Corporates exporting into growth markets are looking for ways to support local distributors with access to affordable finance. Will distributor finance emerge as a popular tool in international supply chain finance? Liz Salecka reports.
Large corporate exporters seeking to expand sales in growth markets are increasingly recognising the need to alleviate the cashflow issues faced by local market distributors, many of which are impeded by lengthy domestic payment terms and limited access to affordable funding.
In order to achieve this, these major exporters are looking to their own global bank services providers for financing solutions that can enhance the working capital resources of their distributors, thereby enabling them to take on more goods and drive forward sales.
“A lot of exporters do go down the franchising route, and franchisees are recognised as having high creditworthiness and hence have access to low-cost credit. However, a lot of distributors fall into the mid-market segment and for them the average cost of credit is high, and they may even find it difficult to arrange credit lines,” explains Vinod Madhavan, global head of letter of credit products and receivables, supply chain financing at Standard Chartered.
He adds that disparities between the payment terms typically applied by large western exporters and the payment terms distributors work to with their own customers have heightened the cashflow issues local distributors face.
“In such commercial transactions, there is typically a large corporate exporter or supplier in the fast-moving consumer goods (FMCG) or retail sector selling to distributors who then sell the goods on to end consumers. The supplier sells its goods on 30-day credit terms, for example, while the distributor is more likely to sell them to the end customer on longer terms: say 50-days,” he says.
As such, at the end of the 30-day credit period allowed by the supplier, the distributor needs to pay the supplier – but may not yet have received money from the end customer.
An emerging market issue
At present, the greatest demand for distributor finance is coming from large corporate exporters that are distributing goods in developing markets across the globe.
“We are seeing growth in distributor finance across all these trade flows, and in a multitude of currencies,” says Paul Johnson, director, senior product manager, global trade and supply chain products at Bank of America Merrill Lynch (BofAML), noting that demand most typically comes from large equipment manufacturers in industries such as computing and telecommunications. “Demand for distributor finance is growing in line with the growth experienced in trade flows between these [developing market] regions.”
Standard Chartered’s Madhavan adds: “Over the last 12 to 18 months, there has been increased interest in this type of financing, and this is probably a reflection of the world economy getting back on track and an increase in trade – especially with emerging markets. This type of financing is particularly pertinent in trade flows between Asia, the Middle East and Africa.”
The need for distributor finance is particularly evident in the Middle East, which is a major importer of goods, about 60% of which emanate from Asia. Multinational corporations (MNCs) exporting into the Middle East typically have either a presence in the region or use the distributor model.
“In this region, distributors are generally small, and can sometimes find it difficult to meet the aggressive terms of overseas suppliers. As a result they face cashflow and working capital constraints, meaning there is pressure on them to raise finance. However, most local distributors, being small in size, do not normally fall inside the target market of the global banks,” explains Faraz Haider, trade head for Middle East and Pakistan, treasury and trade solutions at Citi.
“If distributors are financially healthy, they can help a supplier achieve growth in key markets. Saudi Arabia, for example, is a big market that offers opportunities, but it is also a difficult market to set up a business in. By using distributors and arranging domestic distributor finance programmes, suppliers can push this market as far as possible and increase their sales.”
According to Demica, there are now three main types of distributor financing solutions that can address the working capital issues faced by emerging market distributors:
Receivables-based financing programmes, where the corporate exporter receives early payment via the purchase or discounting of distributor receivables, and can then offer extended payment terms to its distributors.
The provision of direct loans and credit facilities to distributors, backed by varying levels of support and involvement by the corporate exporter.
Other types of asset-backed financing, backed by support from the corporate exporter.
At BofAML, Johnson points out that the provision of receivables-based financing programmes, which enable corporate exporters to extend payment terms with their distributors, is core to his bank’s channel finance proposition.
“As distributors in emerging markets have limited access to local finance, it is critical for the anchor seller in the chain to offer extended payment terms. If a distributor, which can sell inventory within 90 days, can arrange 90-day payment terms with the exporter, this eliminates the need for local finance,” he says, noting that although an exporter may want to extend payment terms to provide financing to the distributor, it will still want to monetise those receivables earlier.
“The provision of distributor finance is all about helping the exporter to sell more products, and there is growing recognition that distributors in emerging markets are more constrained when it comes to accessing capital. This type of distributor finance has a strategic role to play in ensuring that sales grow in emerging markets, with banks providing the liquidity needed to enable exporters to offer extended payment terms.”
He adds that receivables finance, of which distributor finance is one flavour, is becoming very popular in a cross-border context. “It is growing faster than more traditional types of buyer-centric programmes in the payables space,” he says, pointing out that, from a small base, his bank has seen cross-border receivables finance, including distributor finance, double over the last two years.
