Trade finance remains an essential tool for cross-border B2B trade, and with an estimated US$1.5tn gap in available trade finance, non-bank players have flooded the market to address the demand and introduce efficiencies to an area of finance that has historically been bogged down by paper, manual processes and burdensome compliance requirements.
However, the trade finance arena is not without its controversies and concerns.
With so many trade finance solutions available, from supply chain financing to factoring, it can be difficult and confusing for businesses — namely, small businesses — to understand which is appropriate for their needs. Furthermore, with analysts and regulators around the world placing greater scrutiny on certain trade finance solutions, B2B traders can face even greater uncertainty over how to finance transactions (responsibly).
Yet, as Dr. Kerstin Braun, president of trade finance solutions provider Stenn said, the global trade finance gap is only expected to grow in the coming years, meaning businesses conducting trade across borders will continue to demand ways to finance operations with tools they may not entirely understand.
In the last decade, tightening regulations have lowered banks’ appetite for risk, and forced many to slash their exposures, with trade finance operations often among the first to go. Thanks to the high cost and procedural burden of paper documents, on top of pricey due diligence requirements, trade finance is simply not profitable enough for many of the largest global banks to facilitate, Braun said.
Looking ahead, she pointed to one particular trend likely to further widen the trade finance gap.
“We’re talking about US$1.5tn, and we believe this gap will stay at that level — it might even increase, slightly, because of the trend of trading on open accounts,” she said, explaining that this practice means goods and services are delivered often months before a payment is ever made.
She pointed to 2019 research from the Boston Consulting Group, which predicted that global trading on open accounts will make up as much as 60% of trade finance revenues — up from the current 45% — by 2027. With regulatory constraints also expected to continue growing, Braun noted that this shift means more non-bank trade finance providers will step in to help fill the rising demand for trade finance.
Amid this trade finance growth, however, there is concern over how corporations are using certain products. Supply chain finance, for example, has faced particular scrutiny as of late, with analysts at Moody’s and Fitch highlighting the risk of supply chain finance potentially limiting the ability for investors and auditors to obtain a clear view of company financials.
Indeed, the heavy reliance on supply chain finance — in which a buyer turns to a third-party financier to fund an unpaid invoice at a discount — by UK construction conglomerate Carillion came under fire following the company’s collapse and subsequent criticism for its practice of paying suppliers late, or forcing its vendors to accept discounts. Braun explained that this is a buyer-led strategy to trade finance and should be approached with caution.
Supplier-led trade finance initiatives are typically less concerning, Braun noted, though she advised that any trade finance tool should be used only when appropriate.
“Factoring should never replace a bank. That’s last-resort lending,” she said.
Instead, a supplier-led solution like factoring — also known as receivables financing, in which a supplier initiates the introduction of a third-party financier to finance outstanding invoices — should be used in conjunction with an existing bank loan strategy.
Finding the right scenario
There are three particular instances in which factoring is most appropriate, said Braun.
One is when a company’s bank will not increase a line of credit or expand an existing bank loan, but its growth rate is so large that it needs supplemental financing to accept and fulfil more orders.
Another is what she described as a ‘turnaround situation’, when a company is in a growth period after a time of struggling through a recession or other financial hardship. In this case, a business’ financials do not yet meet banks’ risk portfolio requirements, but projections and opportunities are on the rise — and financing is needed to achieve them.
Finally, she pointed to a case that has become increasingly common in Europe, particularly as banks’ risk appetites continue to fluctuate. Factoring can enable a business to obtain financing quickly when its financial institution has adjusted its lending strategy, and that business no longer fits into what that lender needs in its portfolio.
It’s in this current banking climate of stringent regulations, and a bank pullback from trade finance, that non-bank players like Stenn have found a major opportunity. The emergence of RegTech and technologies like blockchain has also introduced elevated functionality around compliance, speed and security for these tech-focused players, said Braun (though, she noted, blockchain has yet to offer a fully integrated ecosystem of global trade financing), while banks are finding their own opportunity in facilitating trade finance indirectly through these players.
It’s a complicated industry facing increasing scrutiny that can quickly hamper clarity for small B2B suppliers looking to responsibly finance their operations. Yet, Braun said, these companies do not necessarily need to know all the technical terms that financing players use — they simply need a financing solution that appropriately and affordably meets their needs.
“What does the client need?” she said. “They just need to finance a transaction.”
To find out more about supply chain finance, please join us in Amsterdam on 30-31 of January, 2020 at BCR's Supply Chain Finance Summit.