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The year 2011 opened with positive growth prospects for global exports and imports, with both were projected to recover their pre-crisis volume level. However the year 2011 saw a series of global shocks such as the earthquake in Japan, Arab Spring disruptions and the debt crises in the eurozone and the US. These global shocks dampened the global trade performance in 2011 with annual trade volume growth closed at 6.6 percent.

According to the recently published “ICC Global Survey on Trade Finance for 2012”, the outlook for annual trade volume for 2012 is expected to have a negative carry-over, with annual growth forecast at 5.2 percent for 2012 and 7.2 percent in 2013.
Some of the key findings of the ICC Global Survey are:

  • Letter of Credit remained the predominant settlement product. LC is seen today as the classic form international export payment, especially in trade between distant partners
  • 51 percent of respondents reported an increase in export LC volume and 56 percent an increase in import LC volume
  • However, historically open account trade has represented around 80 to 85 percent of world trade, although it is widely expected that this figure fell between 2007 and 2011 as exporters sought a more secure method of settlement.

Further the recent “Financial Supply Chain Survey 2011” conducted by gtnews, an Association for Financial Professional Company and the leading bank SEB revealed that supply chain finance techniques are becoming prevalent among survey respondents with over 43 percent of buyers and 34 percent of sellers using this method to manage open account risks.

Alluding to the above trend, major global banks have been taking steps to improve their capabilities in trade finance products and for open-account based trade such as supplier finance.

This article highlights how supply chain finance fits with more conventional trade finance and shows how these two disciplines complement and interlink each other.

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Advantage of Trade Finance

Trade finance can be defined as the provision of bank credit facilities and services to meet a corporate’s needs in relation to their export and import activities. Transactional control is one of the principal advantages of trade finance instruments. For instance, by requiring a full set of bills of lading in a letter of credit, the importer will not be able to take possession of goods until he accepts or pays a bill of exchange, thereby giving the exporter a high level of confidence that his trade debt will be settled. Transactional control also helps an importer to delay paying until he knows he has received the goods he has ordered say under import LC.
One of the sharp trade trends identified in recent years is that there is a movement towards open account and away from usage of LC and documentary collections. Unlike trade finance, which generally relates to cross-border commerce, supply chain finance has an extremely important domestic dimension. For instance the buyer-backed reverse factoring can benefit both domestic and international supply chains.

Before we take a deep dive into various aspects of supply chain finance, let us now briefly look at two popular financing solutions viz.: factoring and purchase order financing. These solutions have been metamorphosed to meet the changing supply chain finance world as well.

Factoring solution

Factoring is a structured working capital finance solution that includes finance against supplier’s domestic or export receivables, collection of receivables on due date. Thus factoring or accounts receivables financing helps suppliers to convert their invoices or account receivables into cash thereby releasing the cash generation potential of their business.

Purchase Order financing solution

Purchase order financing provides companies with a short-term solution for funding inventory required to complete sales transactions. This form of finance is provided to meet sudden and large sales opportunity. The finance can be availed to fund the cost of manufacturing inventory and the related logistics costs.

Supply Chain Finance’s fit with Trade Finance

Over the past few years, there has been increased focus to develop an open account financing techniques to make supply chain more competitive.

Importers seek a move towards open account to cut costs, reduce the need for bank credit lines and improve efficiency. On the other hand, open account terms of trade can be bad news for suppliers. They take on increasing risk and lose access to local finance backed by LC’s, resulting in a reduction in valuable funding. Often a supplier’s size and geographical location, such as emerging market, mean that local financing is very expensive in terms of underlying interest rates, margins and fees.

Hence capital constrained small and medium enterprises find themselves obliged to raise finance through traditional accounts receivable factoring. With globalization of trade, a growing percentage of receivables are now based on exports to remote markets. These invoices carry longer payment terms than domestic receivables. Buyers wish to extend payment terms for as long as possible in order to improve their Days Payable Outstanding (DPO). These factors can have a negative impact on an exporter’s Days Sales Outstanding (DSO) and working capital.

Innovative Financing Solutions

The above open account business has, thus, driven demand for new financing solutions, both at pre-shipment and post-shipment stages. This has led to the emergence of web-based solutions that create a win-win for the buyer and supplier.

