Modernizing Customs Procedures with Distributed Ledger Technology: Requirements for Issuing the Certificate of Origin ^†

Abstract

Over the last decades, globalization in manufacturing and in international trade has led to unprecedented complexity in customs procedures. A basic requirement for Customs Authorities is to determine the origin of products and materials/ inputs in order to perform the appropriate customs procedures. This paper investigates the potential of Distributed Ledger Technologies (DLT) to address the challenges of determining correctly the origin of products in order to safeguard the public revenues, accelerate clearance procedures and promote the international trade. The paper analyzes the requirements of the clearance procedures of imports under preferential trade agreements, discusses the unique attributes of DLT and presents DLT implementations in customs procedures and in international trade. Then it provides a requirements analysis and an architecture for the development of DLT-based system for the handling of the origin of products in customs procedures.

1. Introduction

In recent years, the increasing globalization of manufacturing and international trade has resulted in significant complications in customs protocols. Customs procedures include rules related to the transport of goods across national borders, and therefore constitute an integral part of any successful international trade transaction, while the documents accompanying the goods must be verified and validated by different individuals each time. Companies often face problems and costly delays in the customs process due to its complexity, compliance requirements, and corruption. For this reason, simplifying and modernizing customs procedures has emerged as a significant factor in improving the global trading system.

A key responsibility for Customs Authorities is identifying the source of products and materials to enforce suitable customs regulations. However, as end-products tend to contain inputs originating in different countries, this task becomes tricky and sometimes problematic. The issue becomes critical as countries, or blocks of countries, tend to constitute preferential agreements with other countries in order to increase their mutual trade flows. In EU, in particular, the certificate of preferential origin allows goods to benefit from reduced or zero duties when they are imported from a non-EU country with which EU has a preferential agreement. These agreements include complex rules that must be satisfied that cause lack of trust in certificates of origin ad inefficiencies in the customs procedures (e.g., delays and fraud). This issue has a wider social impact regarding the information of the ingredients that make up the goods people buy and consume and the compliance to international rules, environmental standards and ethical principles.

This paper investigates the potential of Distributed Ledger Technologies (DLT) to address the challenges of determining correctly the origin of products in order to safeguard the public revenues, accelerate clearance procedures and promote the international trade. DLT refers to a type of database that is distributed across multiple locations that can be used as a ‘shared digital ledger’ by different users to record and manage transactions in a secure way [1]. In a traditional database there is central control over data management, which fosters trust among participants that data is being maintained in the correct way. In a distributed ledger there is usually no central control over the management of the data, but processes are in place to collectively verify the data, before it is finally recorded in the ledger, by all participating parties. Collective data verification is the mechanism that develops trust and makes possible cooperation between participants who do not usually know each other, do not trust each other a priori and possibly have conflicting interests. Therefore, updates are not carried out by a central authority, but by consensus between the parties, according to a set of rules or procedures accepted by all. Thus, DLT allows any organization or trader to engage in transactions with others at a greater speed than was previously possible. Blockchain is the most common type of DLT.

Initially the paper analyzes the requirements of the clearance procedures of imports under preferential trade agreements, discusses the unique attributes of DLT and presents DLT implementations in customs procedures and in international trade. Then it provides a requirements analysis for the development of DLT-based systems and procedures for the determination of the origin of products and the execution of customs procedures. The paper discusses the key success factors and the involved shortcomings and risks from organizational and technological point of view and outlines an architecture for the development of DLT-based system for the handling of the origin of products in customs procedures.

2. Research Background

DLT has been used in international trade as it has the ability to support transactions in cooperative environments characterized by the co-participation of multiple entities. Several research projects are already underway for the integration and exploration of the advantages of DLT in the field of international trade [2,3,4,5,6].

Next to the scientific research, the field of international trade has already advanced commercial applications, with the most characteristic being the TradeLens platform developed by the collaboration of IBM, Maersk and other leading companies in international transportation [7]. The platform allows all parties involved in shipping a container to track it from start to end. Participants have the ability to digitize and exchange commercial documents in a secure controlled environment where the data cannot be altered. A similar commercial application has been developed by Agility for the management and monitoring of container shipments. The goal is to integrate all shipment information into a single secure platform accessible to supply chain parties (carriers, shippers, exporters, importers, etc.). Kuehne+Nagel has developed an application to make it easier for shippers to complete VGM (Verified Gross Mass) declarations required for maritime transport under the International Maritime Safety Convention (SOLAS). All information submitted through the platform is stored on the blockchain, simplifying data exchange with third parties and eliminating the need for additional off-chain communication channels [8].

