet operators who are managing inventory flow to ensure goods arrive at the right place at exactly the right time. For example, Amazon has built its entire supply chain around facilitating the storage and sale of goods from third party vendors. With more than 100 warehouses in the US alone, it has kept accelerating its delivery - from 48 hours, to next day, to the evening of the same day. 12 Supply Chain 2020 Report Amazon has built its entire supply chain around facilitating the storage and sale of goods from third party vendors. With more than 100 warehouses in the US alone, it keeps accelerating its delivery – from 48 hours, to next day, to the evening of the same day 13 As supply chains become ever more focused on just in time delivery, the impact of any disruption has increased. This is resulting in increasing contingent business interruption losses. For example, the fire at SK Hynix factory in Wuxi, China, in September 2013 was reported to have cost insurers USD 1 billion alone. This is a result of the time and expense of restoring specialist “clean rooms”, as well as losses claimed by computer equipment manufacturers in North America. 14 Emergence of new transportation routes New shipping laws continue to increase red tape in the sector. This includes rules on weighing containers to reduce the risk of overloading, along with increased concerns over pollution. Given that 90% of all world trade is currently shipped by sea7 , recent developments in road transport could prove to be a critical disruptor. Innovation in trucking could see operating costs driven down by as much as 28% by 2025, according to a recent report8 . By embracing digital supply chain technology, tighter supply chain integration and real-time visibility of freight is becoming a reality. This could culminate in driverless vehicles and HGVs which can communicate with each other. In fact, the UK Government has confirmed that driverless lorries will be trialled in the UK this year9 . Software that can enable trucks to optimise routes and avoid disruptions is also now being utilised10. At the same time, the environmental impact of road transport could be mitigated by the development of electric highways, already being trialled in Sweden11. These would enable trucks to operate much like trams, eliminating emissions. However, shipping is unlikely to give up market share easily. Developments such as mega-ships which can be loaded and unloaded faster, and more eco-friendly ships with improved performance, are rapidly progressing. Solar-powered ships are already in use12, and Rolls-Royce is currently developing unmanned ships which they believe will hit the market by 202013. Supply and demand shifts as China moves from being primarily a producer to being a major consumer, means alternative options to shipping by sea could gain momentum. For example, the development of a new “Silk Road” from China to Europe could have the potential to radically alter the dynamics of supply chains – shifting the focus onto Central Asia and Eastern Europe as major hubs. The USD 40 billion Silk Road Fund, sponsored by official foreign exchange reserves, China Investment Corporation, the Export-Import Bank of China and the China Development Bank, aims to identify investment opportunities and provide financing and investment services along ‘Belt and Road’. The Silk Road Fund has picked a Pakistan power project to initiate its first investment, worth USD 1.65 billion.14 7. Source: International Chamber of Shipping http://www.ics-shipping.org/shipping-facts/shipping-facts 8. Source: PwC Strategy& “The era of digitised trucking: transforming the logistics value chain http://www.strategyand.pwc.com/media/file/The-era-of-digitizedtrucking.pdf 9. Source: http://www.bbc.co.uk/news/technology-35820873 10. Source: http://mhlnews.com/global-supply-chain/mhls-innovation-awards-2015-top-10-supply-chain-innovations-year 11. Source: Supply Management https://www.cips.org/en/supply-management/news/2016/october/a-world-of-innovation--supply-chains-at-work/ 12. Source: http://mhlnews.com/global-supply-chain/mhls-innovation-awards-2015-top-10-supply-chain-innovations-year 13. Source: YIBADA http://en.yibada.com/articles/135830/20160628/rolls-royce-tests-crewless-self-driving-cargo-ships-marine-conditions.htm 14. Source: http://www.bochk.com/dam/bochk/desktop/top/aboutus/ir/docs/presentations/2016/offshore_CNH_market.pdf 14 Supply Chain 2020 Report Rolls Royce is currently developing unmanned ships which will hit the market by 2020. Rolls-Royce is currently developing unmanned ships which they believe will hit the market by 2020. Trade hubs and the changing global marketplace Despite the globalised nature of trade today, the proliferation of a truly worldwide network of major trade hubs has yet to materialise. Traditional trading centres such as London, New York and Singapore may not see their role under serious threat in the near future, however, the likelihood of other hubs developing in importance in key locations in the years ahead is increasing. Already the emphasis has started to shift towards Asia, with China a key player. Similarly, pivotal trading locations in the Middle East, Africa and South America could start to emerge, as these markets mature and look at ways to gain greater market prominence. As investment improves transport, energy and communications infrastructure, and demographics change, this could start to become a more feasible prospect. With technological innovation continuing to break down physical barriers by establishing interconnected global networks operating in real time, demand for a more extensive global infrastructure, able to operate across different time zones and link geographies, looks set to grow. Trade hubs and the changing global marketplace Despite the globalised nature of trade today, the proliferation of a truly worldwide network of major trade hubs has yet to materialise. Traditional trading centres such as London, New York and Singapore may not see their role under serious threat in the near future. However, the likelihood of other hubs developing in importance in key locations in the years ahead is increasing. Already the emphasis has started to shift towards Asia, with China a key player. Similarly, pivotal trading locations in the Middle East, Africa and South