A sea change in trade finance
At a time when digitisation, regulation and new liquidity are on the rise, Hesham Zakai explores how these factors are changing the trade-finance landscape.
16 September 2015
From digitisation and disruptive innovation to regulation and reprioritisation, the world of trade finance and treasury management is changing rapidly and, in most instances, irreversibly.
The need for organisations to adapt their strategies to a fast-transforming environment has seldom been stronger, but at the same time embarking on a sustainable path forward brings its own set of challenges.
So, what exactly are the key evolutions driving change in trade finance and how are they taking shape?
Harnessing the power of a digital ecosystem
There are a number of digitisation markers in the trade landscape, including the growth of open-account trading, initiatives such as the Bank Payment Obligation and electronic presentation (ePresentation) tools. These all point to the evolution of a digital ecosystem that can facilitate trade quicker, more efficiently and, in most instances, with greater security.
A digital ecosystem leverages the fact that global marketplaces are more connected to each other than ever – a trend which Ian Kerr, chief executive officer of cloud-based platform provider ~Bolero^, sees increasing:
“As a connectivity platform, we can see that one of the absolute givens of the world is that it is going to be increasingly connected; the world will become a network of networks. This means there is a need to connect more counterparties electronically, and a need for total straight-through processing.
“If you look at what is happening in the world, opportunities are opening up to bring the physical movement of goods together with financial data flows – albeit we are still at a reasonably early period in the process. This process relies on a digital ecosystem, which we are constantly harnessing.”
Signs of this process taking shape can be seen in the increasing popularity of electronic Bills of Lading (eBL), for example. Moreover, for facilitators such as Bolero, they are experiencing a broadening of their customer base as organisations that initially participated in their ePresentation system as importers are now working with them as exporters too, thereby spreading the digitisation trend in domino-fashion.
“That has certainly boosted the number of clients we are working with as exporters. We are also finding that we are being introduced by banks to their customers, which allows them to come on board to our platform electronically too,” adds Kerr, who additionally identifies India and South America as regions that are now moving fast in this domain.
Non-bank players with a strong focus on the latest technologies and user-friendly interfaces have found a space in the digitisation realm where they can become valued parts of the financial supply chain, making life easier for corporates in the process. Their involvement has also acted as a fillip for banks to digitise their services more speedily, enhancing the overall take-up of digital solutions.
Prompted though it may be, this has been a positive development for banks that has given them a better oversight over their supply chains and, critically, improved their resistance to potential fraud and foul-play.
“By going digital, banks have increased visibility over the end-to-end physical and financial supply chain. This would make it possible to intermediate in the chain at a much earlier stage than what happens today, giving banks a greater role in the process,” states Hari Janakiraman, head of global core trade products at ~ANZ^.
Supply chain finance continues to evolve
In the supply chain finance space, the early pioneers are already reaping the rewards of investment seeds sown years ago. Even those new on the block that have been following the progress of the sector are looking at ways in which they can benefit from the ongoing evolution of the solution.
The digitisation aspect is important because it can, for example, accelerate the process of onboarding suppliers – a stage within supply chain finance that is critical to its success. Similarly, the dynamic-discounting solutions on offer afford participants a greater degree of flexibility in managing their working capital.
These more incremental developments reflect how the broad category of supply chain finance, while sometimes seen as a single innovation, is perhaps more accurately described as a series of innovations – a process still in flux.
Eugenio Cavenaghi, ~Santander^’s head of trade, export & supply chain finance for Germany, Austria, Switzerland, concurs: “Supply chain finance is an evolving proposition that keeps adding innovative edges to its core idea, which is all about using the power of trade relationships among corporates to facilitate financing.”
Cavenaghi adds: “What we have recently seen, especially in a mature market like Germany, is a push to become even more lean and efficient in the deployment of the product in the lowest corporate segments, where a very high number of very small enterprises supply to the buyers leading large programmes. The large vendors have now long been onboarded and facilities need to reach out to SMEs in order to increase their utilisation of the product.”
One of the ways in which Santander has endeavoured to do this is through simplifying its KYC requirements for buyers and suppliers, ensuring they still collect all the data they need but in a way that is more manageable for the corporates. Finding the right balance between streamlining compliance requirements without compromising them at all is a key exercise all banks and many platform providers will have to contend with in the regulatory landscape of today and tomorrow.
