With trade volumes massively down and many of the major US corporates awash in liquidity, how is it that interest in trade finance is increasing, asks Jon Richman, Managing Director, Head of US Trade and Working Capital at Santander CIB.
The crisis begins… and trade finance delivers
It is March 25, 2020, Covid-19 cases rise above 450,000, the Dow is down by more than 25% from its record a few weeks prior, commercial paper markets break, and bond yields are spiking 200 to 300%. Panicking clients are asking for all sources of liquidity. Short-term lines, including trade-related funding sources, remain open and become a key source of funding for many companies to weather the storm – much like the 2008-09 crisis of the past. Companies that previously relied heavily on commercial paper now appreciate the importance of diversified funding sources.
The picture changes dramatically only three months later, following a massive intervention from the Central Bank with corporate bond issuances at a record pace. As of the end of May, companies had already issued more than a trillion dollars through the bond market year to date. Borrowing at more than twice the pace of last year has left the companies that are well positioned for the crisis awash in cash.1 So with no short-term liquidity needs and with trade volumes down by an estimated 30%, who needs trade finance?
While there is liquidity for some, this is far from the case for all, especially in vulnerable sectors and for small and medium-sized companies. Major US corporates have redoubled their efforts to support their supply chains, including key supply sources and channel partners. They know that their trading partners need help now and will need it even more so as the economic recovery begins, and as they restaff, restock, and manage higher levels of working capital. So now it is about the provision of supply chain finance – which can be an affordable and incremental source of credit to suppliers – and accounts receivables finance structures, including those with extended terms to support longer payment terms from key customers. Companies that may not have believed in these working capital programmes previously are starting to do so now, and those that already had programmes may want to increase the size of these programmes or implement additional ones to increase capacity and resilience.
If the past is any guide… the focus on working capital and trade finance will increase
While the 2008-09 crisis and the current one are each unique, there are common themes. During the 2008-09 financial crisis, bank-intermediated trade finance held up, as banks generally remained willing to provide liquidity in order to support international trade. A paper by the International Monetary Fund demonstrated that while merchandise trade fell by approximately 10% year over year in Q4 of 2008, trade finance actually grew by 3.4%.2 Trade finance can serve as a lifeboat for all enterprises, ranging from local subject matter experts to large multinationals, as it can be a reliable way to access liquidity and fulfill operational funding needs required to run a business.
Furthermore, trade finance and working capital management often have a multiplier effect that can help better position corporates to succeed in the near term future post-crisis. Corporates with strong working capital metrics during the peak of the 2008-09 crisis (defined as 2008 Q4) were best positioned to rebound. S&P 1500 companies in the top quartile of working capital efficiency (defined as the shortest cash conversion cycle within their industry) showed 120% growth in earnings per share between Q4 2008 and Q2 2011, compared to 66% growth for companies in the bottom quartile.3
So should corporates now change their use of trade finance?
While trade finance will clearly be seen as an increasingly important tool in managing liquidity and supply chain activity, the emphasis and priorities of corporate clients may shift. Here are some of the initial observations:
It is not just about your own working capital metrics
It is also about supporting key trading partners. While corporates will remain highly interested in managing their own metrics and cash flow, they are now likely to be more deeply invested in ensuring the success of their suppliers and buyers. It is appreciated that a failure in the supply chain impacts everyone, and that access to flexible, affordable finance can have benefits for everyone.
Shoring up the supply chain is today’s primary focus, but tomorrow’s objectives will likely also include rewarding suppliers based on environmental, social and governance (ESG) criteria. Increasingly, companies will work with their banks to develop programmes that deliver tangible benefits to those who “do good”.
Helping to reconfigure supply chains
Another potential fallout of the current crisis, as well as international trade tensions, could be a reconfiguration of supply chains. It is likely that there will be less reliance on any single market or supplier, and a greater focus on ensuring resilience over efficiency. Trade finance instruments can help companies manage the increased risk associated with new party dealings and can continue to provide additional support as activity ramps up with these less established relationships.
The pandemic has also accelerated the digitisation of communications between various parties. As most people work from home, we have all learned to exchange documents/data electronically in a much more comprehensive way, which certainly helps to open new efficiency opportunities.
Driving top line into new markets
During the crisis, the extension of sales terms has been an important development to ensure the survival of key distribution channels into many markets. As the recovery takes hold and volumes recover, additional sources of finance to support this expansion will be key. Accounts receivables purchase and distributor finance tools can help parties bridge the need between getting paid faster (with less risk) and ensuring ample liquidity to support sales activity in the channel. Increasingly, these programmes will be seen as ways to manage not just working capital metrics, but as another source of liquidity, risk mitigation, and a key tool for the business to drive top line and market expansion.
Managing liquidity and risk
While bond yields leapt by 200 to 300% at the peak of the crisis from prior levels, trade finance pricing was broadly seen to have a muted increase of about 30%. More importantly, trade finance remained very much open as compared to capital markets alternatives. Previously, companies that shunned trade finance (in various forms such as accounts receivables purchases, supply chain finance or simple trade loans) because they may have been slightly more expensive than commercial paper, may now clearly see the benefit of having these additional tools available alongside other sources.
Companies that had one supply chain finance programme are now more often looking to have another as these programmes are becoming so mission-critical, and they prefer not to be solely dependent on one provider. Major trade banks are expected to continue to enhance their programme capabilities by making them more global, more automated, more intelligent (for example, the provision of event-based finance earlier in the process), and more ESG aware.
So where do we go from here?
While this crisis will dissipate and the economic recovery will happen, there will be some lasting changes. The importance of trade finance, like in crises of the past, will be heightened. It will be seen by many companies as a key tool for managing liquidity and supply chains.
It is likely to be considered a force for good through its continued support of world trade (and associated benefits like lower poverty levels and delivery of essential goods) and the promotion of ESG initiatives.
For Santander, trade finance has always been a key business, helping us support corporate relationships at a time when other sources of liquidity are difficult to access. It is expected to remain a core area of growth and investment in the US and other markets as we help our clients and their trading partners through the recovery and beyond.
1 (Brennan, 2020)
2 (Irena Asmundson, 2011)
3 (J.P. Morgan Chase, 2020)