A New World Order and Supply Chain Finance: Unlocking the Potential
Economic growth has always been consumption-led, but events in recent years have changed these patterns. As developed economies struggled and giant corporate houses saw a drop in profitability, developing countries continued to grow at a much faster pace.
While emerging markets (EMs) are currently showing some volatility, there are undeniable long-term trends – such as demographics, urbanisation and the rise of middle class – that drive the growth of EM economies. This momentum paved the way for the establishment of new trade corridors with a significant increase in South-South trade and a corresponding increase in supplies from emerging markets to the rest of the world. This impetus is expected to continue, with EMs contributing 60% of global trade volumes. Trade between emerging countries is expected to account for 40% of global trade by 2030, up from the current 18%, as shown below in figures 1 and 2.
Road ahead for Supply Chain Finance
As supply chains in emerging markets become increasingly instrumental to global recovery, it is imperative for small and medium-sized enterprises (SMEs) from these countries to have access to unwavering sources of financing.
The availability of working capital is what should have kept the growth engine running in the background, while the world recovered from the aftershocks of the major upheaval caused by the global financial meltdown and the sovereign debt crisis.
However, the ideal doesn’t always match the reality. As credit became tough and liquidity fled the market, smaller economies were worst hit. Payment delays and credit losses exposed system vulnerabilities that were further compounded by natural disasters and the breakdown of financial stability across the globe. The financial crisis resulted in widening credit spreads between investment grade and non-investment grade companies, limiting access to the much-required working capital for manufactures and suppliers.
The changing regulatory environment has tightened cash availability in the system, warranting new financing structures for companies. Corporate treasurers sought alternative solutions to optimise their cash position and better return products for surplus cash. In the meantime, banks around the world were required to manage their capital more wisely under the Basel III capital adequacy regulations, while meeting the bottom-line for their shareholders.
This led to the convergence of two very different yet mutually beneficial set of objectives that encouraged the development of innovative solutions to drive further growth and maximise profits. Several new supply chain finance products were introduced to meet these objectives, including:
Suppliers traditionally approached their bankers to obtain working capital financing against the receivables they own. Since banks provided bilateral lending based on standalone credit assessments, suppliers paid a lot more in the form of discounting interest. As the crisis widened and spreads increased in lower rated markets, less money was made available to suppliers against their receivables. With less operating cash, suppliers could no longer support the manufacturing needs of their large buyer counterparts.
This resulted in the emergence of a new product, where large buying houses with much better credit standing initiate the financing for key suppliers – ensuring lower interest rates and steady access to finance. Banks act as intermediaries and provided financing to suppliers based on their credit underwriting of large buyers. This arrangement helps achieve the mutual objectives for buyers and sellers by extending days payable outstanding (DPOs) for buyers and shortening the days sales outstanding (DSOs) for sellers.
Treasurers around the world are struggling to optimise their returns. One of the ways for them to enhance returns is by analysing their investment yields against vendor financing rates and early payment discounts to arrive at the best solution for their needs – as outlined below in figure 3.
Dynamic discounting accommodates continuous process adjustments based on rates fluctuation, thus achieving optimal result for corporates. This is further complemented by the strengthening of supply chain relationships with key vendors.
Risk Participation in own supply chain:
Another option for corporates is investment in their own supply chains via banks that provide financing to their procurement or distribution network. Cash deposits held at these banks can act as collateral against trade loans, off-setting interest cost for corporates and at the same time providing risk mitigation for banks by reducing their risk weighted asset (RWA) requirements. This arrangement is particularly useful for corporates that are cash-rich and prefer control of available cash over pre-payment arrangements with vendors. Banks will have to devise their internal infrastructure and ability to link cash accounts and trade loans to offer this solution.
Multilateral agencies can also play an important role in supporting global supply chain solutions. Their guarantee mechanism and funding partnerships with commercial banks and third party solutions providers can help broaden financing avenues to suppliers in countries underserved by international banks.
Standard Chartered recently announced its partnership with Asian Development Bank (ADB) to provide supply chain financing (SCF) for businesses in Asia. Such partnerships are ideal for both parties like ADB and commercial banks as they create a symbiotic environment in some of the most challenging markets in the world. The global trade finance community would greatly benefit from such public-private alliances in the long run.
With dominant trade powers shifting from west to east and the advent of the new world order catalysing working capital needs, it has become abundantly clear that there is a pressing need to continuously innovate the way business is conducted to drive continued growth.
While the innovative solutions described above promote the growth of supply chains, challenges around dematerialising the entire process, easing up supplier on-boarding, standardising payment and electronic channels and, most importantly, providing timely and accurate cash reconciliation solutions for clients will eventually determine its success.
Treasurers are expecting holistic solutions from their bankers that encompass both their cash management and working capital needs based on a prudent risk framework. Banks must respond by offering matching products that leverage their full capabilities and deliver on the key objective of maximising returns.