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Risk and reward in using Distributed Ledger Technology: Legal issues for commodity companies

21 November 2018

The commercial possibilities of Distributed Ledger Technology (DLT) are constantly evolving as participants in all industries consider how its use can address their business needs. In a commodities context, DLT has huge potential.

Its ability to drive out inefficiencies, increase transparency, manage risk and track assets is hugely attractive in sophisticated and competitive markets. However there is also some scepticism as issues arise over its security and scope.

As the technology behind DLT progresses apace, legal issues that the new technology throws up and any changes in law required to address these, can lag behind. This can pose its own challenges to companies looking to implement DLT into a workable supply chain.

Legal and risk advisers, both in-house and external, need to work together to implement procedure and policy to protect companies looking to use DLT technology. This article considers four examples.

Managing domestic and geopolitical risk.

Sanctions, tariffs, and political impediments to trade continue to be of particular significance for companies engaged in commodity trading, and the countries which rely on exports of commodities to fund their other activities. It is therefore not surprising that countries which are the subject of sanctions are investing in DLT (as well as reducing their exposure to USD payments) to help them maintain trade. For example, it has been reported that Russia has begun developing its own state-backed cryptorouble, to facilitate trade and economic processes in the country by allowing it to reduce its exposure to banks which decline to be involved in trades impacted by sanctions.

From a legal and risk perspective, effective KYC and due diligence on DLT participants is required to mitigate against potential risk, as is constant updating as law and regulation develop. For example, when Venezuela announced that it planned to launch a cryptocurrency to avoid the consequences of US sanctions, the US authorities responded with an executive order restricting its use.

There is increasing scrutiny by governments in relation to DLT and how it is employed. This is discussed further in an HFW article here. Failure to properly safeguard the DLT trade or to keep pace with developing regulation could result in legal and regulatory consequences for companies, including fines and possible criminal penalties.

Risk of user error

DLT as a technology is only as good as its users. If erroneous material is put onto the blockchain network, an immutable erroneous record will remain.

It is unlikely that this risk can be completely avoided, although the consensus verification process is intended to keep it to a minimum. Risk functions can assist by establishing appropriate procedures, training, checks and resources.

Electronic documentation and legal risk

E-bills of lading have already been in use for some time. Trials are being run to further remove the need for paper documentation and increase supply chain efficiency through the use of DLT technology. English law is now being required to develop in response.

MSC Mediterranean Shipping Company SA v. Glencore International AG (MSC Eugenia) [2017] EWCA Civ 365, which involved misdelivery of goods under an electronic release system for containers, required the English Court of Appeal to apply existing law to this increasingly widely used new technology. Its decision has offered some clarity, for example on whether electronic release notes and pin codes amount to a “delivery order” in this context. There will continue to be some uncertainty for users until the body of case law develops more comprehensively. An express allocation of risk in contracts involving new technologies should help to reduce this uncertainty. This in turn requires a full understanding of the technology by the legal advisers, see below.

Engaging in dialogue with DLT platforms

DLT platforms and DLT technology developers are currently vying to be the chosen providers to commodity companies, and adapt their offering to the complexities and idiosyncrasies of each trade.

It is important for legal advisers and risk functions (in addition to trading, logistics and operations teams) to engage with these platforms and developers from the outset, to understand how they work, and to assess how risk will be mitigated and managed on the proposed DLT platform. If DLT is to be used to trade, the parties should be contracting on the basis on which DLT will be used, and their agreements should set out expressly how the risks and liabilities of the trade will be managed.

At the moment companies are experimenting using specific areas of supply chains, and trusted trade participants, to execute DLT trades. As the technology develops, the use of DLT will become more widespread. It is vital for legal advisers and risk functions to understand the changing nature of their clients’ business and how to protect them.

John Court
Global Director of Information Technology