Germany's Import Business: Challenges from China and Structured Commodity Trade Finance
According to the German Federal Statistics Office, Destatis, the country’s imports reached an all-time high of €902bn in 2011 – an increase of 13.2% compared to 2010. Approximately two-thirds of the import of goods came from other EU countries, but Asia is also an important, and fast developing, trading partner for Germany.
What are the main challenges faced by German importers? As the global economy power axis is shifting towards China, are German corporates ready for renminbi (RMB) trade transactions? For most companies, there is still much to be done, such as:
Over the past 12 months, we have seen an increase in demand for qualified and duly settlement of letters of credit (L/Cs) and collections. Corporate customers with international operations prefer banks with an international network and high quality settlement. Key requirements in foreign trade are: a comprehensive product portfolio and customer support close to the importing company and their counterparts abroad.
In addition, importing companies are looking at ways to reduce cost and risk in their financial supply chain. Structured trade finance products, with underlying securitised commodities, provide a convenient solution for European corporates importing goods from Asia.
The main feature of the financing structure is using the involved commodity and related trade cash flows as a bankable security to mitigate the borrower’s credit risk. Structured trade finance is targeted at clients who are commodity trading companies, as well as commodity producers.
Germany mainly trades with other EU countries. According to World Trade Organisation (WTO) 2010 figures, 56.4% of the country’s imports came from the EU, while 9.4% came from China. On the export side, 60.3% of exports were to the EU and 5.6% to China.1 The US, Switzerland and Russia are also important trading partners.
Despite the eurozone sovereign and debt crisis in 2011 and early 2012, there have not been significant changes in the way German corporates are conducting their import or export business within the EU. Most EU-based companies have long-standing relationships with their trade counterparties and, as a result, they are trading on open account, with no need for guarantees or documentary credits. However, payment-in-advance is likely to become more common, particularly for Greek trade and possibly companies in other debt-stricken EU member countries.
In 2011, the growth in Germany’s imports exceeded its growth of exports: imports increased by 13.2%, while exports increased by just 11.4%. It must be remembered that Germany receives imported goods from other EU states, which it then exports to areas outside the EU, particularly machinery and automotive parts.
Asia, and China in particular, is developing as an important import market for Germany. The quality of goods imported into Germany from Asia has been improving in recent years. Germany is now importing electronics and machinery, rather than just consumer goods from China.
As well as the transformation in the types of Chinese goods being imported into Germany, there is also a change in payment terms and currency. While the US dollar and euro are still the major currencies used in trade transactions between German importers and Asian exporters, there is likely to be an increase in RMB payments in the coming years. At the moment, the flow of RMB into and out of Germany is still modest and this is true across the EU as a whole. In fact, most RMB payments are currently from one Asian country to another, with Hong Kong acting as the major trading hub. This could change in future, with the RMB set to become a major trading currency outside Asia as well.
If payments in RMB increase in future, this will pose a challenge for European importers: many are not ready to handle the currency. It is likely that Chinese exporters may push European importers to pay directly in RMB in future.
The RMB is restricted by a managed floating exchange rate linked to a basket of currencies (mainly US dollar, euro, yen and South Korean won) and there are other regulations that restrict payments in RMB. However, there will be a move towards RMB payments for international trade and European banks need to be ready to support this business. For example, corporates will want RMB bank accounts in Germany, and will need to make payments in and out of China, plus they may need trade finance support for RMB trade. They will also have to establish new hedging strategies for the currency risk.
Many companies are already asking for RMB accounts in Germany, even though they may not have yet started conducting any RMB business. However, many companies are assuming that within the next year or two they will begin trading with a Chinese exporter, who will require a RMB payment and they want to be ready for this eventuality. Companies are also interested to find out how to issue an import L/C in RMB. Companies want to be prepared to settle payments with Asia; in the same way that they can settle payments with European trading partners.
The main regulatory challenge with regards to the RMB is to understand what the Chinese authorities intend to do next. What restrictions will they maintain or lift in future? At the moment it’s only possible to transfer RMB if there is an underlying trade, in the form of exports or imports to or from China. So the question now is: how will China open up the possibilities for using the RMB? Will they allow its use for investments, financial trades or for loans? There are political developments that indicate that the RMB may become a world currency in the next five years, an event European corporates and banks should prepare for.
Corporates are increasingly demanding quality trade finance services. They want imports that are handled and processed within a few days. They also want to have direct contact with someone at their bank in the import country, as well as contact with someone in the country of export. Some of the big German importers have offices in Shanghai or Hong Kong, and they want a direct link to the bank that is settling their RMB import business.
German companies with purchasing arms in Asia are keen to simplify and speed up their procedures for payments and handling documents. Importers in Germany are even able to access their import documents in Asia directly online from their headquarters in Germany and are able to initiate payments directly to beneficiaries in China.
China is becoming increasingly active in trading goods with different countries around the world, while inter-Asia trade flows are also strong. Corporate importers in the EU can facilitate their trade with Asia with structured trade finance. These financial products offer medium-term financing for international trade transactions and are based on existing or future trade growth and inventories of commodities or other goods.
Structured trade finance is used mainly by commodity trading and importing companies (typically oil, coal and gas firms). These complex structures require a specialised team of commodity and structuring experts within the supporting bank. The main feature of these financial structures is that the traded commodity and related cash flows are used as an underlying security for the loan. This, if structured well enough, improves the importer’s credit risk.
There has been increased demand for structured trade finance business in recent years. This is partly due to the tough economic times that have driven companies to seek more secure, less risky trade terms. Another factor is that borrowing has – in general – become more expensive. Structured trade finance can provide an easier way to access competitive funding sources in order to settle commodity imports. In Asia, Singapore is the financial hub for commodity trading for a number of big corporates.
Structured trade finance has an important impact on working capital management because companies can manage their liabilities and achieve a more positive liquidity situation. Structured trade finance products may also be a cheaper way for corporates to fund commodity imports because the bank is able to consider the value of the commodities in the overall calculation of the lending costs. One of the structural elements needed is that, in cases of default, the bank would need direct access to the commodity that serves as security for the financing.
Structured trade finance is a tailor-made business. Different regulations govern different commodities, and the structure depends on whether the customer needs a loan on the asset side or the liability side, or both. The type of business is another factor, as well as corporate policy and the types of transactions used.
As Germany’s imports increase, and emerges as a strategic trading partner, German corporates are preparing for a shifting trade finance environment. Many companies are already establishing RMB-denominated bank accounts in Europe, in preparation for making RMB trade transactions. Corporate risk management frameworks and policies are also incorporating RMB risk, and this will increase in future.
Importers are demanding RMB-denominated L/Cs, but they are also looking to structured trade finance products, with underlying securitised goods, to provide lower costs and mitigate risks for their Asian imports. Overall, the import business is rapidly changing, so banks and importers need to be ready to interact with new Asian trade partners and provide financial support for their businesses.
1https://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Language=E&Country=DE,E27.