Alternative trade finance solutions are becoming increasingly available to Mena distributors of goods and services, whose cashflows are often impeded by requirements to hold more stock, as well as lengthier payment terms. Liz Salecka reports.
Since the financial crisis, government and bank initiatives to promote growth in trade have helped to ease some of the cashflow issues faced by regional and local distributors, many of which have traditionally been squeezed by the more lengthy payment terms that prevail across Mena.
“Some of the cashflow issues experienced by distributors in the region two years ago have eased considerably due to a number of factors. These include greater global spending and investment in the Middle East as a region; growth in consumption; local government initiatives geared at promoting trade; and a greater focus by banks on the provision of structured solutions, including distributor financing,” explains Asif Raza, managing director, head of treasury services Mena at JP Morgan.
“In the past, large distributors have looked towards their banks to provide working capital facilities to keep their businesses funded, but now there is a greater focus by banks on the provision of structured trade finance facilities.”
Squeezed in the middle
The cashflow pressures faced by distributors of goods and services in the Mena region emanate from both the buy and supply side of their business models.
On one side, distributors are often obliged to take on large amounts of stock from the major local and foreign manufacturers or suppliers they source from, and pay for them in good time. On the other, the lengthy payment terms that exist in different Mena countries – which can range by up to six months for distributors of goods and services to SME outlets – means that distributors can face a long wait to get paid themselves.
As Raza points out: “Cashflow is a key issue for distributors on both sides because they need to pay their suppliers but also collect money in from SME outlets, and this situation needs to be ironed out.”
This is confirmed by Farooq Siddiqi, head of transaction banking for Mena at Standard Chartered: “There are two common cashflow issues experienced by distributors in the region, one of which arises where a credit facility is offered to the purchaser (for non-cash business) as this affects the distributor’s working capital cycle because payment terms can be quite lengthy in the region.
“On the other side, manufacturers also put pressure on their distributors to take on more stock than they can actually need to hold, and this is quite often the case with electronic and telecom product manufacturers. This leads to cashflow problems in that inventory is held on the distributor’s balance sheets for some time – and the cash it represents is locked.”
Many of the cashflow issues experienced by distributors are often related to the nature of the products they sell, and tend to arise in non-cash business, where the end buyer is allowed a period of credit by the distributor.
This is the case with large ticket consumer items such as cars, imported from overseas for distribution in local markets, because their distribution typically involves offering the end buyer a credit facility. Lengthy payment terms are also typical in the sale of industrial goods, such as equipment and heavy machinery, where cashflows and ultimate payment can be closely linked to the success of the project they are used for.
These cashflow issues are also often compounded by the fact that it is not unusual for regional supply chain models across the Mena region to include multiple distributors. Major distributors, sourcing from large manufacturers, often sell their stock through sub-distributors, and this increases the likelihood of payment delays and the possibility of a payment default in the chain.
“Within the different types of distributor models evident in the Middle East there are level one distributors and level two distributors – and potentially level three as well,” explains Siddiqi. “There can be many links in the supply chain before products reach the end customer.”
Whereas historically many Middle Eastern distributors relied heavily on traditional working capital loans to fund any discrepancies between their payables and receivables, the financial crisis of 2008 tested this practice as bank lending tightened and became more expensive.
However, over the last two years, many distributors have been able to take greater advantage of receivables discounting to monetise their invoices, as well as inventory finance facilities made available by local, regional and global banks.
Today, newer more sophisticated trade and supply chain finance solutions are also emerging.
Although traditional bank facilities are still available, given that local banks in the region are still relatively liquid, many local banks are now setting up transaction banking businesses – and they want to differentiate themselves.
“By and large, a preponderance of bilateral facilities are now offered directly by banks to local distributors, and these can take many different forms including inventory finance, receivables financing and factoring,” says Siddiqi. “However, some banks are also looking to introduce supply chain finance and other new types of distributor financing.”
One structured supply chain finance solution starting to make a major mark in the region is manufacturer-sponsored distributor financing in which the manufacturer steps in to dissolve some of the risk faced by a bank when offering credit facilities to distributors.
