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The use of supply chain finance (SCF) is steadily spreading into South America. In the region’s more developed countries, such as Brazil and Chile, it is already present. Aiming to push SCF further into the southern half of the continent, financial advisory firm DBA Corporate Finance has teamed up with supply chain finance provider Demica and through its joint venture is on the lookout for new opportunities in the Americas, writes Justin Pugsley.

Latin America receives the blanket classification of being an emerging market. This term does, however, mask the very different stages of development of the countries within that continent.

Chile and Brazil are already advanced countries with well-established financial infrastructures. They are also well integrated into the global economy and the supply chains of many multinationals. They have both benefited from substantial economic reforms and heavy private sector investment. The global banks are also present there and offer a full range of services including supply chain finance.

Move south of Brazil’s border and the situation is different. Uruguay, Paraguay and Argentina represent frontier markets for SCF. DBA Corporate Finance, which offers strategy and financial advisory services to companies based in Mercosur (Argentina, Brazil, Paraguay and Uruguay) and abroad, is attempting to change that. It has teamed up with UK-based Demica, which provides specialised working capital solutions and has a technology platform for SCF called Citadel.

“The venture is mainly focusing on Argentina and Uruguay. Other Latin American countries might be added later on,” says Philip Kerle, managing director, Demica. He does, however, stress that the venture is still in the early stages and it is therefore difficult to report concrete results yet.

A key criteria for DBA was to find a partner who could easily adapt to the local business culture and one that had an appetite for transactions involving lower volumes than typically seen in Europe. Demica ticked all of the boxes.

For Demica it is also an opportunity to further globalise its offering. It intends to make inroads into other emerging markets as well. “I think there is a great opportunity for SCF across emerging markets generally,” says Kerle. Access to affordable working capital for SMEs was already an issue in many emerging market countries before the credit crunch.

A unique opening
Both partners feel that the current situation presents a unique opening for SCF. Access to finance is still a challenge for many Latin American suppliers, especially for SMEs in countries such as Argentina, Uruguay and Paraguay. Existing solutions, some of which have been badly impaired by recent political developments, are costly and don’t allow for prompt payment to suppliers.

“Bringing more efficiency and just-in-time payment to suppliers can be done via supply chain finance and it can substantially improve the supply chain to the benefit of all its participants in various industries,” says Montevideo-based Rudy Lion, head of structured finance with DBA Corporate Finance. Demica’s Citadel platform, which has been adapted before to other markets, such as Japan, was identified by DBA as being ideal for the Latin American market as it is tried and tested and highly regarded.
“I would distinguish between countries like Brazil, Chile and Mexico from the rest of the Latin American countries,” says Lion. “These three countries, which are all investment grade, have the highest volume of factoring in Latin America, and the commercial finance sector is more advanced than in countries like Uruguay and Argentina.” He goes on to explain that these countries are more akin to ‘quasi’ emerging when compared to the later two. “They already have experienced SCF programmes,” says Lion. “A good example is the Nafin supply chain finance platform in Mexico which was developed with the support of the Mexican government.” Nafin is one of the largest development banks in Mexico.

The main sources of working capital in Argentina and Uruguay tend to be based around invoice discounting, where volumes are still relatively low, and differed cheques. Unlike, its two neighbours, Brazil and Chile, Argentina has once again been beset by political problems, which have badly impeded the economy. After suffering an economic collapse in 2001-02, Argentina is again flirting with measures which are undermining investor confidence. In one example, president Cristina Fernández de Kirchner nationalised the private pension system back in October in a bid to keep public spending flowing. It merely triggered a flight of capital. This may also impact on the country’s ability to roll over US$23bn-worth of debt, which matures this year and next.

Unintended consequences
These ‘macro’ problems quickly ricocheted across the wider economy and are accentuated by the toxic effects of the global credit crunch. For corporates that basically translates into much more expensive capital. An unintended consequence of nationalising the pension system has been to make funding more expensive than it should be. For instance, Argentina had a clever initiative designed to lower the cost of finance for companies, especially smaller ones. Supplier invoices were effectively tradable almost like short-term debt securities. And these in turn were often bought by pension funds seeking higher yields.

“The objective is to allow suppliers to benefit from a lower discount rate based on the credit quality of the SGR or the issuer,” explains Lion. SGR, which stands for ‘Sociedad de Garantia Reciproca’ is a regulated company created mainly to help SMEs access credit on better terms than they otherwise could. An SGR has the ability to guarantee the obligations of SMEs or to negotiate better borrowing terms. Similar schemes can be found in El Salvador and Venezuela. Differed cheques with a 10-day tenor were recently being discounted at 18.9% moving up to 26% for those with longer maturities.

Nonetheless, that still beats the discount rates typically offered by banks, which can be as high as 40%.

“A large chunk of working capital finance for SMEs in Argentina relies on the capital market and the SGR,” says Lion. “When the government nationalised the pension funds, one of the main investors in differed cheques vanished, which saw spreads go up.”

The government is apparently looking for ways to continue channelling pension funds into the market.

Uruguay has a similar scheme for funding SME working capital, but it is not as developed as Argentina’s. There isn’t a tradable market as such for cheques or SGR paper. Even so, SMEs there are facing higher funding costs as well, which hasn’t been helped by the central bank raising its base rate to 10% from 7.75%.

“A common point in both countries is that an associative working capital finance solution such as SCF, which would bring all the supply chain participants around the table for the benefit of all, does not exist as such,” says Lion. And this is despite the existence of SGRs and the differed cheques mechanism.

“Existing mechanisms are still very much paper-based and imply high administration costs, generally slow payment to suppliers and operational risk,” he says. “The SCF programme and the Citadel platform could substantially lower transaction costs, speed up payment to suppliers and improve operational risk management.”

Indeed, SCF could address some other key issues. When the economy deteriorates buyers typically try to stretch payment terms as far out as possible, which is at the expense of the suppliers’ balance sheets.

Hence, suppliers get caught in a pincer movement of falling sales and pricing pressure at one end and payment delays at the other. The situation is then exacerbated by the fact the credit becomes more expensive as risk aversion rises during downturns – a story which is being told across the world at the moment.

“Suppliers get totally squeezed and the entire supply chain becomes vulnerable,” explains Lion. “SCF could play a very important role in this context.” He adds that the spread between buyer and supplier cost of funding also creates interesting revenue opportunities for participating credit institutions.

Supranational interest
There is yet another interesting twist for SCF. “There is a lot of interest from (supranational) development banks in SCF, especially those looking at emerging markets,” says Kerle. These institutions potentially see it as another tool to help support the development of SMEs. Even the IMF is apparently looking into its potential. DBA Corporate Finance already works with numerous regional development agencies.

Meanwhile, Kerle used to work for the Asian Development Bank. So there is a real possibility they could persuade supranational organisations, which represent some of the few pools of liquidity presently available, to look to support SCF schemes.