Banks are looking to set up more supply chain finance programmes with buyers based in the emerging markets. Liz Salecka reports.
Banks offering supply chain finance (SCF) to suppliers in emerging market economies face a number of major challenges.
From understanding the different business and legal environments that prevail, to ensuring the financial strength and reliability of their counterparties, there are many risks that need to be mitigated.
To date, many global banks have entered emerging markets by setting up buyer-led programmes for western corporates, and have been able to dispel many of the uncertainties involved by structuring most of the risk on the buyer.
However, many of them are now looking to offer structured solutions to emerging market buyers as well – adding to the counterparty risks they face.
“Buyers in emerging markets may not be well-known internationally, and it is vital that banks understand the financial strength of the buyer so that they can assess the payment risk involved,” says Ashutosh Kumar, global head of corporate cash and trade product management, Standard Chartered. The bank has already launched several programmes for emerging market buyers in industries such as consumer electronics, lighting equipment manufacturing, automobiles and pharmaceuticals.
“A bank does not want to be in a situation where it provides pre-shipment finance to a supplier, and then finds out that the buyer has cancelled the order.”
At RBS, Anil Walia, Emea and UK advisory head, SCF, global transaction services (GTS) points out that having developed an understanding of emerging markets by working with western buyers in these countries, RBS is now growing its business on the ground too, aided by its own global network of SCF specialists, which structure SCF deals.
“We started our foray into the Middle East last year, and we have a growing pipeline of deals with local companies,” he says. “Our reliance on a global network of SCF specialists/advisors has enabled us to move into difficult markets more easily and do business in these markets.”
JP Morgan too is already working with emerging market companies as well as affiliates and subsidiaries of, and distributors for, large western companies.
The bank works closely with correspondent banks to mitigate any counterparty risks. “We are the leading partner bank for a lot of local banks,” says Jeremy Shaw, head of global trade, JP Morgan Europe, Middle East and Africa. “We work with local banks that provide services to mid-sized and smaller companies and we then talk to these companies, explore structures with them and steer them in the right direction with our local partners.”
Emerging market suppliers also need to be assessed for their suitability to join SCF programmes. Barclays hopes to establish electronic trade finance solutions for local buyers in the future, and points out that, although it places risks largely on the buyer, understanding suppliers’ businesses is important.
“We do work closely with suppliers to make sure that we understand their business, and that they meet our Know Your Customer (KYC) requirements. On rare occasions, this can be challenging. There may be situations where a supplier does not meet our criteria in terms of its business, reputation and other activities, and in that instance we would discuss these issues with the buyer,” says Maria Malinowska, director, SCF, Barclays Corporate.
“When you are working in emerging markets in Africa, one of the biggest advantages a bank can have is a local presence – this local presence provides management and control structures on the ground,” she adds, pointing out that Barclays’ local presence helped the bank set up a US$25mn SCF programme for Unilever in Kenya in 2010, which supports local tea growers.
Assessing the risks presented by emerging market suppliers is particularly important when offering pre-shipment finance.
“Financing suppliers at an earlier stage requires a good understanding of how the supply chain works, the relationship between the buyer and its individual suppliers, and the performance of those suppliers when it comes to meeting orders,” Standard Chartered’s Kumar says, pointing out that banks also have to ensure they have the risk appetite to finance smaller suppliers.
“It may be the case that you are setting up a programme which involves a supplier with sales of less than US$1mn, and you have to ensure that this is viable given the amount of performance risk assessment and due diligence work that needs to be put in.”
Local market practices
For banks entering emerging market economies, having a good understanding of local market business practices is vital.
A lack of formal business procedures and differences in the payment culture can present new risks.
“We may, for example, buy invoices from a supplier, expecting funds from the buyer in 60-90 days, but then have to wait ourselves for 180 days to receive payment from the buyer,” explains RBS’s Walia.
“This increases the risk involved in these transactions and, as a result, it affects the way we structure such deals and what we charge for them.” He explains that RBS relies on the expertise of local solicitors and accountants who understand the business culture, as well as the input from the clients. Rather than providing off-the-shelf solutions, the bank designs solutions that deal with local market risks.
“In many cases, we may mitigate risks by reaching a risk-sharing agreement with the buyer whereby it takes a stake in the SCF programme arranged,” Walia adds.
Understanding the different legal frameworks that prevail in emerging markets can prove challenging.
“A bank has to be able to appreciate the different legal frameworks that are in operation. This means accepting that there may not be adjudication by a court of law or that such processes may be handled by a different body,” says JP Morgan’s Shaw.
“A bank not only needs to be present in these markets – to eliminate these risks – but have had that presence for several years.”