“Many banks are now looking towards the large manufacturers in these supply chains to start some form of manufacturer-sponsored finance programmes,” says Siddiqi, pointing out that Standard Chartered already engages in the provision of this type of facility. “When banks offer financing to distributors in these circumstances, they do so on behalf of the manufacturer. They share information with the manufacturer on the distributor, and the relationship the manufacturer has with the distributor, and this provides a degree of comfort to the bank.
“The stickiness of the relationship between a manufacturer and distributor is vital,” he continues. “If the manufacturer does not have a long-term strategic relationship with the distributor, then it does not have control, and there may also be a higher probability of the distributor defaulting.”
Although manufacturer-led distributor financing is new to the Mena region, its appeal is expected to grow. Multinational corporations (MNCs) operating in states such as Dubai, which have taken advantage of similar solutions in other parts of the world such as Asia are expected to spearhead its use. Manufacturer-led financing has also already captured the interest of the major manufacturers of mobile handsets that are active in Mena.
“Many large manufacturers selling products here are looking to increase their competitiveness and their sales. They recognise that by helping their distributors to improve their own working capital cycles they can boost sales. Some manufacturers are even willing to partner with a bank and put a joint financing solution in place for their distributors,” says Siddiqi.
The greater use of manufacturer-sponsored financing can also benefit manufacturers from a working capital perspective. In many cases distributors buy on credit from manufacturers and/or suppliers, and the latter have to fund this from their own working capital.
By adopting this kind of solution, they do not need to offer a period of credit to their distributors.
“They can simply get the bank to finance the purchase by the distributor instead,” concludes Siddiqi.
The manufacturer-led approach to distributor finance is also backed strongly by the International Finance Corporation (IFC), which is now actively supporting the provision of this type of facility to distributors in low-income, emerging market countries in regions that include Africa and the Middle East.
“Industry practice clearly shows that strong commitment by an anchor corporate is key to the success of distributor finance programmes,” says Nevin Turk, principal investment officer, trade and supply chain solutions department at the IFC.
She explains that the distributor financing schemes in which the IFC is involved are generally structured as risk-sharing facilities with an anchor manufacturer/seller and intermediary banks.
“In distributor financing programmes, the IFC offers funded or unfunded risk-sharing facilities to banks for up to 50% of the risk,” she says. “In most cases, the structure will include a contribution by the anchor seller in the form of a reserve, a counter-guarantee or a first loss, which results in more attractive pricing for the distributors and sub-distributors.”
IFC offers strong support for distributors
The IFC has taken a lead in the provision of credit to distributors in emerging markets in Mena through its support for financings on an individual project basis since 2006.
Ultimately, internal approval will be sought for a global distributor financing programme, valued at an estimated US$250-500mn.
Today, the organisation is focusing primarily on distributors in all emerging market, low-to-medium income economies in key sectors that include agribusiness, food and beverages; health; infrastructure, IT and telecoms; climate change/energy efficient machinery and equipment; and fast-moving consumer goods.
According to the IFC’s Nevin Turk, the key goal is to increase access to finance for SME distributors in emerging markets, many of which have not been able to tap into such facilities in the past.
“Through distributor finance, SME distributors and sub-distributors will be able to obtain short-term working capital finance. For some of the sub-distributors, this will be the first time they may have access to credit,” she says. “Distributor finance programmes will supplement the availability of credit by providing a financing solution that builds upon and strengthens linkages in corporate value chains.”
The IFC believes that the provision of distributor finance will improve the financial sustainability of SME distributors in emerging markets, enabling them to grow their business volumes with lower capital requirements. It will also aid private sector development in lower income countries.
“We also believe that distributor finance programmes will confirm that the SME sector is a viable and profitable segment in the lending market, thus encouraging other banks to also consider offering finance to this under-served sector,” adds Turk.
The IFC’s support for distributor finance is complemented by advisory services to distributors and sub-distributors which aim to add value, improve their financial sustainability and mitigate credit risks.