With regard to customs procedures, the adoption of DLT by Customs Authorities remains at the initial stage of studies and pilot implementations. While the potential advantages of DLT are widely recognized, Customs Authorities hesitate to proceed vigorously to implementations of DLTs [9]. The reasons for this are mainly institutional, as it is considered unthinkable that auditors would share data with the auditees.

Of course, some Customs Administrations have started exploring and implementing blockchain solutions to enhance their operations as they have initiated pilot projects, proof of concepts, or even full deployments of blockchain and DLT technology. These initiatives aim to improve various aspects of customs processes, such as risk management, fraud detection, compliance, audits, anomaly identification, trend prediction, facilitation, revenue collection, and imaging analysis. By integrating DLT into their operations, Customs Authorities seek to achieve greater efficiency, transparency, and security in cross-border trade activities [8].

For instance, Australia has conducted a blockchain Proof of Concept (PoC) in collaboration with Singapore under the Australia-Singapore Digital Economy Agreement. The aim of this trial was to achieve document interoperability for paperless cross-border trade. Italy has been actively involved in utilizing blockchain technology in various sectors, including customs and trade. One significant initiative in Italy is the “Made in Italy” project, which leverages blockchain to certify high-quality manufacturing products and ensure the authenticity and quality of goods placed on the market. This initiative involves certifying products at different levels, including sustainability certification, chemical certification for non-toxicity, and Country of Origin (CoO) certification. Finally, another country that has made significant progress in this area is Georgia that has launched a new blockchain project issuing preferential Certificates of Origin (CoOs) with QR codes that link to the transaction on the Ethereum Blockchain. Customs officials can scan the QR code or search manually to access all the information in the CoO and verify that it was issued by the Georgia Revenue Service [8].

The use of DLTs for trade financing processes has also attracted the interest of monetary authorities. The Monetary Authority of Hong Kong developed a trade finance platform using blockchain technology and the Monetary Authority of Singapore is collaborating with the IBM Center for Blockchain Innovation to develop applications and solutions using blockchain to improve the efficiency of trade finance processes and transactions [9]. Τhe value of blockchain is significant for the capabilities it provides in financial intermediation, improving transparency, reducing transaction costs and indirect expenses due to the optimization it offers and the safer management of data [10]. Banking operations are cash flows that require collaboration, and blockchain can provide the digital environment that connects various heterogeneous public and private databases and allows them to operate synchronously. Also, financial transactions and, more broadly, all economic transactions involve continuous redistribution of ownership and control, including the stages of settlement, exchange, and clearing, which can easily be managed by blockchain [11].

3. Certificate of Origin—Rules of Origin

Customs is typically responsible for implementing the system of rules of origin by checking certificates and issuing origin certificates for local exporters [12]. A basic requirement for Customs Authorities is to determine the origin of products in order to impose the appropriate customs measures such as tariffs, quantitative restrictions, antidumping and countervailing duties. In general, goods that are considered originating products may be eligible for reduced or zero customs duties when imported into a country that has a free trade agreement with the exporting country. This issue has also social impact as consumers demand transparency in the information about the origin, the ingredients and the compliance of the producers to standards.

Importers and exporters must provide the proof of origin, such as a certificate of origin or a declaration of origin, to claim preferential treatment for originating products. Failure to comply with the rules of origin requirements can result in the imposition of regular customs duties and potential penalties for non-compliance. Rules of origin add complexity to trade for traders, Customs officials, and policy makers. Proving origin requires administrative procedures and accurate accounting systems. Companies must comply with processing rules, bear the cost of obtaining origin certificates, and face potential delays. Small companies in particular may struggle with the cost and complexity of these requirements.

The Certificate of Origin is a legally binding document. It was created in the late nineteenth century to verify the authenticity of goods for their origins. The Geneva Convention (1923) simplified and standardize customs procedures, including the issuance of the Certificate of Origin. Several trade agreements since then provided guidelines for the issuance of the Certificate of Origin. Notice that there is no global standard format or information requirements agreed upon when declaring the origin of a good crossing borders. Each country has its own regulations and rules of origin, set differently in each trade agreement.