America could start to emerge, as these markets mature and look at ways to gain greater market prominence. As investment improves transport, energy and communications infrastructure, and demographics change, this could start to become a more feasible prospect. With technological innovation continuing to break down physical barriers by establishing interconnected global networks operating in real time, demand for a more extensive global infrastructure, able to operate across different time zones and link geographies, looks set to grow. 15 16 Impact of technological advances on logistics and distribution Technological innovation in logistics and distribution is gathering pace and taking many forms. Drone deliveries are poised to become reality, in the hope of making the “last mile” to the customer, which accounts for more than 50% of total logistics costs15, far less expensive. Drones are quickly picking up momentum around the world in everything from military strikes to pizza delivery. Africa, the continent with some of the most entrenched humanitarian crises, hopes the technology will bring progress. A drone network has been launched in Rwanda this year to deliver blood supplies and medicines to remote hospitals and clinics. What could take weeks to deliver, may now take hours16. There are also signs that the logistics sector could be one of the early adopters of Blockchain. The technology behind the virtual currency Bitcoin, which is shaking up the financial services sector, enables a permanent record of transactions to be created. In the supply chain, this could revolutionise tracking systems. Reports suggest17 shipping companies are already looking at using it to create online ledgers so that details of transactions can be shared between partners in the supply chain in real-time, improving visibility and spurring efficiency. Could technological advances ultimately eliminate the need for transportation? 3D printing is making DIY manufacturing of replacement parts, if not entire products, a realistic prospect. This could mean less stock to be shipped. A diverse range of companies are already using 3D printing techniques to make many different products, from components for military and commercial aircraft, to car parts and toys18. Ford recently printed its 500,000th part with a 3D printer. According to Ford’s website, traditional methods would take four months, and USD 500,000 but with 3D printing, the same process takes four days and USD 3,000. Forecasts19 estimate that worldwide sales of 3D printers will double this year, to almost half a million units, hitting 6.7million by 2020. What could take weeks to deliver, may now take hours 15. Source: Kogan Page https://www.koganpage.com/article/challenges-of-the-last-mile-delivery-in-serving-e-commerce-business# 16. Source: Japan Times http://www.japantimes.co.jp/news/2016/10/10/world/africa-trying-drones-deliver-medicines-blood-hurdles-fears-abound/#.WBIIZulf2Agn 17. Source: Wall Street Journal http://blogs.wsj.com/cio/2016/09/22/blockchain-makes-inroads-in-shipping/?mod=djemlogistics 18. Source: http://www.techrepublic.com/article/3d-printing-10-companies-using-it-in-ground-breaking-ways/ 19. Source: Gartner http://www.gartner.com/newsroom/id/3476317 16 Supply Chain 2020 Report Forecasts estimate that worldwide sales of 3D printers will double this year, to almost half a million units, hitting 6.7million by 2020 17 Conclusion Supply chains are continuously developing - and expecting more from - their physical and digital infrastructure. Customer and supplier relationships are changing, as the supply “chain” becomes increasingly inter-connected, taking on a less rigidly defined linear structure. As this happens, there are many practical issues to address and hurdles to overcome. Rapid technological advances and evolving supply chain strategies can present a wealth of opportunities, but can also bring threats. A major loss at a critical supplier’s plant could generate substantial losses - a risk for which the insurance industry has recently developed a variety of bespoke solutions. Companies need to be agile in their adoption of, and response to, innovative new systems and techniques. The global trend towards increasingly stringent compliance requirements shows no signs of easing. As new innovations enter the mainstream, regulation to moderate and control them is likely to follow swiftly. While improving business processes and reducing costs is an incentive for innovation in itself, regulation and legislation also play a major role - paradoxically as both a driver and hindrance. Against this backdrop, the inter-connection between the two is surely set to become ever closer as we look to the supply chain of tomorrow. As the trends outlined in this report mature and new ones emerge, thorough due diligence, robust policies and watertight contractual terms are essential to supply chain management. Whatever direction the next developments take, businesses need to be ready. Forecasts estimate that worldwide sales of 3D printers will double this year, to almost half a million units, hitting 6.7million by 2020 Clyde & Co LLP www.clydeco.com J350506 - November 2016 Clyde & Co LLP is a limited liability partnership registered in England and Wales. Authorised and regulated by the Solicitors Regulation Authority. © Clyde & Co LLP 2016 About Us Clyde & Co is a leading international law firm with a pre-eminent reputation in all aspects of international trade. With 1,400 lawyers operating from over 40 offices across 6 continents, Clyde & Co provides advice and guidance on international trade across the globe. Our sector specific approach has led us to focus on our key sectors of international trade and commodities, transportation, energy, infrastructure and insurance. Our business is anchored in these core sectors and we mirror our clients across the whole spread of their operations, viewing the world very much from their perspective, helping them achieve their plans and ambitions. We act for some of the most innovative and successful traders, shippers and financiers across their supply chain - from raw material to market, from market to processor and eventually to end user. Our end to end experience and international coverage gives our advice a particular depth - wherever and whenever it is needed.