Financing the Supply Chain in Asia: Trends and Opportunities
As global economies work their way out of this current financial upheaval, we see a sense of urgency toward effective financial supply chain (FSC) management as companies seek to leverage technology to enhance efficiencies along the supply chain and set free part of that underutilised trillion dollars. This perfect storm is the best opportunity for companies to implement an FSC programme. Toward that front, there now seem to be more conversations between banks and corporates in trade and supply chain financing.
The need for FSC projects stems partly from globalisation and corporates increasingly marketing products and services across the globe, offshoring their manufacturing activities, or sourcing supplies from abroad to ensure cost efficiencies. These, coupled with the phenomena of ‘just in time’ inventory and the ability to remain adaptable to changing customer demands, drive the necessity to trade frequently to sustain a small inventory stockpile.
Meanwhile, corporates have to concurrently ensure that they can maintain ongoing relationships with international suppliers and customers, and yet manage nuances ranging from complex trade regulations to language and cultural differences, plus consider the impact of factors like currency fluctuations on profit margins.
Thus, with risk raised multiple fold and additional layers of operational complexity, corporates are constantly looking to smooth their flow of goods and services. Given the current tight liquidity in the market, this includes the freeing up of working capital internally to self-finance and eliminate hiccups that can arise from the lack of funding. Corporates are scrutinising their supply chain management strategies and seeking opportunities to release cash tied up in inventories, enhance efficiencies in handling of payables and receivables. They are also seeking to automate what is currently a highly manual documentation process and reduce administrative cost, and renegotiate for more favourable payment terms.
Asia-Pacific sits at the leading-edge of FSC development, predominantly due to its export-led growth model and the crucial role trade plays within the economies. Two supply chain developments we are witnessing across the region are:
1. Corporates revisiting letters of credit (LCs). Hitherto, the traditional realm of supply chain financing was evolving, with importers and exporters seeking customised solutions to finance their international transactions. As corporates built relations with their regular suppliers and became more assured in dealing with each other, many had migrated from the long-trusted instrument of LCs and other traditional trade finance products in favour of open account relationships, whereby goods and services are bought and sold without bank intermediation. The LC offered the assurance of a bank obligation but was costly, sometimes cumbersome, and slow. Open account, in which the importer pays after receiving an invoice, is now accountable for about 80% of all international trade business.
However, we see what seems to be a revision, with some companies transitioning back to the safety of LCs to mitigate higher levels of counterparty risks with trading partners and banks brought about by the current volatile environment. Others are meanwhile hesitating to move suppliers to open credit terms for the foreseeable future. For instance, the risk associated with certain types of commodity exports might be too great to move to open account, and the protection of traditional trade tools is still needed.
2. Reshaping of the trade finance landscape. While banks in general remain very engaged in trade finance and are collaborating closely with corporate clients to facilitate supply chain solutions, one of the consequences of the crisis is a wave of mergers and acquisitions among the financial institutions that would reshape the trade finance landscape.
Some argue that the business of financing trade is increasingly one that is best served by international banks with deep pockets and can offer corporates the global reach and on-ground presence, access to capital, and sustained technological investments, and drive marginal players out of the industry.
The opposing camp would argue that both global and local financial institutions can coexist in harmony with a symbiotic partnership. Supply chain financing encompasses numerous features catering to the buyer-seller trading relationship, and even the largest players might benefit from partnering with regional and niche providers of trade finance to unlock and deliver greater value from FSC.
Corporate banks and their clients have to deal with several challenges when it comes to structuring and implementing FSC management schemes. An issue that resonates with institutions now is the impact from a deterioration in international trade flows. An International Chamber of Commerce (ICC) report presented at a meeting of banking experts organised by the World Trade Organization (WTO) in March 2009 indicated a substantial decline in both volume and value of world trade stemming from the ongoing global financial upheaval. Of the 122 banks surveyed in the report, 47% showed a decrease in export LC volume, with 43% suffering a decline in the LC value for aggregate transactions, while in excess of 50% tightened their trade credit lines for financial year in the last quarter of 2008.
With the application of more stringent credit criteria and capital allocation restrictions, institutions are making deliberate efforts to trim credit lines by exiting riskier markets and via reduced interbank lending. Intense scrutiny of documents by some banks is leading to higher rates of rejection of LCs on the basis of minor discrepancies, and the lower trade flow is accordingly translating to lower demand for FSC solutions.
Moving from external to internal drawbacks, an earlier study conducted by Financial Insights revealed that a principal challenge faced by financial institutions with regard to realising revenue along the FSC was the lack of scale: 61.5% believed they did not have enough customer or transaction scale to afford investment in solutions (see Figure 1). As such, adherence to open standards will be crucial to winning new clients. This is an opportunity for software as a service (SaaS) to step in and enable banks to pursue growth.
In Figure 1, the observation about the need for an adaptive framework to meet the varying needs of customer segments is also indicated, with 53.8% of the multiple responses viewing platform and integration issues and a lack of consistent messaging standards as supply chain issues. Success of FSC management would require interoperability among different buyer/supplier networks and among different financial institutions.
