The Big Unknown

Increasingly banks and corporates involved in international trade need to consider what potential pitfalls lurk around the next corner. More than ever, they need to work out how best to manage their supply chain as well as their counterparty and political risks. Rebecca Spong reports


Supply chain risks are moving up the agenda of many corporates as concerns about potential geopolitical problems and counterparty risks grow. With no one truly knowing what the next problem will be, corporates want to be well-prepared for the unexpected.

The business risk consultancy, Control Risks, even warned in a report released at the end of last year that international business will face “intensifying volatility” in 2012, driven by political instability and economic uncertainty.

Against such a backdrop, managing both the physical and financial supply chains has been a key talking point among corporates, governments and banks alike.

Supply chain risks came under close scrutiny at the annual World Economic Forum (WEF) meeting in Davos, Switzerland in January, as delegates debated how companies can better cope with the unexpected, citing examples such as last year’s Japan nuclear crisis and the increasing level of piracy seen off the coast of Africa.

A new WEF study entitled “new models for addressing supply chain and transport risk” launched at Davos, found that supply chain and transport disruptions were no longer just a concern for operational risk managers, but an issue that even company boards need to address.

The study revealed that more than 90% of those surveyed by WEF indicated that supply chain and transport risk management had become a greater priority in their organisation over the last five years.

A further WEF supply chain and transport risk survey 2011 (see fig.1) found that 46% of respondents cited conflict and political risk as a key concern.

For example, military conflict caused disruption to major transport routes and production hubs in 2011, with the violence in Libya preventing much of the country’s oil production from getting to market.

“Boards at the top are saying we need to have a more structured approach to looking at risks and opportunities around the world,” remarks DJ Peterson, director of corporate advisory services at the political risk research and consulting firm Eurasia Group.

Peterson observes that the awareness of political risk has widened across a variety of industries. Historically only mining and oil companies would typically pay close attention to political risk, now retail and consumer firms are taking it into consideration, particularly when it comes to brand or reputational risk.

The heightened awareness of political and supply chain risks is further fuelled by the fact that so many more companies are looking to operate in the emerging markets, given the dearth of demand in the Western economies.

The emerging markets are the growth markets, but they are also subject to potentially high levels of volatility, be it environmental disasters such as flooding or labour disputes and riots.

Question marks remain over where the next banking problem will rear its head, whether there will be another contraction in credit or where the next riot will happen.

The financial markets continue to grapple with where oil prices are going to move to. The escalating tension with Iran threatens to push up international oil prices.

At the International Petroleum week held in London in February, it is reported that Ian Taylor, chief executive of Vitol, said that oil prices could jump to US$150 a barrel due to the Iran issue.

Sam Sehgal, trade head for the Emea region at Citi, reflects on all the varying factors affecting oil prices, remarking: “So many events at the moment could swing the pendulum any way.”

Financial supply chains

Given the heightened economic uncertainty, interest from corporates in supply chain finance (SCF) is growing and translating into increased business volumes for some banks.

Companies nervous about the ability of their suppliers to fulfil orders due to a lack of credit availability are turning to SCF as a means of enabling their suppliers to access financing.

“There is heightened awareness of the power of supply chain financing as a tool to counter economic and financial uncertainty,” observes Sehgal at Citi.

“On the sales side counterparty or buyer risk has come to the fore,” adds Mark Emmerson, regional head of trade and supply chain, Europe, at HSBC.

He explains that there is a whole mixture of reasons why buyers are looking to establish or extend schemes, such as improving their working capital position and giving suppliers an additional banking line.

Tan Kah Chye, global head of trade finance at Barclays agrees: “What we are seeing is that corporates today are a lot more aware of the need to maintain sufficient liquidity and it is more important than ever that our corporates get their physical and financial supply chain right.” JP Morgan is one bank benefiting from the increased interest in supply chain finance.

Jeremy Shaw, head of trade finance for Emea at JP Morgan reports that trade loans at the bank were up 73% to US$36.7bn in the last quarter of 2011, compared to the same quarter the year before.  “Before the financial crisis, we were receiving one or two supply chain finance requests for proposals a month but that has now risen to one or two a week,” he adds.

Counterparty risks

Corporates are not only worried about their corporate counterparties, they are also anxious about their bank counterparties, given the downgrades of global banks last year and the huge deleveraging seen across the European banking sector. “Banks need to rebuild trust post the deleveraging process,” comments Tan at Barclays.

But until that trust has been rebuilt, corporates will remain cautious and will look to widen their portfolio of banks that provide them with cash management and trade finance services to minimise concentration risk in their banking relationships.

