The Middle East’s growth as a trading hub has accelerated both the provision and use of structured financing solutions. Although letters of credit are often still used to back trade flows, open account trade and modern-day instruments – such as the BPO – are also finding favour. Liz Salecka reports.
As the spotlight falls on Dubai for this year’s Sibos convention, delegates can expect to gain a deeper insight into the emirate’s development as a world-leading trading hub, which is managing rising volumes of imports and exports.
In recent years, Dubai’s favourable tax regime and strengths as a financial centre have attracted international trading companies, which are also seeking to capitalise on its strategic geographic trading location and huge investment in local infrastructure.
“There has been a big push by the Dubai government to make it an attractive trading centre, and the freezone has also made a big difference,” says Farooq Siddiqi, managing director and regional head of transaction banking, Mena at Standard Chartered, noting that Dubai is now the third major trading hub in the world after Hong Kong and Singapore. “Many businesses now look at Dubai as a geographic location well-suited for their distribution, procurement and invoicing across the Mena region.”
“The UAE has become a key trading hub, facilitating global trade. More and more companies are establishing themselves here and much of this comes down to location and infrastructure,” adds Asif Raza, managing director, head of treasury services, Mena at JP Morgan.
Connectivity with Asia, Africa and Europe is facilitated by the port of Dubai and growth in the region’s airline industries. But the region’s success is not confined to Dubai alone. The Middle East as a whole is developing into a strategic location for large companies doing business across Asia, Africa and Europe.
“Dubai is spearheading developments here, but Abu Dhabi, Saudi and Qatar are also building up trading hub-styled facilities, and are expanding quickly,” says Faraz Haider, trade head for Middle East at Pakistan, treasury and trade solutions at Citi.
Harold Leenen, regional head of global transaction banking for the Middle East and Africa at Deutsche Bank also notes that other countries, such as Saudi Arabia, are following the lead set by Dubai in terms of investment in seaports and airports. “The infrastructure being developed today aims to cater not just for the needs of today, but also the years to come.”
In line with the Middle East’s development into a world-leading trading hub, it is also witnessing growth in both the availability, and take-up, of structured financing solutions.
“With more and more players trying to both locate and expand their regional offices in the Middle East, the demand for bespoke trade finance solutions is on the rise,” says Haider, pointing out that multinational corporations (MNCs) are looking for sophisticated trade and supply chain finance solutions, which they have had experience with in more developed markets.
He adds that the historical approach by banks of “one size fits all” solutions is no longer the norm – and they now have to tailor solutions to meet the needs of large, diversified organisations.
To date, leading international banks present in the region have spearheaded much of the movement towards structured financing solutions, catering for the needs of MNCs, but the example they have set is now being pursued by both regional and local banks.
“Many local banks are now following in the footsteps of global banks by bringing in innovative solutions and new technologies and, as long as liquidity is not an issue, they could become a bigger competitive force to international banks operating in this region,” confirms Raza.
Meanwhile, Leenen notes that local banks are also gaining ground in the deployment of automated services. “International banks have played a big role in the provision of transaction banking services, but local banks are also developing such capabilities, and are catching up – meaning the level of sophistication is rising quite quickly across the region,” he says, pointing out that a number of bankers with international experience have moved from global to local banks and are driving this trend.
It is the provision of trade finance solutions in particular that has been embraced by local Middle Eastern banks, which now recognise its merits as a short-term, lower-risk alternative to direct lending. Above all, they are capitalising on receivables financing when it comes to satisfying the needs of home-grown large and mid-market enterprises as well as SMEs looking for working capital finance.
“Before the financial crisis, there was a huge amount of lending, but the way in which companies borrow has changed since then,” explains Siddiqi. “Banks have become savvier – and are looking to do more structured lending to corporate clients, which is both safer and easier for them to track and monitor.”
He explains that there has been a move to more balance sheet-linked financing, which involves the monetising of balance sheet assets to raise working capital finance. “This has given rise to huge growth in receivables financing,” he says.
But the drive towards trade finance is not coming from banks alone. Many home-grown Middle Eastern corporates are now more sophisticated and cost-conscious in their use of financing solutions.
“They are looking to their banks for trade finance solutions and structures, which will enable them to maximise profits and increase efficiency,” says Raza. He adds that this applies mainly to top-end and mid-market companies, many of which now trade with sophisticated entities in other parts of the world. “They are also looking for more customised solutions as opposed to product sets, and this provides an opportunity for banks to work together with their corporate clients on new solutions.”
Supplier and distributor financing
The use of structured supply chain financing solutions is also gaining momentum across the Middle East.
Although supply chain finance programmes, geared at supporting smaller suppliers, have not been readily exploited by Middle Eastern corporates, this is more a reflection of the fact that the region’s traditional oil and gas industries are not so dependent on inputs from SME suppliers. Distributor finance, by direct contrast, has emerged as a much sought-after form of supply chain finance due to the predominance of distributor networks.
