From the April/May 2012 issue of Treasury & Risk magazine

Next Generation Innovations in Trade Finance: North and Latin America

Recent trade finance developments, particularly in the wake of the global financial crisis,   benefit   corporates in developed markets and those based in burgeoning growth areas such as export-driven Latin America. Jon Richman, Deutsche Bank’s Head of Trade Finance and Financial Supply Chain, Americas and Burkhard Ziegenhorn, Latin America Regional Head of Global Transaction Banking, Deutsche Bank, discuss trends in both regions, and consider the future of global trade finance.

Global trade was once predominantly conducted on letter of credit (LC) terms. LCs, though expensive and comprising a largely inefficient, paper-based process, were favored because of the security and bank credit support they offer.

Times have changed. The march of globalization, the rise of the emerging markets and the pre-crisis free-flowing of liquidity led to a shift away from the LC towards open account (OA) trade. OA offers more efficiency through lower fees and paperwork, making it an attractive way for trusted counterparties to conduct business, provided they can get comfortable with the issues around higher counterparty risk and reduced access to finance.

While on a global level LCs have lost significant ground to OA trade, they have never lost relevance in the international trade arena. They remain the option of choice for riskier markets and certain sectors – such as commodities – in which sustained high transaction volumes continue to drive demand for risk-mitigating instruments. LCs also made something of a comeback in the wake of the global economic downturn. As trade entities found once open bank-supplied credit lines and capital markets to be restricted (or prohibitively expensive), and became increasingly conscious of counterparty risk, appreciation for the risk-mitigating properties of the LC returned. However, this was not the only trend that stemmed from the credit crisis.

As abundant liquidity was no longer available to keep supply chains flowing, companies had little choice but to focus on internal working capital management practices to ensure business continuity and underpin the strength and security of their supply chains. In response to this change in corporate focus banks, particularly the major international trade banks, developed financial supply chain products designed to combine the risk-mitigating features of the LC with improved access to liquidity and increased processing efficiency. Such Next Generation Treasury Solutions are increasingly being viewed by treasurers as an important source of capital.

Financial Supply Chain Solutions
Financial supply chain (FSC) solutions are – at least at a fundamental level – a fairly well-established trade finance tool, but sophistication levels are rising. This comes as a result of corporates, particularly larger US based trade entities that have tended to drive innovation in the trade arena, increasingly turning to FSC programs to meet their working capital needs.

A key way in which these companies are doing this is through extending the working capital cycle – by increasing days payable outstanding – and standardizing payment terms. This could mean that buyers have 60 days rather than 45, for example, in which to pay their suppliers, leading to notable improvements in working capital and cash flow management. Certainly, managing working capital in this way has become a key strategic activity for many large US companies.

Yet, this is not to suggest that FSC solutions work to the sole benefit of larger corporates in more advanced markets. In exchange for such extended and standardized payment terms, smaller suppliers can leverage the credit-worthiness of their larger trading partners (known as ‘anchor’ corporates) to obtain more favorable credit terms than they could in a bilateral situation. The benefits here are numerous. Not only can such financial arbitrage opportunities improve buyer-supplier relationships – vital in an age in which strong counterparty relationships are essential – but also increase the financial stability of individual trade entities and boost the overall strength and security of supply chains.

As a result, FSC solutions can work to the advantage of both large and small corporates and the needs of developed and emerging economies. Most importantly, they can complement the more traditional trade finance instruments, which tend to dominate trade finance in many developing economies.

Trade Finance Developments in Latin America
Latin America’s flourishing export markets are a key driver of trade finance in the region. Despite the opening up of key markets such as Brazil – the region’s largest economy – conventional tools remain the trade method of choice. This may be explained by the special regulations many Latin American countries have for trade finance instruments that sometimes grant them benefits under tax and insolvency laws. Certainly, the rapidly changing regional taxation and regulatory environment makes tax a chief consideration for domestic trade entities, which is reflected by the predominant use of tools covered by the regulations.

One such tool is the standby LC, which can effectively mitigate risk without being as labor-intensive as commercial LCs. The downside of this option, however, is that credit constraints have largely reduced the size of corporates’ revolving credit facilities, meaning that contingency funds reserved for standby LCs can be used up by daily cash management needs.

To overcome this, some banks like Deutsche Bank are extending bilateral facilities dedicated to corporates’ standby LCs. This can free-up working capital and allow companies to consolidate their total exposure with one bank – as well as providing a single point of entry for the submission of all standby LC business. As regional trade activity grows, markets that still have a strong appetite for traditional trade finance – such as Brazil, Argentina, Venezuela and Colombia – are expected to eventually adopt a similar dynamic to countries such as Mexico that are closely interlinked with the US market, and in which corporates are using more sophisticated FSC solutions. Evidence of this is found in Brazil which has a sophisticated trade finance market although still has huge potential for FSC solutions to evolve.

The Future of Trade Finance
While the LC was once the trade tool of choice for corporates worldwide, changes in the global economic and regulatory landscape have led companies to consider trade finance crucial to working capital and supply chain management. This in turn has sparked innovations, such as FSC solutions, that serve to enhance working capital management, risk mitigation and processing efficiency.

As cross-border trade has become an increasingly complex arena many local banks have been unable to keep pace, and now lack the expertise or capability to support trade finance on an international scale – and in line with the needs of different market users. This means that modern global trade solutions have largely become the domain of larger banks that have invested in the specialized platforms, products, services and staff required to maintain cross-border trade flows.

Deutsche Bank is one such provider. As a trusted and experienced partner to many corporates throughout North and Latin America and beyond, the Bank is able to provide a broad range of trade finance solutions and products designed to suit the varying needs and sophistication levels of different types of trading partners. Such Next Generation Treasury Solutions include FSC programs and bilateral standby LC facilities and are supported by an extensive network as well as harmonized and high quality service provision. Our commitment to providing market-leading solutions in both regions is frequently recognized in industry surveys and awards, such as the recent Euromoney Trade Finance Survey 2012 where clients selected Deutsche Bank as Best Domestic Trade Finance Provider in the USA and Brazil, demonstrating the strength of our client relationships. We recognize that trade is a relationship-dependent and solution-driven business and we will continue to invest in innovation to ensure our clients can benefit from future trade finance developments.

 

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