Buyer-backed reverse factoring

The first solution conceived is “buyer-backed reverse factoring”. This would involve a strong buyer and many smaller suppliers in need of a financing platform that would match the liquidity gap. The traditional factoring uses an invoice as the underlying asset for financing, while the reverse factoring brings the qualified invoices, which are approved by buyers, into play. Thus traditional factoring deals with the supplier’s receivables from many unknown buyers, whereas reverse factoring deals with the payables of one well-known buyer.

To cite an example, a large Multinational Corporation buyer procuring goods from several smaller suppliers can have buyer-backed reverse factoring arrangement with his banker. This arrangement would help financing bank to provide finance to the smaller buyers based on invoices approved by the buyer. Ideally this arrangement would involve smaller buyers riding on the balance sheet strength of the large buyer. In this scenario, the smaller buyers would upload the invoices in the web-based application which would then be approved by the buyer. Armed with buyer’s approval, bank would have more confidence to provide finance to the smaller suppliers.

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The smaller suppliers due to their small size may not be able to secure credit facility on their own. Hence the buyer-backed reverse factoring would facilitate the buyer to lend his strong credit rating that would benefit smaller buyers. Since this arrangement would involve relying on the strength of the large buyer, banks would provide more favourable credit terms to buyer.Thus this supply chain optimization technique provides the buyer with longer payment terms or lower cost of goods, whereas the supplier gets lower cost and reliable finance.

Spanish banks have pioneered this reverse factoring technique, initially in their domestic Iberian markets and later in Latin America. This reverse factoring structure strengthens buyer’s core supplier relationship. Currently the market focus is around post-shipment finance, when goods have been shipped and invoices have been presented and approved by the buyer using the web-based solution. This payer centric reverse factoring solutions rely heavily on the large buyer using his strong credit rating to support his supply chain.

Invoice discounting services

The above buyer-backed reverse factoring solution helps buyers to extend DPO and retain cash flow as long as possible. On the contrary, large exporters want to accelerate the conversion of international receivables into cash and hence improving their own DSO. To address these requirements, banks are providing a growing range of web-based “invoice discounting services” or export factoring, with or without recourse to the supplier.

One major difference between supplier-backed receivables financing (invoice discounting services) and buyer-backed reverse factoring is that while the latter benefits from buyer data (viz.: knowledge that invoices to be financed have been approved), factors and invoice discounters are generally reliant on information solely from the supplier at the point when funds are advanced.

Other innovations in the industry

eInvoicing

A number of innovative banks are beginning to partner with e-invoicing solution providers (or launch their own proprietary solutions) in order to streamline electronic purchase order (PO) distribution, invoice receipt and matching of these documents for buyers and suppliers. This matching is sometimes achieved through a device known as PO flip, whereby the original PO is used as the basis to create a new invoice. The more sophisticated solutions produce and exchange invoices that are fully compliant with VAT requirements in wide range of countries such as UK, Europe

Event triggered finance

With improved visibility in the supply chain, banks are exploring using key milestones in the trade cycle as triggers for the release of finance. For instance, credit can be made available at a decreasing cost of finance as successive transport data is provided showing that the goods are progressing satisfactorily towards their destination and that the contract is more likely to be fulfilled. From a banker’s perspective, this information demonstrates that the risk of default on the transaction is steadily reducing.
One classic case of event driven finance is in-transit finance. A logistics company has control over goods and can track where the goods are located, for instance in a distribution center or in transit using the logistics company’s transportation capabilities. In these circumstances, a financing partner can mitigate risk in making available finance for these goods. This transactional control can be used to provide competitive financing.

SWIFT’s new initiatives

SWIFT has taken new initiatives to supplement industry’s effort towards open account transactions. For instance, its Trade Services Utility (TSU) and Bank Payment Obligation (BPO) facilitate banks and financing agencies to exchange and process trade data quickly.
Conclusion

Supply chain finance can’t take over from trade finance, but actually complements traditional trade finance instruments that will continue to have an important role for years to come. The trade finance instruments meet the needs of specific markets and specific phases in a business relationship. At the same time, considering vast potential in the supply chain finance, the trade banks and financing agencies can ride this opportunity wave by offering a full range of pre-shipment, in-transit and post-shipment finance solutions.

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  • No monthly requirements.
  • No financials needed.
  • No setup fees