New SCF for the new normal in emerging markets
In a discussion supported by Finverity, TXF looks at new ways for companies to effectively use digitisation in emerging markets to propel access to financing for sustainable international trade through supply chain finance (SCF).
As the world emerges from the current crisis, it’s fair to say that global supply chains have been disoriented and globalisation retrenched. It’s never been more important for companies in emerging markets to get access to liquidity to keep supply chains moving efficiently. The $1.5 trillion trade finance gap has been widening, with some estimates more than doubling the amounts of funds lacking. In emerging markets, particularly for midmarket corporates with limited access to bank funds for trade, it is getting tougher. And with the disruptions hitting certain trade finance banks’ exposure at the same time as demand for liquidity is rising, pressures are rising to provide effective finance for trade.
Context: Unprecedented times
The context for where we are now in the Covid-19 era is unprecedented. How has the current challenged situation evolved and where do we actually stand? “The trade finance gap, as estimated by the ADB, has increased during Covid, although nobody yet has the data in the emerging markets to see by how much,” says Viacheslav (Slava) Oganezov, CEO of Finverity. “Over 74% of the gap was already estimated to be concentrated on SMEs and mid-market companies, and over 60% of the gap was estimated to fall in emerging markets.”
As 80% of global trade is dependent on some form of financing to keep the trade flowing, emerging markets need access to funds, and during Covid-19, demand for capital has been increasing in certain areas. “On the flip side, we are seeing the supply of funding drying further as many banks have already been withdrawing from financing trade since the increase of capital requirements through Basel regulation,” Oganezov adds. Not only that, the crisis has pushed out payment terms in many markets, which has impacted many further down supply chains.
“A lot of alternative financing providers are also coming into the space as trade finance is a safe, uncorrelated asset class which performs well in environments of uncertainty,” says Oganezov. “Finverity aims to bridge the gap and provide a platform that would firstly provide origination of good quality credit deals across the emerging markets and secondly match them with the relevant funding and provide an automation engine to take care of back-office tasks and operations to run these types of facilities at scale.”
Where does supply chain finance (SCF) stand as a proposition for financing working capital across borders, particularly in emerging markets? “The nature of the SCF product is such that it would be very beneficial for anyone who is in a lesser developed space who could benefit, say, from the creditworthiness of their off takers who are typically larger, especially in areas where a lot of SMEs are not necessarily bankable,” says Steven van der Hooft, CEO at Capital Chains. “The problem is what you need for SCF to work is some level of technology in order to scale it – to corporates, funders and suppliers. That’s the challenge we see in Africa. Those who bring the technology are going to capture a large market share as there is a lot of demand and a lot of opportunity.”
“Bank rationalisation in this space has sometimes harmed smaller players’ access to finance,” Amitji Odedra, Director at Qbera Capital, says. “From our perspective there’s always appetite, and we exist as we see trade finance as an investible asset class.“
Recovery: A paradigm shift
How can digitisation help all concerned? Alex Fenechiu Co-founder & COO at Finverity says, “We have found that one of the biggest hurdles to banks funding midmarket companies is that when you overlap banks’ capital costs with operational costs and sometimes outdated legacy systems, those costs make it uncompetitive to use without digitisation.” He adds that for alternative funds without those constraints, it paints a different picture. “We’re seeing a paradigm shift where banks and multinationals are going to form one side of the trade finance world and non-bank and alternative funders will form another with more midmarket companies.” Add back into that mix the layers of complexity for companies in emerging markets, of fraud and KYC, and digitisation becomes vital.
Readiness: Getting the proposition in place
One of the reasons for the wide trade finance gap is that deals aren’t easily bankable. How do players determine how prepared they are both in terms of physical ability and what they know to be able to use the available technologies to fund cross border trade and how can those hurdles be overcome? It’s certainly not an easy task. “There’s two sides of the readiness picture – one is readiness of funders, whether they understand the market, have the feet on the ground to support rolling out programmes, the access to currency and resources and whether they can bring the right technology, etc,” says van der Hooft. Many cannot. The second part is if the bank/funder has a programme in place with the right training and staff and funding, they need then to go and sell that to the corporate. “That’s where you see a whole different level of readiness. Do the corporates understand what they need to do, are they in synch with the benefits associated and the hurdles they may have to cross, even if they are small there are always hurdles for them. Have they looked at supply chain segmentation processes, at who should be in or out and why?”
In terms of payables finance, the most typical (and notionally easiest), proposition of SCF, is whether the corporates are able to get electronic invoices and upload them, and when in the payables/outstanding process will they be submitted and when do they need to be paid? All these questions and more need to be answered and assessed before embarking on programmes. “Using people who have done it before really accelerates that time to market,” van der Hooft adds.
Nonetheless, in terms of readiness, as Odedra points out, many companies in emerging markets are not embedded in legacy systems that are overwhelmed by paper and are able to jump onto technologies and leapfrog legacies.
Keeping a close eye on deals is key to risk management in supply chain finance in emerging markets (and elsewhere), rather than a check-box approach to using risk enhancement or recourse to credit insurance, particularly as getting cover for midmarket companies is expensive, not easy to secure, and should be unnecessary if deals are monitored correctly, participants said.
Tactics: Transparency is paramount
Getting high quality reporting via technology is part of Finverity’s proposition. It operates, in part, as a source of filtered origination (currently in MENA and Eastern Europe) of midsized unlisted local companies, funding them with trade finance funds/credit funds/family offices funding, etc. Filtered origination means the company uses its in-house credit team to help find and reliable self-liquidating flows for funds over the long term in a way that’s digitally accessible to investors. Finverity doesn’t make credit decisions, per se, but ranks the data for the investors to make informed decisions. The second part of the company’s proposition – particularly through Covid – is to white label SCF into banks, predominantly in African markets, from KYC through client onboarding, engaging the whole process. Building platforms with emerging markets in mind means automating processes which cuts down on operational work right through to reconciliations.
Transparency, more than insurance, is the key to unlock the whole of the trade finance process, as Fenechiu says, “Bad transparency has been underlying many of the high profile frauds in the recent past. If you can have a high level of transparency through the system and you can get data which is predictive, the risk equation changes dramatically.”
For sure, as Odedra underlines, there remains no substitute to going and proverbially ‘kicking the tyres’ on top of the technology to check the underlying proposition and distinguish the virtual from the not real. “Technology is good at automating things and increasing efficiency, but if you feed bad data into any system, the output is going to be bad. That’s why you have to do on the ground due diligence before you set up a facility,” adds Oganezov.
Digitisation plus quality information in a post-Covid world
Knowing what you are financing is vital. As van der Hooft points out one of the benefits of moving into SCF as opposed to the sorts of deals that provoked the GFC more than a decade ago, is that there remain tangible deals being financed. Going forward, proper engagement with the pre-shipment space for SCF will also be very important. Covid may have thrown a spanner in the works for those who use historical data as a predictor of the future, and it’s never been more important to do proper due diligence, but accessible technology, particularly for local players who have been ‘derisked’ by global banks should be a real enabler to help bridge the liquidity gap for mid-market while providing funders with a reliable, efficient and scalable way to participate in the asset class.