Melodie Michel looks at recent progress in the financing of services, construction and medical technology, three of the sectors most misunderstood by the trade finance community.
For a publication focused on trade finance, it is all too easy to believe that the global economy is made up of only a handful of sectors. Oil and gas, mining, aircraft, telecoms, infrastructure, agribusiness, shipping and manufacturing always take centre stage in our world, to the point where the lamenting of a medical technology exporter about not being able to access trade finance can come as a surprising revelation.
Looking at the issue more closely, it appears a number of sectors are deemed too risky or too complex to be served by trade finance providers. Lack of physical collateral, complex invoicing structures and varied customer bases all seem to raise red flags in an industry that has traditionally been about financing the movement of a good from point A to point B.
But regardless of the reasons, financiers are missing a huge trick by not serving certain industries: the overall services sector is estimated to represent no less than 78% of US GDP, with professional and business services alone making up US$2tn of the country’s US$17.3tn revenue in 2014 – roughly 10%.
According to Inwha Huh, Americas head of global trade and receivables finance at HSBC, financiers are finally waking up to this tremendous opportunity: “We’re focused on it because our corporate clients’ business dynamics are changing, and the services component of most industries is the most stable and growing. For some of our clients, services form 100% of the business model, so if you’re going to work with them you have to figure out how to structure it,” she tells GTR.
She adds that the difficulty in financing services revolves around quantifying the collateral and figuring out the enforceability of payment. “In trade finance we’re so asset-driven that without a hard asset or an invoice it’s very hard to quantify the collateral. Then, depending on what the contract looks like, the enforceability of payment by clients is not always as clear as it should be. With a lot of services, it’s ongoing, it’s milestones, it’s not certain times when services are rendered and payments are irrevocably due, which makes it a bit harder.”
Customisation vs standardisation
Huh explains that getting comfortable with such deals as a bank involves examining each client and business to come up with a tailor-made solution. For example, in the online content world, financiers could look at click rates and software services contracts to evaluate collateral rights and legal enforceability.
“There isn’t a standard structure for services like there is for the physical export and import of goods. It needs to be a customised structuring solution,” she says. There is, however, one development that could help standardise parts of this system, and as it often seems to be the case these days, the answer is in the blockchain.
Tallysticks, a London-based tech firm focusing on blockchain invoicing solutions, is one company that is on a mission to make invoice financing more accessible to companies and sectors previously deemed too risky to finance.
Co-founder and CTO Adi Ben-Ari explains: “We’re now testing with real invoices and real customers on the blockchain where, by the time the invoice reaches the lender, it’s been digitally signed by the supplier’s own systems and by the buyer, so the bank can see the timestamp and nobody can change the evidence of what actually happened, so it takes some of the risk out of invoice lending in the first place.
“The second part is that because we’re connecting the systems together in digital form, the process becomes more efficient both for the lender and for the company receiving the loan. We use a smart contract to automate the workflow and the way we’re implementing the process would allow the bank to sift through the data and make a decision, invoice by invoice, something that is very challenging today because of the overheads.”
Tallysticks started operations as part of the Barclays accelerator programme in the UK, but now the firm is working with a number of lenders to create an agnostic marketplace where any lender can lend against individual invoices – opening up the market to underserved sectors.
In fact, Ben-Ari cites two practical applications the company is working on, one in IT services, and the other in construction. Asked how the blockchain could help streamline complex invoicing processes, he admits that the technology doesn’t lend itself well to holding large amounts of data.
“We don’t even store the entire invoice on the blockchain. We store the bits that we need each party to know about in order to deal with the others, so the trust points if you like. But what we can do is implement some fairly complex workflow,” he says.
For example, the IT services project Tallysticks is working on in the Netherlands involves contractors, a co-operative and a large corporate customer, which means three stages of invoicing. The solutions provider has built a system through which, when the contractor invoices the co-operative, this triggers an automatic invoice to the corporate, and payment is also automatically activated.
“That can be built, but it has to be customised. It’s a customer-based business, and we kind of layer that on top of our standard business. As it’s customised by the type of flow, it could be set up for a specific sector if there’s a standard pattern,” Ben-Ari tells GTR.
The length of the onboarding process depends on what the company’s existing enterprise resource planning (ERP) software is, but once Tallysticks’ system has integrated with a platform, the other customers of that same platform can go live almost instantly.
And while a timeline on mass adoption of blockchain technology is difficult to define, it is fair to say things are accelerating: Tallysticks already has a company live on its system, and is set to announce the first Barclays customer implementing its solution in September – the days of theory and proof of concept are coming to an end.
Bright future for construction
The construction sector, too, is on the verge of a revolution, and rightly so: it contributed 4% to the US GDP in 2014 and is heralded as one of the fastest-growing markets of the next 15 years.
PwC’s Global Construction 2030 report forecasts that the volume of global construction output will grow by 85% to US$$15.5tn by 2030, with China, the US and India accounting for 57% of global growth. This is an increase of 3.9% a year to 2030, outpacing that of global GDP by over one percentage point.
Until recently, the complexity of construction invoices made them practically impossible to finance: monthly invoices prepared by subcontractor or material suppliers for the general contractor on a project include fairly complex legal documents, detailed levels of information around the work that was carried out (including quality surveys and other engineering or architectural input), as well as supporting documents about the labour employed. A less than straightforward process.
But once again, technological advances are changing the status quo. Textura is a construction payment software company launched in the US in 2004, which is currently used by over 200,000 subcontractors and handling US$200bn of domestic and cross-border payments.
