Open Account Trade Financing in Asia
Open account trade in Asia in the recent years has been experiencing accelerated growth as compared to the rest of the world. Statistics show that Asia’s 2010 factoring volumes have grown to US$472.5bn, a 57% growth year-on-year from 2009, compared with Europe’s 11% and Americas’ 21% growth figures. Asian growth powerhouses such as China and Hong Kong grew even more impressively, by 113% and 66% respectively. Even Taiwan, a relatively mature factoring market, has grown by a staggering 98%.1
In this new climate, many trends are developing and these present many opportunities and challenges for both financial institutions and corporates looking to manage their working capital needs.
One of the most obvious trends that we see is the increasing acceptance of open account trade by large corporates in Asia. Although much of Asia’s trade is still done on documentary credit terms, we see more and more corporates transacting with their business partners via open account credit terms. This is more evident from cross-border trade, where latest research shows that approximately 85% of the global cross-border trade in transacted on open account terms.
With this, we also see a greater acceptance of factoring by large corporates as a solution to enhance their working capital requirements. Previously touted as the preferred financing tool for small and medium-sized enterprises (SMEs), large corporates have come to appreciate the value of factoring not only for liquidity, but also to effectively manage counterparty risk and collections. Corporates in the telecommunications and technology sectors are the latest to demonstrate large-scale acceptance of factoring.
The recent push towards electronic invoicing (e-invoicing) and financing (e-financing) has also gained momentum in Asia. Many third party electronic platforms (e-platforms) have developed e-invoicing capabilities for corporate clients to reduce their paper trails in the physical supply chain. E-financing platforms by banks make up the financial supply chain leg to substantially increase the online transaction capabilities of a corporate.
Although most systems are still largely in development, there is much emphasis on the integration of these two capabilities to provide a total electronic solution (e-solution). As corporates get more comfortable with the end-to-end process, it provides greater incentive for corporates to shift to open account terms to reduce documentary costs and enhance relationships.
In this climate of economic uncertainty, effectively managing counterparty risk and liquidity are two major concerns for corporates. The former is especially pertinent when transacting with overseas or new entities. Supply chain financing (SCF) has recently gained prominence as an effective tool to manage counterparty risk and liquidity by leveraging on the large corporate as an anchor to provide credit to its business partners. The buyer-centric SCF model is proving to be very popular in Asia; large-scale programmes are already running in China, India and other manufacturing engines in Asia.
However, open account trade has its own set of challenges to overcome. Moving from documentary trade to open account trade could potentially have an adverse effect on a corporate’s cash conversion cycle. In the absence of letters of credit (L/Cs), corporates also have to take on counterparty risk for the tenor of the credit terms. In today’s environment of tight credit, corporate liquidity and risk have become even harder to manage should a corporate choose to move to open account trading terms. However, the market momentum is shifting towards open account terms. Corporates have to explore the option to stay competitive and also to ensure the viability of their supply chain.
Financing open account transactions also carry certain challenges for banks. In open account financing, banks usually take assignment/ownership of the receivable as the basis for funding. However, laws specific to this assignment are not available in all jurisdictions and this can cause differing opinions as to what constitutes a true sale of a receivable. Such mismatched expectations could potentially lead to expensive settlement methods for banks. Moreover, some jurisdictions insist that all counterparties be informed of the assignment before it is valid, adding additional work to the financing proposition.
Open account trade is still relatively new to Asia. Although open account trade financing has grown significantly, only in recent years has this phenomenon has become more prevalent. As such, the market practices and lessons are still lacking in certain quarters, particularly for SCF, where awareness in the market is still relatively low. As such, scepticism and the lack of knowledge sometimes constitute a challenge when pitching open account financing propositions, particularly with regards to the accounting treatment of these loans. In the case of factoring, it has had a historical negative connotation as the ‘lending of last resort’, which still bears weight in certain markets and which could present an additional hurdle in Asia with regards to companies who place heavy emphasis on their corporate image.
Many corporates in Asia already transact on open account terms to a certain degree. The growth of open account trade in Asia in the near future, although expected to grow faster than other mature regions, will still be dampened by the effects of the global financial downturn. Having said that, the usual regression to L/Cs during financial turmoil observed previously has not been as noticeable in this downturn, and this signifies the continued growth of open account trade.
While factoring has long been so called negatively associated, it is still very much a practical, effective and widely used trade finance solution. Industry players can leverage on industry associations such as Factors Chain International (FCI) for guidance on regulations around the practice of factoring and treatment of receivables.
FCI is an organisation of factoring institutions with members in many economies with high trade volumes. These include both mature economies such as the US and Germany, as well as emerging economies like Brazil, Russia, India and China (BRICs). These members usually provide information to fellow members regarding local jurisdiction applicable to the treatment of accounts receivable (A/R). However, legal opinions still can be sought to confirm the information and also for locations with no FCI member presence. This workaround presents a viable alternative for now, but in future more work still has to be done to enhance the open account trade financing offerings to export-oriented Asian corporates.
1Factors Chain International.