As the world witnesses one of its most challenging years in recent times, trade finance continues to play a critical role in supporting the flow of goods and services across global supply chains, and has again demonstrated its resilience and ability to adapt in the face of significant change and disruption, writes Peter Jameson, head of Asia Pacific Trade & Supply Chain Finance, Global Transaction Services at Bank of America.
As we entered 2020, the evolving US-China trade negotiations and the arrival of Brexit were the main themes that we thought would influence global trade in the year ahead. As the global pandemic took hold, it was clear that it would become the headline event of 2020 and have a significant impact on the global economy and society as a whole.
Despite the unprecedented impact of the pandemic, trade finance has responded well, as it has done during previous market crises: supporting importers and exporters with critical tools to manage risk, free up working capital and ensure global supply chains continued to function during a period of extreme stress.
What will be the longer-term impact of the events of 2020 on trade finance? With the World Trade Organization estimating a reduction of between 13-32% in global trade volumes, how will companies respond as they aim to preserve stability, profitability and manage risks in their global supply chains? And how will banks support their changing priorities?
In short, the core drivers of market themes that were shaping how companies manage their business pre-pandemic are likely to remain: shifting supply chains, increased adoption of supply chain financing, and the digitalisation of trade flows.
What will differ is the sense of urgency and pace of these changes; the pandemic and other market forces will act as a catalyst, accelerating these trends as corporates – and their banks – adapt to the new post-Covid world.
Shifting supply chains
The evolution of supply chain locations is not new, as companies have frequently adapted their business model to take advantage of technology, talent and efficiency gains. Even before Covid-19 many companies were evaluating how to diversify their supply chains, particularly where they perceived an over-reliance on China – many evaluating a ’China plus’ approach of supplementing existing production capacity with new sites in other locations, such as countries across Southeast Asia. The initial supply-side shock in China from Covid-19 reinforced this strategy, but the quick recovery of manufacturing and exports reinforced the resilience of China’s infrastructure in maintaining production.
We will see companies continue to drive diversification in their supply chain locations, due in part to the recognition that any supply chain that is dependent on a single market presents risks in the post-Covid world. There are other drivers – the continued uncertainty surrounding the outcome of the US-China trade discussions, as well as a heightened focus on Environment, Social & Governance (ESG) considerations, which– along with increased automation – are driving companies towards manufacturing closer to where end customers are located. This reshoring trend is expected to continue, particularly for US companies.
However, relocating supply chains is neither quick nor easy. A recent Bank of America report estimated a cost of US$1tn to shift all foreign manufacturing in China that is not intended for consumption in China. With the anticipated economic downturn, investing at these levels may not be sufficiently compelling vs adopting a ‘wait and see’ approach to how the US-China discussions progress.
Supply chain finance: an even more compelling proposition
Supply chain finance (SCF) came of age after the 2008 global financial crisis by demonstrating its ability to unlock working capital for companies during stressed liquidity situations. Over time, both buyers and suppliers have recognised the benefits of SCF – not only in terms of unlocking liquidity, but also as a technique to provide greater certainty for suppliers and drive financial risk out of their supply chain. For many companies, the failure of one supplier could cause an entire production line to slow down. Supply chain financing could help mitigate this by providing suppliers with the option to monetise their receivables.
During 2020, SCF has again proven its worth, helping suppliers and buyers by ‘greasing the wheels’ of the working capital cycle. Having continued to grow through a full economic cycle, SCF has demonstrated its value in providing a reliable and cost-effective source of liquidity to carry companies through difficult financial times, its short-term nature also being attractive to banks active in this space.
Furthermore, with many governments focusing on banks prioritising support for sustainable supply chains during the pandemic, SCF has again come to the fore as a critical component of ensuring goods continued to flow despite the strain on liquidity.
The result? Despite the reduction in overall trade flows, SCF has continued to grow at an estimated 5% in 2020. Many organisations that did not employ this capability in the past are now actively exploring how they can integrate payables, receivables or inventory finance into their working capital cycle, as a way of protecting their supply chains and safeguarding them from future shock. It has also become a competitive tool, with suppliers often gravitating towards buyers that provide this facility as part of their procurement process.
The digitalisation imperative
Arguably the most meaningful by-product of the pandemic for trade finance is the renewed drive to digitalise its historically manual and paper-based processes. In a recent poll by Ernst & Young of over 7,000 organisations, 50% cited operational continuity as the single biggest impact of the pandemic. With large portions of the world economy working remotely, the importance of being able to operate effectively outside the office environment and in a fully electronic manner has come to the fore.1
For many organisations, the inability to provide physical documents, wet signatures or corporate stamps led to significant disruption in the financial supply chain. Even today, many organisations retain a surprising number of inefficient or paper-based processes, which could easily be automated by readily available digital capabilities – whether through simply delivering transactions electronically, leveraging eSignature capability, or transmitting corporate documents through online portals.
As with the other trends, the move towards digitalisation is not new, but is accelerating due to impact of the pandemic. It has shifted from being a ‘nice to have’ to being an imperative to provide operational resilience.
The challenge for trade finance has not necessarily been a reluctance to adopt – most companies recognise the benefits of automation. The historical barrier has been the complexity of global supply chains, with many diverse constituents, often in countries with disparate rules, practices and standards. End-to-end automation is hampered by the least sophisticated party (or country) in the supply chain, which is in turn governed by local market rules.
As governments recognise the importance of keeping supply chains moving during the pandemic, many policymakers are re-examining how the legal and regulatory environment needs to evolve in order to accommodate greater digitalisation of trade finance, whilst providing the same level of certainty and risk mitigation afforded by paper-based predecessors. These moves should set the framework for – finally – enabling trade finance to move towards a digitalised future.
Trade finance – bright horizon
There is no doubt that the events of 2020 will shape the world for years to come. In the case of trade finance, the impact will be no less significant, but the long-term outcome will be positive.
As companies seek to reframe their supply chains, they will look to their trade finance banks to support them as they execute these changes, supporting their needs as they re-shore or explore new markets. As buyers and sellers seek to further improve liquidity, sustainability and flexibility, they will continue to seek out ways to integrate SCF into their core business process. And as the trend towards digitised trade finance accelerates, it will open up opportunities to drive further automation and efficiency in what has historically been a highly manual part of the banking industry.
Finally, unlike the 2008 financial crisis where – in most cases – banks and regulators were polarised, the 2020 crisis is bringing banks, regulators, companies, fintech and other players together to collaborate, solve problems, and provide safety and resilience in an increasingly uncertain world.
All of these developments point to a new ‘golden age’ for trade finance. It has proven its resilience – yet again – through a full economic cycle and stressed scenario. It will emerge from 2020 on a path to being a more agile, more digitalised and more relevant capability for the post-Covid world.
Bank of America is transforming the way we deliver SCF to clients with the new supplier enablement portal coming soon. Utilising an advanced artificial intelligence data analytics software, digitisation and automation to accelerate the supplier onboarding process, companies can benefit from richer and cleaner data that will help prioritise strategic suppliers for onboarding, improved program reporting capabilities and increased digitisation of processes.
- ‘How trade finance can operate effectively in the wake of COVID-19’, Ernst & Young, 20 July 2020