A couple of years ago, its path crossed with that of supply chain financier Greensill Capital, and the two started a system whereby Greensill could provide early payment to subcontractors at the point of invoice approval.
“What Textura and Greensill did was to put in place the technology to, in effect, create an industry-wide supply chain finance solution for commercial construction that’s available to every project that’s using Textura’s functionality,” Textura co-founder Pat Allin, who has since joined Greensill as executive chairman, tells GTR.
In June 2016, Textura was purchased by software giant Oracle, which bodes well for the expansion of the solution. “We believe Oracle will be rolling out Textura’s solution on a global basis, and Greensill will be offering supply chain finance as part of the programme. This is really to provide an early payment programme for the construction industry, which is, depending on the numbers you look at, about 15% of the global economy,” Allin adds.
With Tallysticks also working with a construction firm to handle invoices and automate workflow on the blockchain, it looks like the idea of trade finance as an integral part of construction firms’ working capital management could become a reality within months.
Whether banks will be able to participate, though, is a differentstory: Allin warns that the onboarding process put in place through Textura is “simply a process of clicking through a number of screens”, which may be a deterrent to KYC-heavy financiers. “The subcontractor clicks through those screens and we capture an electronic signature for terms and conditions, and that’s all that’s really required. Onboarding is a fairly instantaneous process, which makes it a very democratic solution that’s applicable to everyone that’s using Textura’s invoicing solution. I suppose a bank could get involved with such a tech solution but they have this inherent problem of onboarding, which
is a complex process,” he says.
The healthcare sector, too, faces financing hurdles, but they have to do with more than invoicing and contracts, and therefore may be a lot more difficult to overcome. “Many years ago, one banker said something to me that really stuck in my mind: ‘The healthcare sector is the most difficult to finance in the economy’,” a representative from a large medical technology company recalls in a conversation with GTR.
This is not a nascent market: the US is the largest medical device market in the world at around US$148bn – 43% of the global market value in 2015 – and is expected to reach US$155bn by 2017. US exports of medical devices grew at a compound annual growth rate of 4.5% from 2008 to 2013, and exceeded US$44bn in 2015, but most of that is done on an open account basis.
Financiers’ reluctance is not linked to the creditworthiness of the sector’s exporters either: as of October 2014, US companies held four of the top five rankings for medical device companies with the most revenue, and represented 22 of the top 40 spots. Overall, US companies account for almost two-thirds of the total revenue for the top 40 medical device companies, followed by Germany with 14% and Japan with 7%.
GTR’s unnamed source, whose company works primarily in the implantable medical device space, explains: “The normal use of trade finance is usually by the big capital equipment companies: GE, Siemens and Phillips for example – the ‘big metal’ manufacturers. They are very high-ticket items that last a long period of time, so they usually have their own facilities, with support from Coface or US Exim, etc.
“By contrast, the implantable part of the industry is also very expensive but very small. In the capital equipment case, you can take the equipment in the case of non-payments – but you do not want to be removing an insulin pump from a patient. The technologies we have in people’s bodies are actually capital equipment because they can last years, but the difference is that you’re not going to be able to repossess them.”
Medical technology companies sell to a wide variety of clients, from patients themselves to doctors’ practices, hospitals, health ministries and even distributors in some cases. This buyer diversity undeniably adds to the complexity of lending structures required, as does the fact that most of these buyers come from a medicine background, and therefore speak a different language from financiers.
“Also, in many health systems, particularly in Europe, it’s not a privilege to have health, it’s an expectation of the government. As such, when you cross the private and the public sector in this way, people sometimes think we can write off debts, or lengthen payment terms etc,” says our source.
“We have these negotiations with governments that are so surreal and would never happen in any other industry. And another point is that we cannot cut off supply in case of late payment, because of the public health aspect of what we do. For example, we saw the Greek crisis coming. We were already at 300-plus days well before the broader market understood there was a problem. But we couldn’t really cut things off because we could be seen as bankrupting the Greek people of their healthcare. Our technologies are vital for health,” he adds, coming back to Huh’s point about enforceability.
Because of the public interest aspect of the sector, governments and multilateral financial institutions are stepping up to the plate to solve the financial challenge. US Exim, for example, extends medium-term cover of up to seven years for medical device exports (as well as environmental goods), instead of five years for other sectors, and other export credit agencies have done the same.
Medical technology companies have also worked with the likes of the International Finance Corporation (IFC) to set up patient financing programmes in emerging markets, but according to our expert, “this doesn’t change the fundamentals”. “The difficulty we’ve had is on a structural level, but then also on a transactional level, because the reality is that it’s a fairly cash-rich industry. We feel – incorrectly – a little bit elite, so we basically don’t have, in my view, the attitude that we should be extending credit to customers. If you can afford it, great, if not, it’s your fault. We need to get on the side of the customer and to think about emerging markets,” he points out.
Initiatives like the USA Healthcare Alliance (USAHA), which aims to enable diverse US healthcare manufacturers and service providers to pursue joint export opportunities, packaging individual sales into a more bankable ‘project’, have the potential to relieve the sector’s woes, but progress remains slow.
In the end, for the healthcare sector as for all the other sectors underserved by trade finance, education is key.
“There’s a huge education curve that is missing, mainly because [these sectors] didn’t look to trade finance as a key working capital financing structure. There’s also a lot that the trade finance world can do to educate itself in terms of how the contracts work and how enforceability works. But once there is more transparency, the financial institutions can structure better around that,” explains Huh.