Corporate TreasuryFinancial Supply ChainTrade Finance 2006

Trade Finance 2006

Q: What new instruments/technology are available to facilitate trade finance?

A (Dan Scanlan, Bank of America): On the technology front, some banks are providing end-to-end electronic solutions that allow buyers and sellers to consummate the financial side of their transactions seamlessly, minimizing paper and reducing the transaction costs normally associated with cross-border trade. Technology exists which allows buyers to send, directly from their ERP systems, purchase orders to their bank. The bank determines the nature of the transaction, i.e. is it for a letter of credit (LC) or is it an open account transaction? In either case, the supplier can be notified electronically, which of course allows the supplier to prepare the shipment, and using software provided by the bank, create the documents that will be used later by the bank to verify that the shipment complies with the purchase order (PO). In some cases, third party documents (documents from other companies. e.g. the shipper or an insurance company) can be scanned and sent electronically to the bank as well. In many cases, however, some paper documents are used and presented to the bank. In any event, the bank can take these paper documents and convert the information on them into data that can then be automatically reconciled against the original PO data and analyzed for discrepancies. Based on this electronic reconciliation, a payment can be generated depending on the original business rules requested by the buyer.
In this way, the entire financial supply chain process can be moved or outsourced from the buyer’s office to the bank. All this, while reducing fees and the paper normally associated with these cross-border transactions. Again, this electronic process is available for transactions done on open terms as well as using a LC.

On the financing front, banks are making progress with their lending capability. Some banks are making loans and analyzing risk to suppliers based on specific transactions and the history between the buyer and the seller, rather than the traditional methods involving factory visits and the rigorous analysis of financial statements. This helps to speed up the lending process and provides the suppliers, who are typically smaller companies in need of cash, the cash necessary to build the products sold in the marketplace. In addition, banks are creating opportunities for buyers to extend their payment terms and to provide supplier financing into these extended terms. Some banks have web-based programs available to facilitate this buyer-supported lending to suppliers (we call it buyer-supported because the lending institution is using the buyer’s credit capabilities to extend the funds to the suppliers).

A (Tovy Smuel, Surecomp): In the global market, corporate customers who maintain relationships with many banks want to work in a multi-banking environment maintaining control of their trade finance portfolio and facilitating communication from/to the various banks. These customers are not prepared to learn and operate a multitude of different front-end systems offered by different banks. In this scenario, the front-end systems offered by banks may become less relevant and web-enabled solutions that are installed at the corporate side, providing multi-banking communication, are becoming more relevant.

A (Carl Wegner, TradeCard): Now that there is a focus on the financial side of trade finance, there is a small group of software companies who have entered into the global trade management business. Some of these still focus more on the physical supply chain and are trying to move to the financial side of the transaction, while some are entirely focused on the financial side of trade rather than warehouse management. Among these suppliers are an increasing number of web-based applications that provide a substitute for the paper-based LC process by providing payment guarantees, movement of purchase order, invoice, and packing lists to help all the members in a trade community move their information electronically. The beauty of these applications is that they also automate open account transactions and bring much-needed visibility in the payment schedule.

Banks have also spotted the trend and many are upgrading their trade services divisions to supply chain management divisions, and offering electronic solutions. Most of the time these are links to the bank that allow buyers to electronically send LC applications to the bank, which speeds up the application process, but the final payment decisions and document checking still happens manually.

Q: What are the characteristics of doing trade finance business in South East Asia? (i.e. what regulations affect trade finance in the various countries of South East Asia? Do strict FX controls have an impact? To what extent is trade done on open account? To what extent are documentary credits done electronically?)

A (Dan Scanlan, Bank of America): Trade in South East Asia is not that different from trade in other parts of the world. Some of the countries in this region have restrictions that require importers and exporters to secure more documentation before importing or exporting goods. These additional steps do not really hinder or impact trade flows. The biggest difference in doing trade with these countries is the perception of the commercial and country risk in these countries. The extra paperwork that an importer needs is not really a big deal. For example, he or she may need to secure permission to convert local currency into US dollars or euros, but that is usually easily obtained once the local regulators are satisfied that the purpose of the payment is legitimate.

The risk, or the perception of risk, of doing business with these countries, on the other hand, can add cost to each transaction as the seller who is shipping products to these countries will want to make sure they get paid and, so, will first ask for an LC and second will want that LC to be confirmed. The reason for this, of course, is directly related to their fear that the country will impose a new more restrictive currency regime or that the importer may not have the ability to pay them. At the end of the day, the countries in South East Asia want to encourage international trade, especially exports, and so do not want to make cross-border transactions too difficult for local importers and exporters.

A (David Toubkin, Surecomp): As a rule, LC is more popular in Asia, both from the importer and exporter side, than open account. In fact, while global volumes of LC business are decreasing as an absolute proportion of world trade, in Asia (especially in China and India) their volumes are increasing dramatically. For example, some banks in China report increases in LC business of more than 30 per cent annually. Electronic documentary credits are also becoming more acceptable in the region as the general usage of the Internet becomes more widespread.