Similarly, at Standard Chartered, Madhaven points out that his bank offers supplier receivables financing to corporate exporters in the form of invoice discounting or asset-backed finance, to enable the corporate exporter to monetise distributor receivables within the typical 30-day term period. As the exporter is paid early, it can do more business with the same distributor and grow its business in the market concerned.
“Most suppliers approach us directly for this type of financing because they want solutions that will help them grow their business in emerging markets,” says Madhavan, pointing out that many corporate exporters are looking for a mechanism by which they can free-up their own balance sheet capacity. “In the case of supplier receivables financing, there is also the option for the supplier to extend payment terms with the distributor.”
But he notes: “In many companies there are policies which dictate the credit terms that should be allowed when dealing with a particular market.”
However, there are also opportunities for distributors themselves to access attractive financing directly from the global banks, which their corporate suppliers work with.
Standard Chartered, for example, offers a distributor finance product which involves the provision of flexible loans directly to distributors based on a credit view of the corporate exporter for the 20-day period in which they may be waiting for payment from their own end customers.
In such lending activities, the bank looks at the relationship between the supplier and distributor and the level of distributor dependency. If it is less than a pre-determined percentage, which varies from market to market and industry to industry, the distributor may not qualify for the loan.
For banks that are involved in the provision of distributor finance – either directly or in the form of receivables financing, risk mitigation continues to present one of the biggest challenges.
According to Demica, as distributors’ balance sheets often imply “high credit risk” and require ongoing monitoring and analysis, support from a corporate exporter in such financings, as well as an efficient, technical bank platform, are “indispensable”.
This is confirmed by Johnson at BofAML who points out that – for credit risk and technology reasons – distributor finance falls within the domain of the top-tier global banks.
“Distributor finance does tend to be the preserve of larger banks because it is one of the most complex types of financing. When a bank is underwriting the risk presented by 100 to 200 different distributors, this cannot be done on an individual basis. Rather, the bank needs to underwrite the entire pool and apply a blended credit rating. This requires the sophisticated underwriting competency typical of larger banks,” he says.
He adds that the provision of distributor finance also requires significant technological investment. “When a bank is discounting the invoices of 100 distributors or more in different countries, it needs a platform that all of them can use to enroll and sign agreements with the bank. The bank also needs sophisticated systems to track distributor activity and the payments they make.”
He explains that one of the biggest risks banks face when dealing with small distributors is that they may not honour their commitments to the corporate exporter. “When you are dealing with small distributors, the products they are distributing can be easily diverted – and a bank cannot take possession of those products. This is more typically the case when you are dealing with smaller distributors or buyers in emerging markets,” he says.
To try and mitigate this risk, BofAML often requires the corporate exporter to agree to a first loss provision, under which losses up to an agreed threshold are ‘put back’ to the exporter.
“In this way, we can avoid a scenario in which an exporter keeps shipping products to a distributor that is experiencing difficulties in making payments,” says Johnson, adding that BofAML also takes out credit insurance in certain instances to protect itself against losses – particularly in high-risk countries.
“If an exporter is using distributors in Western Europe and there is a good trading history spanning many years, it may not be competitively viable for a bank to take a first loss position. However, in emerging markets, a bank would be unlikely to take on 100% of the risk.”
But arranging first loss agreements with large corporate exporters is not always straightforward in certain regions, and this can be a drawback to the provision of pure distributor finance programmes.
“Distributor finance should really be offered on a first loss basis, whereby the first 15 to 20% of any losses are typically picked up by the supplier,” says Citi’s Haider. “Certain ‘stop supply’ agreements should also be put in place to ensure that if the distributor defaults, then it does not receive further supplies from the supplier.”
“In the past, suppliers to the Middle East have proved reluctant to agree to a first loss for balance sheet reasons, and prefer to work on a non-recourse basis,” he adds, though notes that in recent times there has been greater discussion with suppliers about arranging distributor finance on a first loss basis.
Aside from having first loss agreements in place, banks can also do much to counter the risks involved in distributor finance by drawing on the expertise and knowledge of the corporate exporters they work with.
Haider points out that corporate suppliers can play a key role in supporting distributor finance programmes by providing information on the history of their relationships with distributors, such as the length of the relationship and the scale of business flows.
Similarly Madhavan explains that with distributor finance Standard Chartered also typically seeks a ‘comfort letter’ from the supplier which acknowledges that it will stand behind the bank should the distributor fail to pay. The distributor’s financials are also examined, and all this information is then fed into a scorecard on which the loan is assessed.