This trend has played into the hands of  American and some Asian banks. The US and Japanese banks, generally richer in US dollars compared to their European counterparties, are seeing greater client interest in not only their supply chain finance services but also their commodity financing products.

JP Morgan is lapping up this extra business.  Its Q4 results revealed that its treasury and securities services saw its liability balances up 42% year-on-year and its revenue up 6% year-on-year.

Furthermore, an increased number of commodity deals, traditionally headed up by European banks are now seeing greater involvement by the Americans and Japanese.

Supplier finance programmes

The heightened relevance of supply chain finance across the trade finance industry is highlighted by the ICC Banking Commission’s decision to create a new role dedicated to supply chain finance in early 2012.

In February Daniel Schmand, head of trade finance and cash management, corporates,  Emea at Deutsche Bank was appointed as vice-chair of the ICC Banking Commission, mandated to look after the commission’s supply chain  finance projects.

The ICC is heavily involved with Swift’s bank payment obligation (BPO), working to create a set of rules to govern the creation of a new means of electronically matching trade finance data. Upon his appointment, Schmand referred to supply chain finance as “the most important and fastest growing areas in the trade finance space”.

Supply chain finance schemes have also been picked up by export credit agencies as an effective means of providing certainty for corporates in an economic and political environment full of unknowns.

The Export-Import Bank of the US (US Exim) runs a supply chain finance programme and announced in February that Boeing would be the latest company to join the scheme. The programme has an initial capacity of US$740mn. Citi will serve as the lender on the programme, US Exim will cover 90% of the risks and Citi will take 10% of the risk.

Boeing’s US-based suppliers will be able to access working capital financing at competitive prices by receiving early payment of their accounts receivable in exchange for a small discount fee paid to Citi for those receivables accepted on to the programme.

Political risks

As multinational corporates delve deeper into the emerging markets, they will look to not only secure a stable financial supply chain, but will also want to pre-empt any political problems that would damage their physical supply chain.

Political events in 2011 such as the Arab spring and the conflict in Côte d’Ivoire, which temporarily prevented the export of cocoa beans, have highlighted the need for corporates to be ever-vigilant. It recognised more than ever how politics will continue to play a significant role in business and finance.

“I think there is awareness in the marketplace that you can’t escape politics. Politics impacts your business, wherever you are,” remarks Eurasia’s Peterson. With that in mind, corporates are looking to intelligence consultancies and risk analysts for advice.

Dermot Corrigan, managing director at Exclusive Analysis, a specialist intelligence company, remarks to GTR that the company’s retained customer base has doubled in 18 months.

“The company was growing pretty rapidly before the Arab spring as corporates saw the value in intelligence-led forecasting as opposed to just analysis and commentary.

“But we have seen an acceleration since the events in Tunisia. We have seen an unprecedented demand for our tailored work and we are now serving customers domiciled in international markets such as Brazil and China.”

Corrigan has seen an increased awareness among corporates to consider political risk factors in strategic planning as well as a need for more thorough counter-party assessment.

“We’re also finding ourselves called in to help teams beyond business development, strategy and risk management. For example, stakeholder sentiment is never far from the board’s mind now so we are often retained by corporate and social responsibility and investor relations teams to help them better understand and navigate their operational and reputational risk exposures in these less understood markets,” he adds.

Political risk insurance is also becoming an attractive option for banks and corporates to use to mitigate growing risks. The annual report from the World Bank’s insurance arm, Miga, published in 2011 but reviewing 2010 data, notes that the rate of growth in PRI has exceeded that of foreign direct investment, meaning that a higher proportion of FDI is now insured for political risk.

In 2010, 14% of all FDI flows were covered by political risk insurance, the highest level seen since the early 1990s.

Corporates are also looking for different and more specialised types of insurance products to tackle political risks seen in 2011.

At Miga’s annual conference in December last year, Mark Gubbins, executive director, political, project and credit risks at Arthur J Gallagher spoke of the need to create new insurance products that deal with “business disruption” caused by political events.

“We are seeing an increased trend by companies to seek to insure against the disruption of their businesses by political events as much, if not more, than the loss of assets,” Gubbins told GTR after the conference.

He refers to the political violence seen in Côte d’Ivoire in early 2011. The post-election conflict did not cause any permanent loss of assets but did lead to costly disruption to normal business activity.

The development of new products suggests that the banking and insurance world is evolving to provide corporates with new tools that can assist them with managing the continued economic, social and political volatility. But in turn, corporates themselves must also examine how they manage their risks.

As Richard Fenning, CEO of Control Risks, remarked in his company’s annual Risk Map report: “Organisations must develop ever more robust strategies to assess and mitigate exposure to changing security, political, social, operational
and reputational risks.” GTR