There are non-preferential and preferential rules of origin in international trade [13]. Non-preferential rules of origin are applied to various trade measures such as anti-dumping duties, quantitative restrictions, tariff quotas, origin marking, government procurement, and trade statistics. Preferential origin is a concept in trade agreements that allows members to access domestic markets at reduced tariffs. Rules of origin are used to determine if a product qualifies for these preferential tariffs. These rules most typically require that the goods are either wholly obtained (for products entirely obtained or produced in one country) or have undergone a specified amount of working or processing in the beneficiary country. More specifically, the substantial transformation criterion is usually determined according to at least one of the following sub-criteria: (i) change in tariff classification, the production process results in a change of tariff classification between the non-originating materials and the final product (ii) value-added rule, meaning the value of all non-originating materials used cannot exceed a given percentage of the product’s ex-works price, and (iii) specific manufacturing or processing operations [14].

In order to know whether a product has been sufficiently transformed in the partner country, it is important to know when materials and inputs used can be considered as originating in the EU or the trade partner country. The European Union’s preferential rules of origin include the concept of cumulation, which allows importers and exporters, under certain conditions, to consider non-originating materials imported from third countries or processing carried out in non-partner countries as originating in the EU or a trade partner country [15]. There are three types of cumulation used in the EU’s preferential arrangements, each with its own set of rules and criteria: (a) bilateral accumulation (involves only two parties (the EU and its partner country) and permits the use of materials originating in the EU as if they originated in the partner country, and vice versa), (b) diagonal accumulation (it is similar to bilateral accumulation, but is used in agreements involving more than two countries), and (c) full accumulation (it takes into account not only materials originating in the EU or a specified country, but also allows non-originating inputs to be considered towards originating content; the non-originating inputs can be used for accumulation purposes and counted as originating in the partner country). The three types of accumulation described above apply to the main rules used in determining the origin of goods, such as the value-added rule, change of tariff classification rule, and manufacture from certain products rule.

4. Requirements for Handling the Certificate of Origin

In EU, goods originating from a country involved in a preferential agreement are eligible for preferential duties/tariffs treatment when they are imported in an EU country. In order to prove the origin of the goods, the exporter must provide either a EUR.1 movement certificate (which is the most common), a EUR-MED movement certificate, or an origin declaration provided by the exporter on an invoice (or other relevant commercial document detailing the products sufficiently for identification).

4.1. Operational Requirements

When a shipment accompanied by an EUR.1 certificate arrives at Customs in the destination country, Customs officials will carry out a clearance procedure to verify the authenticity and accuracy of the certificate. This may involve checking the information on the certificate against the accompanying shipment, as well as verifying that the goods meet the rules of origin requirements under the relevant trade agreement. Once the clearance procedure is complete and the EUR.1 certificate is deemed valid, the importer can claim the preferential tariff treatment for the goods.

It is important for exporters to ensure that the EUR.1 certificate is completed accurately and in compliance with the rules of origin requirements of the trade agreement in order to facilitate smooth customs clearance procedures in the destination country.

4.2. Data Requirements

The information/data content of an EUR.1 movement certificate typically includes:

• Name and address of the exporter: This is the company or individual who is sending the goods from the EU to a country with a preferential trade agreement.
• Name and address of the consignee: This is the company or individual who will be receiving the goods in the destination country.
• Description of the goods: This includes detailed information about the goods being exported, such as the quantity, weight, and value of the goods.
• Harmonized System (HS) code: This is a standardized system for classifying goods for import and export purposes. The HS code helps customs authorities identify and categorize the goods being exported.
• Country of origin: This is the country where the goods were produced or manufactured. The EUR.1 proof of origin certifies that the goods meet the rules of origin requirements for preferential tariff treatment.
• Invoice declaration: The exporter must declare on the invoice that the goods are of EU origin and meet the rules of origin requirements for preferential tariff treatment.
• Authorized signature and stamp: The EUR.1 proof of origin must be signed and stamped by the authorized body responsible for issuing the document, such as a chamber of commerce or customs authority.

4.3. Technological Requirements

Some of the new technologies that are being used for the clearance and handling of EUR.1 documents include [9]:

• Electronic submission and processing of EUR.1 documents: Many countries now allow for electronic submission of EUR.1 documents, which streamlines the clearance process and reduces paperwork.
• Digital signatures: Digital signatures are being used to authenticate EUR.1 documents, providing a secure way to verify the authenticity of the document.
• Electronic tracking systems: Some countries have implemented electronic tracking systems for EUR.1 documents, allowing for real-time monitoring of the document’s location and status.
• Blockchain technology: Blockchain technology is being explored as a way to securely store and track EUR.1 documents, ensuring transparency and security throughout the clearance process.
• Automated data extraction: Automated data extraction tools are being used to quickly extract relevant information from EUR.1 documents, speeding up the clearance process and reducing the risk of errors.