One of the biggest concerns for most banks is ensuring that they have legal ownership of the receivables they purchase when offering early financing to suppliers.
“If you are purchasing receivables from suppliers, you need to have recourse to the buyer, so you need to ensure that the assignment of receivables from the supplier to the bank is perfected. This will follow the laws of the land, which do differ from country to country,” says Standard Chartered’s Kumar.
“It may also be the case that you need to comply with laws in two or more jurisdictions – that of the buyer and that of the supplier(s).” Barclays always seeks to ensure that any receivables purchasing documentation is legally enforceable by seeking legal advice.
“We have to make sure that a supplier has not given another bank preference to its cash flows, and check if any charges are registered. If we purchase the receivables, we have to make sure that we are purchasing them on an unencumbered basis,” says Malinowska.
In certain jurisdictions, the transfer of receivables from a supplier to a bank is only 100% secure when the transaction is registered with a local regulatory authority – and this can add to the many challenges faced.
“When you are typically dealing with hundreds and thousands of invoices, this can pose an almost insurmountable logistical challenge,” RBS’s Walia says, pointing out that registration is not made any easier by the tendency for companies, suppliers, governments and regulatory bodies in emerging markets to rely on paper-based solutions.
“This may leave a bank dealing with thousands of paper documents for different buyers, which need to be registered in paper format – sometimes in several copies.
“In the western world, technology is used to process and manage SCF deals, and this allows the straight-through flow of information from one system to another, thereby mitigating the risks involved.”
RBS is currently working on a global supplier financing programme for a major western retailer, which has involved onboarding suppliers in Sri Lanka, and could be extended to suppliers in Cambodia too.
“Before we went in, we had no suppliers in these countries, but they were key for the retailer,” says Walia. “We found a way of getting around the problems posed by processes in such countries as a result of discussions with the buyer. This emphasises that banks need to look at everything on a case-by-case basis.”
IFC help is at hand
The provision of supplier programmes in emerging markets looks set to be boosted by recent initiatives from the IFC, which launched a US$500mn supplier financing programme at the end of 2010.
The IFC is already in close discussions with banks including JP Morgan, Standard Chartered, Deutsche Bank, Unicredit and BNP Paribas, as well as third-party solution providers, over the support it can offer for OECD buyer-led programmes rolled out for suppliers in emerging markets.
“We believe that increasing the availability of buyer-led supplier financing in emerging markets will fill a large and under-served need and enable suppliers to access an efficient financing solution by leveraging on the buyer’s cost of credit,” says Priyamvada Singh, programme lead, global trade supplier finance, IFC, who points out that the IFC is likely to announce its first deals in August this year.
Singh explains that the IFC is looking to participate in both funded structures, where it offers a proportion of the financing made available for a SCF programme, and unfunded structures, in which the IFC shares the credit risk presented by the buyer with banks.
It is also currently talkingdirectly to western buyers, which are interested in setting up new programmes for suppliers in emerging markets, and also wants to offer support to emerging market suppliers, which are looking to finance sales to selected large buyers.
A corporate perspective
While banks have offered SCF in South Africa for a number of years, the solution is not yet available across the continent, giving rise to claims that this could impede Africa’s prospects as an emerging trading power.
“Financial institutions are still struggling with trade finance, and while supply chain finance is a novel and appropriate concept, the reality is that it is not yet readily available,” says Jean Crawford, head of corporate finance, Export Trading Company, which specialises in the procurement and international trade of agricultural commodities.
“SCF would be advantageous without a doubt. One of the biggest things hampering growth in Africa is the lack of availability of finance – but banks just tend to talk the talk.”
He explains that many banks in Africa are still grappling with country risks, political risks and a lack of transparency, as well as the average credit quality presented by mid-sized corporates, which account for a large proportion of business and trade activities.
“Financial players in Africa today are opting to avoid risk – rather than seeking to manage it, but there are opportunities for growth – and high yields and returns,” he says. “Many large banks’ approach tends to be to look at the top 50 companies, and then provide them with general bank account facilities. They need to understand the market more deeply, and broaden their product base.”
Last year, Export Trading Company arranged a US$120mn collateral-backed import and export finance facility with Standard Chartered to finance its trade in soft commodities in Tanzania, Zambia, Kenya, Malawi, Uganda and India.
Crawford believes that collateral-based financings are a step in the right direction, but argues that banks’ are still placing too much emphasis on the strength of a company’s balance sheet.
“This really needs to evolve so that banks take on risk by looking more closely at the collateral offered. There are a lot of established companies in Africa with insufficient balance sheet strength to obtain credit.”