Several distribution models are used across the region, including:
- Principal distributors: these distributors take total responsibility for redistributing goods into other regional markets;
- Single geography distributors: large exporters appoint distributors in individual geographic markets to distribute their goods;
- Franchises: set up by companies from within the region operating in sectors such as food and clothing, which are expanding into other local markets;
- Specific location distribution model: MNCs, such as IT companies, which have a local presence, appoint specific distributors in specific locations.
“Distribution companies across the region are playing the biggest role in supporting trade activities across the region,” confirms JP Morgan’s Raza.
Siddiqi at Standard Chartered adds: “Distribution networks are the biggest part of supply chains in this region. The market for supply chain finance, for suppliers, is still in its infancy when compared to the way in which many large western corporates are supporting smaller suppliers in Asia.”
However, he also notes that there are some large manufacturers in the region that do rely on suppliers in other markets – and there has been growing interest in supply chain finance from them.
Reliance on traditional instruments
In spite of growing acknowledgement of the merits of structured trade finance solutions, many Middle Eastern corporates are still very traditional in their dependence on letters of credit and guarantees to support trade flows.
Raza comments: “Generally speaking, there has not been a big switch from letters of credit to open account over the last two to three years – although where buyers and suppliers are in longstanding trading relationships, there has been a natural progression to open account trade.” One of the main reasons for the ongoing use of letters of credit is price compression in trade finance business. “Although moving to open account can make trade more efficient, the cost of traditional trade finance has come down so much over the last 12 months that there is not a significant cost benefit in switching to open account,” he adds.
In line with this, traditional trade finance techniques are still used in the commodities space.
“Commodity finance solutions are available, but have not reached the same level of sophistication as those offered in developed markets such as pre-export financing and inventory-backed financing,” explains Citi’s Haider.
Nevertheless there has been a rise in requests from many global names for commodity finance. “I foresee that in the near future the Middle East market will offer more solutions. The establishment of players such as the Dubai Multi Commodities Centre (DMCC) is certainly going to help accelerate the pace at which banks offer more sophisticated solutions.”
This is confirmed by Deutsche Bank’s Leenen: “There will definitely be a bigger role for more sophisticated commodity finance solutions in the future,” he says, pointing out that the region is increasingly dealing in commodities – more of which are now coming from Africa – and corporate clients are putting banks under growing pressure for commodity finance. “Meanwhile, Basel III is expected to put pressure on banks’ credit availability, and they are looking for instruments that are cheaper from a financing perspective.”
A strong future for BPOs
Although the use of traditional trade finance instruments prevails among many Middle Eastern trading companies, other modern-day trade finance instruments are on their radar.
Last year, one major Middle Eastern buyer, OCTAL Oman, participated in the region’s first trade financing, backed by the bank payment obligation (BPO), a new electronic payments guarantee and risk mitigation instrument. This has given rise to expectations that more Middle Eastern corporates will engage in BPOs – especially major exporters operating in the oil and gas industries which have traditionally relied on letters of credit to secure their trade flows.
“It is still early days for the BPO, although it is likely that this instrument will play a bigger role in the future,” says Leenen, noting that it could potentially be seen as an alternative to both letter of credit-based trade and open account trade.
Meanwhile, Standard Chartered, which facilitated the first BPO transaction involving a Middle Eastern corporate, is looking to do another BPO between two companies – one in UAE and one in Asia – soon.
“There is definitely interest in BPOs from commodity manufacturers and in the hydrocarbon sector too,” says Siddiqi, pointing out that the BPO is most suited for situations where there are long-term supply contracts in place; there is a long-term relationship between the buyer and supplier; and where there are reccurring trade flows.
“Oil and gas product exporters in this region do have long-term supply contracts in place, and traditionally conduct trade transactions under letters of credit. By using the BPO instead of letters of credit, this process can be made much more efficient.”
This is confirmed by Haider: “There is no reason why the BPO should not play a bigger role in future transactions. We may also see flows that are already on open account switch to the BPO,” he says, noting that political events in the region, such as the Arab Spring, have indicated how quickly things can change – accentuating the need for greater security in trade finance.
While Middle Eastern exporters are recognised as clear potential users of the BPO in future, distributors, selling goods across the Middle East on behalf of foreign manufacturers, could also benefit.
“From an import perspective, there are also a lot of large equipment suppliers outside the Middle East which have large distributor relationships in the region, and they too are interested in conducting BPOs,” says Siddiqi, noting that this also applies to Middle Easter distributors of other large ticket products. “There have been instances where banks representing clients in other regions have approached us about engaging local distributors, which we represent, in a BPO.”