Another evolution in this space has been what some are terming ‘Supply Chain Finance 2.0’. Here, the solution empowers suppliers and fuels not only their working capital but also their wider trade ambitions, as articulated by a senior analyst at ~Aite Group^, Enrico Camerinelli:
“SCF 2.0 shifts the focus of the security of the transaction from the approved invoice to the trade relationship between the supplier and its client buyer. Hence, a positive and vital trade relationship (ie goods delivered on time, in quality, with no disputes) is the foundation for SCF 2.0.
“The supplier’s operational excellence becomes the new paradigm of a ‘sustainable’ SCF and encourages the company to develop further attention and care to its trade operations,” says Camerinelli.
This shifting relationship is a sentiment echoed by supply chain finance vendors, such as ~Taulia^, whose European marketing director Matthew Stammers adds: “We offer dynamic payment terms, which is a change from the old-fashioned static payment terms and a move towards a modern, dynamic trading relationship that has value for both the buyer and supplier.”
Taking the alternative route
It is not just how cash is managed and optimised that is influencing the trade-finance landscape, but where that cash is coming from in the first place. Increasingly, new sources of liquidity are entering the market, the most recent wave prompted by a couple of key reasons: the regulatory environment and the low global interest rates.
“Banks are required to hold more capital against various trade-finance assets (and all types of financial assets), thereby lowering a bank’s effective return on capital,” says Adrian Katz, chief executive officer at trade-securitisation specialists ~Finacity^. “At the same time, institutional fixed-income investors (such as pension funds and insurance companies) are experiencing extraordinarily low interest rates and tight spreads, encouraging them to broaden their potential universe of eligible investments.”
In their bid to broaden their investments, investors are enticed by trade-finance assets because they represent a good risk-reward asset class, given they are short duration and have relatively low default rates. This is, however, accompanied by a complexity that requires such assets to be overlaid with a structure that has broad investor accessibility, adds Katz.
“New sources of liquidity are being achieved through applying structured-finance techniques, with the primary example that of securitisation. Potential investors in securitisations do not need to be trade-finance experts. In a sense, the necessary trade-finance expertise is encapsulated in the structural requirements of securitisations (sufficient obligor diversification, dynamic reserves for loss and dilution, etc),” says Katz.
“Potential investors therefore can rely on high explicit or implicit credit ratings and third-party operational constituents (e.g. Finacity) to manage the ongoing dynamics and provide detailed and simplified reporting,” he adds.
The involvement of investors broadens the pool of liquidity available to corporates, and this increase in working-capital options could boost companies through more access to cost-efficient capital. The potential range of beneficiaries of this development has broadened in recent years, according to Katz:
“A very important breakthrough over the past few years (that I believe Finacity can take some credit for) is a widening range of corporate-credit profiles that can be supported as securitisation issuers. Weaker credit companies now have access that they heretofore did not. If a non-investment grade company can have access to financing via an investment-grade trade-finance securitisation, such a company would be motivated to implement.
“Further motivating corporates is that, depending on structure, off-balance sheet financing can be achieved, thereby offering improved capital ratios and easier covenant compliance, in contrast to more traditional debt financing,” adds Katz.
As advances in this space continue to be made by institutional investors, the lending paradigm, more broadly, is concurrently welcoming more new players. That includes the rising trend of peer-to-peer lending, which will become increasingly crucial in years to come.
From generalisation to specialisation
In the midst of these digital, capital and regulatory changes, banks have to be more strategic about where they position themselves. A senior trade finance banker tells TXF: “Banks need to understand that the era of generalisation is long over and today it is all about specialisation”.
“We have trade banks that are doing everything,” he says, “they have 100 products that fulfil just three key functions: risk mitigation, financing/working capital, and document handling.”
At the same time, boutique firms that specialise in just one product or solution are growing in number, and they are able to offer smart solutions, focused technology tools, niche expertise and sharp pricing. This is a challenge that banks will have to respond to and, judging by some of the changes seen in the market in terms of certain banks retrenching and refocusing on key markets, this is a process that is very much underway.
“There is still a greater need going forward for really specialised banks that focus on fewer, specific services but do them exceptionally well,” says a senior advisor at a European trade-finance consultancy. “Regulation and compliance requirements are forcing them to reconsider their business strategies, alongside increasing competition from alternative-finance providers and payment facilitators.”
If regulation is a sign of why banks have to change, then it is also a sign of their enduring relevance and role. While trimmed down, their correspondent banking networks – for example – remain a key cog in the global trade-finance machine. Similarly, their expertise in managing risk and providing credit is more necessary than ever.
The challenge is the same for bank and non-bank participants: innovate and acclimatise to the new environment or drown in the wave of change currently sweeping through trade.