There are some specific characteristics in the way trade finance is operated in the Asia-Pacific region. Some examples include extensive usage of the shipping guarantee, usage of freely negotiable documentary credits and extensive usage of certain types of short term trade financing, such as trust receipt loans, export bill purchase and discount and packing credit schemes (pre-export finance), which may vary from country to country, and which may offer very favourable terms. In the factoring area, invoice discounting seems to be more common than whole turnover factoring.

A (Carl Wegner, TradeCard): Although you would think that stricter FX controls would impede trade, it is a fact that most countries encourage exports, so even if there are restrictions in this area, they are generally biased toward helping exporters. Of course, the trend throughout the industry, not just in South East Asia, is to move from the more paper intensive and expensive LC process to more inexpensive and simpler open account terms. However, open account, although cheaper at first glance, may not be so.

The buyer has to take into account the document checking that used to be handled by their bank under LC. In open account, the buyer has to make the payment decision if documents are correct and decide whether he should pay or not. For sellers, open account can be cheaper for the specific export transaction, but the risk is of course higher without any payment protection from a letter of credit, and if they do want to mitigate that risk, then alternatives like factoring are often more expensive than the original LC process was. In terms of LCs being managed electronically, most international trade banks have some sort of electronic LC application system that allows the buyer to create and submit LC applications online. However, this is usually as far as the electronic system goes, as once issued by SWIFT to the advising bank, the transaction becomes paper again, to be negotiated with the required stack of documents for a payment claim. Complete electronic delivery of the whole trade chain, from purchase order to payment, with electronic – and therefore far more efficient – checking of shipment and payment documents, is available, but only from third party providers.

Q: In many places financing against receivables is in vogue but it is difficult for the financing banker to ensure quality if the borrower does not maintain proper records. How can the bank monitor the borrower’s portfolio in such a situation?

A (Dan Scanlan, Bank of America): In many cases the lending financial institutions will ether take over the processing of all receivables or outsource this job to a competent third-party company. This is especially true if the receivables are being sold in the capital markets.

A (David Toubkin, Surecomp): Receivables financing can be carried out either via factoring or traditional trade financing. In the factoring scenario, the seller offers his invoices to the factor and also assigns the invoice to the factor who assumes responsibility for collecting the debt (including communicating with the debtor on behalf of the seller). The factor’s risk is controlled by having a reasonable spread of buyers and checking to ensure that the concentration of debt with a specific buyer does not exceed a pre-defined percentage of the overall portfolio, as the factor expects the buyer to pay the invoice even if the factoring agreement with the seller is on a non-recourse basis (although in case of buyer default the seller will still be the ultimate source of funds).

For traditional trade financing, receivables financing is generally carried out against the credit line of the seller, either in the form of with recourse invoice discounting or non-recourse financing with the security of a guarantee or confirmed LC. Similar to factoring, many banks are becoming more sophisticated by offering non-recourse financing based on non-disclosed credit lines which the bank allocates to the buyer with the idea of risk mitigation through a good spread of buyers.

Whatever the form of financing, it is true that fraudulent or badly kept records do present a risk for the bank. SWIFT’s new TSU (Trade Services Utility) may present a solution as it aims to match the buyer and seller side of the transaction thus providing the financing bank with a greater degree of confidence (see Engaging Risk on Open Account: The Trade Services Utility).

A (Carl Wegner, TradeCard): It is true that with the trend towards open account it is a challenge for banks to be able to provide receivables financing but do it in a manner where they can secure the risk. If the bank has an established line with the seller based on other guarantees, then it is not difficult, but it does increase utilization of the vendor’s credit line. It is hard to book the risk on receivables financing against the buyer.

Two of the main issues are firstly that an exporter’s bank does not have a relationship with the buyer, and secondly, that they cannot verify that there is indeed a payment obligation by the buyer to pay. Therefore, to book lending against the buyer’s line can only happen when the lending bank has a branch in the country of the buyer, or they purchase some sort of credit enhancement via an import factor to cover the buyer risk. Usually this is also expensive for the exporters, as now they have to bear the cost of the paperwork and the credit costs for both themselves and their bank in order to get paid. However, there are some systems now that provide a link from the purchase order to the payment obligation with non-repudiation of documents from both buyer and seller that can allow providers to provide non-recourse financing to vendors, based on buyer’s risk, but not using a buyer’s credit line.

Q: How complicated is it to promote trade finance in China in view of their various local regulations on checking foreign currency payments and collections?

A (Dan Scanlan, Bank of America): The paperwork in China can be a bit more onerous than in other places, but the difficulties of importing and exporting are clearly worth the extra effort, as evidenced by the huge volume of imports and exports. There is no doubt that there are a number of regulations that must be followed and that there are many local regulations that apply in one province but not in others. For example, Chinese law is often not as clear as English law but there are plenty of consultants and banks that can help companies successfully navigate these issues.

A (Carl Wegner, TradeCard): Promoting trade finance, especially exports from China, is not difficult – although there are rules and regulations, they are designed to help exports, so they are usually manageable. Trade from China is booming, and now more and more of the goods leaving China are being sold by domestic Chinese companies instead of foreign invested factories or trading companies. In these cases, if the manufacturer has the rights to sell directly overseas, the total paperwork can be a bit easier than when there has to be a third party trading company in the sales and payment process.

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