4.4. Advantages of DLT-Based Solutions for Handling the Certificate of Origin

DLT can provide a secure and transparent way to track and verify the authenticity of certificates of origin for products. In this case, the certificate of origin (EUR.1) can be recorded on a distributed ledger and store encrypted information about the certificate, including the details of the exporter, the origin of the goods, and the Customs Authorities’ approval. Additionally, DLT can provide real-time access to the certificate of origin for all parties involved in the trade process, reducing the risk of delays or errors in documentation. Overall, the use of DLT for the clearance of certificates of origin can help to streamline the trade process and increase its efficiency in terms of costs and time, prevent fraud and ensure that the information on the certificate is accurate, increase transparency and trust in international trade transactions, and provide a tamper-proof record of the document’s history.

DLT can also facilitate the exchange of certificates of origin between different parties involved in the clearance process, such as exporters, customs authorities, and importers. This can help improve communication and collaboration, ultimately leading to smoother and more efficient trade operations. In general, DLT technology can support the development of more efficient and transparent supply chain management systems for businesses involved in international trade.

Recent studies focus on how the use of DLT can be used for customs purposes and the benefits that can arise [16,17,18,19]:

• Increased accuracy of information, as Customs will be able to see the exact data of goods (seller, buyer, price, quantity, carrier, financing, insurance, etc.) and the location and status of these goods in real time.
• Increased transparency of transactions, as all data will be added in a sequence, without the possibility of deletion or hiding of information, and all information will be in one place/file.
• Faster processing of customs clearances, through the extraction and use of primary source information, thus accelerating the pace of international trade.
• Ability to automate transactions, with positive impacts on speed, cost, and transparency, through the use of smart contract technology. Weakening the role of intermediaries.

According to the WCO/WTO Study Report on Disruptive Technologies [20], some of the main benefits of introducing blockchain and DLT in customs operations are the following ones: improved risk management and profiling, improved fraud detection and compliance, facilitation in customs audits and anomaly identification, increased prediction capacity of future trends, and increased revenue collection. The main obstacles are related to the lack of expertise in the use of DLT technologies by Customs Authorities and the stakeholders, the lack of governmental strategy and good practices in the use of DLT technologies in the public sector, the lack of a standardized dataset used by economic operators within the supply chain, and the lack of trust in using data-sharing platforms.

5. An Approach for a DLT-Based System for Handling the Certificate of Origin

There are several technologies that are used in blockchain implementations. Each has its own unique features and use cases. The two most common options for blockchain solutions that address the requirements of customs procedures with regard the handling of the certificate of origin are Ethereum and Hyperledger.

Ethereum is a decentralized platform that enables smart contracts and decentralized applications to be built and run without any downtime, fraud, control, or interference from a third party. It enables the development of smart contracts, which are self-executing contracts with the terms of the agreement written directly into code [21]. This enables trustless and transparent transactions to take place on the blockchain. It provides its own virtual machine that runs on the Ethereum network and enables smart contracts to be executed. With the use of Ethereum Network, Proof of Stake (PoS) validators create blocks that are distributed across the network for verification. In addition, it provides a platform for developers to build decentralized applications that run on the blockchain, giving users more control over their data and transactions. Ethereum has been used in solutions in international trade and customs procedures to streamline processes and improve transparency in supply chains. For example, Ethereum was used to track the provenance of goods, automate customs procedures, and facilitate trade finance transactions [22]. Ethereum’s smart contracts have also been utilized to create self-executing contracts between parties involved in international trade. Overall, Ethereum has the potential to revolutionize international trade and customs procedures by providing a more secure, transparent, and efficient way to conduct transactions and manage supply chains.

Hyperledger is an open-source collaborative effort, hosted by The Linux Foundation, that includes various frameworks and tools for developers to build and deploy blockchain solutions. It offers a modular architecture that allows users to pick and choose the specific components they need for their blockchain projects [23]. Hyperledger is designed for use in permissioned networks, where participants are known and trusted. Hyperledger has been used in several projects in international trade to track and trace goods along the supply chain, ensuring transparency and accountability, as well as for the execution of secure financial transactions, clearing, and settlement. It can be used to manage and authenticate digital identities securely. For example, Tradelens is a blockchain-based platform developed by IBM and Maersk that uses Hyperledger Fabric to digitize and track global shipping transactions, improving transparency and efficiency in international trade. Additionally, some customs agencies are exploring the use of blockchain technology, including Hyperledger, to streamline customs procedures and combat fraud in cross-border trade.