Figure 1: Barriers to Banks Realising Revenue from the Financial Supply Chain
Source: Financial Insights
n = 14 commercial banks in North America. Multiple responses were allowed for ‘multiple challenge’.
Another hindrance stems from the corporate bank remaining siloed and internally focussed without an apparent FSC strategy at the organisational level. While some have attempted horizontal integration between domestic and international cash management and trade, few have brought finance to the table and fewer still have given all four areas – cash, trade, payments, and finance – an opportunity to collaborate.
Herein, institutions cite incentive alignment as key to ensure that FSC management cuts across the normal realms of responsibility in companies and to ensure that the decision-makers collaborate in executing on the supply chain strategy. From the product perspective, banks typically experiment in a fragmented and localised way, with initiatives driven by trade services and payments in an uncoordinated (and competitive) manner. Such deficiencies in coordination exacerbate, rather than cure, the supply chain complexity problem.
Challenge number three on the lack of consistent invoicing standards points to a deficiency of an electronic equivalent to a paper invoice. Unlike paper documents or possibly email, which can be created, read, and delivered to anyone connected to the system, an e-invoice does not exist except within the confines of proprietary systems that are currently not interoperable. Paper invoices do not conform to a single template, style, or standard and can be supplemented with information required with a pen or a pencil. There is no requirement for a physical signature, and they can be issued and posted with little more than a letterhead for identification.
To enable an FSC, an e-invoice standard is needed. And while work has been under way, a consensus messaging standard remains lacking. In addition, the requirement for electronic signature, ‘sealing’ the e-invoice, archiving, and other technical requirements raise the complexities of creating an e-invoice and place it beyond the technical acumen and process comfort of a typical corporate. Creating an electronic equivalent to the paper invoice remains an exigent task, and until the e-invoice becomes as easy and flexible as hard copy versions, the lack of a consistent invoicing standard will remain an issue of contention.
Other issues that might come to light when structuring FSC management solutions include cultural and legal restrictions, such as legislations pertaining to electronic signatures acceptance and usage that varies between countries and would have implications toward the adoption of paperless invoicing. International trade financiers also have to contend with domestic banks that may be able to finance their domestic clients at very competitive rates. This is especially so for developing jurisdictions in Asia such as China and India, where local state-owned banks flushed with cash may have been urged to prop up the sagging economy with a steady flow of bank loans. The People’s Bank of China (PBC), for instance, stated that it “will enhance the ‘window guidance’ and inform local banks of the meaning of its macroeconomic regulation, to guide reasonable loan extensions,” and ensure ample liquidity to support the country’s drive to stimulate economic growth.
While some banks holding back spend are retreating in terms of risk appetite and market coverage, other trade financiers perceive the untapped opportunity. These financiers are going full steam ahead and not only developing solutions in the supply chain space in response to the needs of large corporates but extending their FSC value proposition for the SME segment of the global trade finance market.
With the relative strength of banks becoming a deciding criterion ever since the near collapse of banking systems in late 2008, now more than ever corporates are seeking to forge relationships with suitable global financial partners. While in the past, this might have meant maintaining a relationship with one dedicated provider, the issue of counterparty risk (where even the largest banks have proved to be fallible) and corporates’ desire for diversification may now result in companies opting to work with a multiplicity of providers.
The key banks developing FSC solutions in Asia-Pacific are predominantly foreign-headquartered financial institutions with a long-standing history and presence in the region. They have sufficient credit standing and reach to cater to global corporates yet boast adequate on-ground presence to service smaller suppliers and thus have captured a foothold across key markets in Asia-Pacific.
The FSC has demonstrated a capacity to manage liquidity and mitigate the underlying financial risks of complex supply chains, particularly in the huge Asia-US and Asia-Europe trade routes. Herein, key regional markets that seemingly attract the most attention from global trade financing banks are India and China, where corporates are increasingly espousing technology in commerce to handle volume expansions, a longer supply chain of activities, increasingly sophisticated purchaser demands, stringent governance standards and regulatory environments, and globalisation of operations. As corporates in developing nations attempt to align their business models with international norms, so does the requirement for end-to-end FSC solutions to unlock liquidity and maximise working capital potential.
China remains one of the most cost-efficient locations for multinationals to establish their global manufacturing hub. This, combined with a large consumer goods domestic market supported by a nation of more than 1.3 billion residents, further reaffirms demand for cash management and the financing of domestic trade within China.
Meanwhile, the allure for India lies in opportunities for trade financiers to assist the corporates in transitioning away (albeit gradually) from paper-based processes and in streamlining payables and receivables via electronic payment systems such as real time gross settlements (RTGS) and national electronic fund transfer (NEFT). Consequently, global banks maintain considerable presence in east Asia and south Asia, where the bulk of suppliers’ merchandise gets produced.
Forerunners in FSC solutions with strong expertise and networks in Asia-Pacific include a handful of global banks such as Citi, Deutsche Bank, HSBC, JPMorgan Chase, and Standard Chartered. While they offer generally comparable programmes, they do differentiate themselves in varying ways.