Trends in trade
The trends in trade do indeed highlight tremendous volatility over the past decade. From 2000 until 2007, global trade grew at about 10% per annum, according to the International Chamber of Commerce (ICC) Global Survey on Trade Finance. Trade volumes declined during the global financial crisis, and dropped more than 20% in 2009 alone. As volumes dropped, the ICC also reported an increase in issues damaging the trade finance market such as court injunctions, allegations of fraud, and contractual disputes under guarantees or standby letters of credit (LC).
Once the global economy recovered so did trade, and 2010-2012 saw a rebound in global trade growth. That recovery did not last long, however, as the end of high commodity prices in 2012 led to another collapse. More recently, global trade plunged by about 12% in 2015.Along with the drops in commodity prices and trade came increased risk, exemplified by 28% increase in confirmations of LCs and standby LCs, as well as an increase in allegations of fraud and court injunctions for LCs.
Growing needs for innovative trade financing
Amidst this volatility in global trade, companies around the world have increasingly begun looking for new solutions to finance the supply chain, so that they can manage operating cash flow and risks far better, and reduce their cost of borrowing. SMEs, in particular, need access to affordable financing for working capital as well as to finance for new sales.Besides looking for traditional postinvoice financing, more companies are looking for solutions that enable them to finance their supply chain earlier with pre-invoice financing. Buyers with strong credit profiles are also looking for solutions that use their own creditworthiness to support financing for their suppliers without increasing their direct liability.The need for financing is greatest in Asia, where trade is still growing despite the overall slowdown globally. The Asian Development Bank (ADB) estimates that there is still US$1.4tn in unmet trade finance demand globally, of which 71% is in Asia Pacific. The greatest need for trade finance comes from SMEs, both because 35% of their applications for credit are rejected and 28% find financing they were offered too expensive. The key reasons banks decline the applications are that the costs of compliance requirements such as Know Your Customer (KYC) assessments are onerous and the cost of onboarding new customers is high.
Factoring and forfaiting solutions to meet companies' needs
Traditional trade finance remains a viable option for many companies, particularly in situations where they need higher security. At the same time, a significant portion of global trade volume is now done on open account trade terms.
With the market changing so rapidly however, banks have begun offering a variety of alternative solutions to meet the needs of companies for more effective SCF.
One of the fastest-growing trade finance solutions, according to DBS global head of trade and supply chain finance, Vijay Vashist, is receivables financing, or factoring. Indeed, factoring has grown faster over the past 5-6 years than both GDP and traditional trade finance. Factoring grew at a 9% compound annual growth rate (CAGR) globally between 2010 and 2014, and cross-border factoring grew even faster at a 19% CAGR. While Europe is still the largest factoring player with a 62% market share, growth rates for factoring in Asia averaging about 15% are stronger than in other parts of the world and have resulted in the region’s market share – currently 26% and growing.
Factoring, Vashist explains, is a financing activity which caters to open account trade between a seller and buyer, which is not backed by an LC. Factoring involves financing the credit terms of the open account trade, collecting receivables from buyers in one or more countries, sales ledgering reconciliation and bad debt protection if the buyer is unable to pay. Factoring can also leverage credit insurance, which has come in to support factoring by underwriting the buyer’s credit risk. While factoring is a valuable cross-border solution, Vashist says that more than 80% of global factoring is currently domestic.
Along with the growth in factoring there has been an increase in forfaiting, a financing solution that involves the purchase of receivables. In the past, forfaiting had been more transactional and was used more to finance equipment or other capital goods, whereas factoring was used to finance working capital. More recently, however, the line between factoring and forfaiting has blurred. Factoring has evolved from shorter-term to also longer-term financing, especially in the technology and telecommunication sectors, while forfaiting is increasingly being used as a shorter-term credit solution.
Key reasons for growth
A key reason factoring has grown more rapidly in Asia, Vashist explains, is that payment terms for companies in the region average about 80 days, compared to about 50 days in other parts of the world. Suppliers need financing for that longer timeframe, until they receive their funds.
Another key reason for the change in market dynamics is an increase in domestic consumption in China, which led to factoring turnover growing at a 43% CAGR from 2009 through 2014 and this resulted in the country becoming one of the top factoring markets in the world. Another is a higher adoption of factoring and supply chain solutions by large corporates, both locally and globally, and on both the sales side and the procurement side.
While about 80% of total global trade is done on open account trade terms, only about 15% of trade finance is currently related to open account trade. This discrepancy offers huge market potential for traders and factoring providers who can convert open account trade into opportunities for financing. Indeed, recent surveys forecast that factoring will grow by double-digit rates over the coming years, driven by growth in cross-border usage and changing dynamics in the market.
New solutions in SCF
An emerging trend in SCF is for banks to offer solutions such as purchase order (PO) management or PO warehousing. Dynamic discounting, whereby corporates use their own funds to make payment and obtain a discount rather than asking a third party for financing, is also an emerging trend in SCF. While most dynamic discounting programs are new and small, Vashist says they seem likely to grow.
Along with these single-provider solutions, banks are increasingly offering multi-bank syndicated financing programmes, whereby companies work directly with one bank as their core provider and 5-6 banks come in indirectly behind the lead bank to provide funding. Clients say they want to talk to one bank, DBS Bank head of supply chain finance, Nicole Wong, says, so that they can deal with a single provider to cover upstream and downstream financing.
While clients want to work with a single bank, the key challenge for banks in Asia is to match their current capabilities and reach with their clients' needs. While multinational banks want to support their large clients by financing those clients’ suppliers, they often don’t have the reach to evaluate the risk of suppliers in remote locations in Asia. Regional banks that do have a strong local presence and can evaluate those suppliers, on the other hand, may not have the people or infrastructure capabilities to support clients with multi-country or multiregional footprints. “One is capable but not able, while the latter is able but not capable,” Wong observes.
To meet clients’ needs, Wong says regional banks such as DBS are energising the supply chain ecosystem and establishing strong practices to enhance their SCF programmes. DBS has, for example, established a solid credit programme with standards that enable onboarding and pre-shipment solutions to be done on a large scale. Bank staff talk to procurement teams so they can understand the business model of anchors, and they make good use of the credit programme by developing an understanding of how companies buy and sell, seasonal impacts on their business, customer payments, and their strategic suppliers. While pre-shipment financing is a riskier form of SCF, this credit programme allows risk diversification by spreading out the counterparties and thereby providing greater value to suppliers’ supply chain linkages.
On the distributor side, banks establish strong relationships with distributors and use their supply chain linkages with anchor buyers to set dedicated distributor finance credit limits for each distributor, over and above what they have as a standard credit line. This capability stems from strong relationship coverage and strong engagement with anchor clients. Extensive post-financing monitoring can also benefit clients by reducing the need for collateral as well as by optimising credit risk.
Gaining a competitive edge
In SCF, Vashist says, every deal structure is unique and deal teams must have a structured approach, which often includes bringing in specialists to provide full-service end-to-end delivery to their clients. Banks with a strong Asian franchise and the ability to leverage their Asian market knowledge can tie up nicely with Western multinationals, which often have trading partners in Asia, to help them capture opportunities on the sales and procurement sides as well as to create an end-to-end holistic solution.
(This article was first published in Global Trade Review, 2016 Asia Supplement.)