The architecture of an DLT-based solution for the handling of the certificates of origin in customs procedures involves several critical levels:

(a) Selection of Platform: Ethereum and Hyperledger can provide the basic blockchain platforms for the implementation of DLT-based solution for the handling of the certificates of origin in customs procedures. A careful analysis of their features, as well as the availability of good practices in their implementation in research projects and system implementations, will indicate the appropriate choice of platform.

(b) Selection of Blockchain Network: Depending on the specific needs of the organization, one can choose to utilize an established global platform, a public blockchain with smart contracts, or create a customized blockchain network. Each option has its advantages and considerations in terms of trust, customization, and transaction costs.

(c) Block Structure Design: Block structure design refers to how the data is organized and stored within individual blocks in the blockchain. The design of the block structure is crucial for the security, efficiency, and scalability of a blockchain project. To ensure the integrity of the transactions within a block, a Merkle tree is used to create a unique hash for all the transactions in the block. This allows for quick verification of the contents of a block without having to check each individual transaction.

(d) Smart Contract Design: Smart contracts are employed to automate and secure the certification process. They play a crucial role in automating tasks such as transaction execution, updating balances, and retrieving data. They are essential for certificate transactions and can automate the certification process, speeding it up and reducing errors. Digital identities are securely recorded for all parties involved in the international trade process.

(e) Data Confidentiality and Access Rights: Organizations must ensure data confidentiality by assigning specific roles and access rights to users of the international trade system. Unauthorized access to information is prevented, enhancing security.

(f) Consensus Mechanism: The consensus mechanism ensures agreement on the history of transactions by selecting new transactions and distributing them to network users. This mechanism is crucial for maintaining the integrity and security of the blockchain network.

The proposed architecture should meet all the dimensions of security in information systems: (a) confidentiality (public key cryptography can be used to ensure the confidentiality of transactions and enhance data security), (b) integrity (the system should maintain the integrity of data by recording transactions on the blockchain, making them immutable and tamper-proof), (c) non-Repudiation (smart contracts enable parties to verify and authorize transactions), and (d) authentication (the system authenticates certificates of origins by tracing them to the issuers, ensuring the validity of documents). In addition, the system should enable efficient document processing and secure data storage (decentralized storage ensures the security and accessibility of documents while preventing unauthorized alterations).

6. Conclusions

The proper handling of Certificates of Origin in customs procedures is essential for ensuring compliance with trade agreements, determining accurate tariffs and duties, preventing fraud, and facilitating efficient trade operations. The handling of Certificates of Origin involves unique requirements regarding the accuracy of information it contains, so that the determination of the eligibility of products for preferential treatment and compliance with trade agreements is performed correctly. In addition, compliance with these rules is essential for accessing preferential tariffs and avoiding penalties for non-compliance. DLT can streamline the trade process by recording Certificates of Origin on a distributed ledger, storing encrypted information about the exporter, origin of goods, and customs approvals. This enables real-time access to certificate information, reducing delays and errors in documentation, increasing transparency, and building trust in international trade transactions. DLT facilitates the exchange of Certificates of Origin among exporters, customs authorities, and importers, improving communication and collaboration in the clearance process. This enhanced interaction leads to smoother and more efficient trade operations.

The paper underscores the potential of DLT to revolutionize customs procedures by enhancing transparency, efficiency, and security in handling Certificates of Origin and promoting smoother international trade transactions. It highlights the unique attributes of DLT and the requirements for developing DLT-based systems for determining product origin and executing customs procedures. Additionally, the paper discusses key success factors, organizational and technological risks, and outlines an architecture for the development of DLT-based systems in Customs.

In the future, the role of blockchains in supply chains is expected to bring significant changes to asset management through tokenization, ensuring security, fairness, and democratizing market access. Legal barriers may need to be addressed to link assets with decentralized ledger technology. The application of blockchains is especially proposed for high-value goods and services industries (like wine, caviar, vaccines, etc.), where tracking is crucial due to perceived value and susceptibility to adulteration. Organizations need to address compatibility issues when integrating blockchains into their systems, starting with specific areas like certification transparency.