Trade finance in the Middle East is at an inflexion point. As the discipline innovates and evolves, it becomes a tool to help businesses grow, rather than being a heavy weight in the firm’s debt repayment schedule. There’s still much to be done but also much to gain.
A survey of exporters in the UAE, conducted by HSBC back in 2016 remains an oft-quoted industry standard. It found local exporters worried about insufficient margins or profitability as well as wildly fluctuating currency rates (a concern right now is the sharp appreciation of the dollar, making dollar-based trade financing more expensive). Fluctuating demand for goods was another perhaps predictable concern – as was the risk of buyers defaulting on payments.
These concerns have, in effect, dampened and limited the benefit of trade finance services. Many bank trade credits are linked to account receivables; not perhaps the most appropriate avenue given that most small and medium sized firms in the Middle East have inventory rather than a steady stream of accounts receivables.
Other issues include sometimes inadequate accounting systems that do not allow proper matching of exposure to counterparty payment cycles and the firm’s own cash flow patterns. Additionally, firms are hampered by outdated approaches to payment defaults. Traditionally, traders in the Middle East favour either secure trade products via banks to cover possible default; or opt for taking smaller orders to minimise risk. Yet others opt to conduct business on an advance payment basis only, all of which restricts potential business growth.
Added to this is the fact the cost of regulatory compliance and fraud risks have increased. Conducting due diligence and KYC (know your customer) is a necessary, but expensive, process. Even so, the cost of conducting measures such as fraud risks, due diligence, and KYC can be managed – if there are economies of scale.
Bank and insurance costs increasing
Unsurprisingly – given the increasing cost of compliance – traditional trade finance facilities provided by the region’s banks, and often backed by export credit insurance, is increasingly at a premium. In fact, such facilities are becoming scarce. International regulation and risk management requirements have contributed to the scaling back of bank financing and export credit insurance. Insurers in particular are now substantially shrinking their limits, even removing some corporate names from being insured; while banks are increasingly reluctant to extend term credits without it.
Some banks have opted for structured finance solutions as a way of mitigating risk, which is an encouraging move. Yet these are often a series of complex financial transactions that are only offered to unique borrowers, usually where business cycles are more sophisticated. Certainly, such products have so-far been unavailable to smaller firms in the Middle East.
For those smaller firms – that make up the bulk of traditional exporters in the region – bank overdrafts or lending based on account receivables are often the only available route. The overdraft is linked to the capital in the business; with terms set and renegotiated annually. Banks regularly require third party guarantees to improve security and reserve the right to demand that the overdraft be repaid at any time.
In opting for account receivables-based financing, problems can arise in establishing the creditworthiness of the customer in assigning receivables, either on a recourse or without recourse basis. Indeed, most bank trade finance facilities are linked to account receivables; but in practice will be carrying inventory on their balance sheet. Typically, the inventory asset class is considered very differently even on traditional trade finance formulas. Again, it is an inflexible and often expensive option.
A more innovative approach
All of which offers scope for a more innovative approach to financing transaction chains from new players. Unlike a business overdraft, trade finance is specific to supplier’s bills and customer invoices. This fact gives providers such as ExWorks Capital a solid base to leverage our own financial resources to help our customers, of course, backed by proper due diligence.
Providers such as ExWorks can help companies finance their supply chains where their balance sheets are already fully leveraged – perhaps when they have won an order and need working capital but have insufficient balance sheet strength to open LCs. Here, we can step in and bridge the gap between what a bank would do and what an exporter needs to fulfil orders.
This is not to negate the role of the banks. Such providers act as partners or in addition to existing banks – aiming to iron out the seasonality in the business cycle. The goal is to let the business take stock positions that would not normally sit within a standing borrowing base formula for a typical trade finance facility.
By employing LCs, standby LCs, revolving letters of credit on repeat type transactions and usance on the receivables side, the client is then in a position to extend more credit to their customer. Also, any additional costs can be mitigated by structuring transactions in ways that create much more value for the client. For instance, receivables streams can be discounted either straight from the receivables themselves, or from the LC by discounting the usance period. It is a much more sophisticated and flexible solution, as no one solution fits all cases.
And there are opportunities in financing transaction chains where there is an established relationship between trading counterparties, where we can work to augment that relationship. For instance, we might encourage a commodities client to look at the vertical relationships in the entire transaction chain, perhaps skipping the trader and going straight to the originator – achieving a better margin and thereby creating value.
Tomorrow’s trade financing toolset involves looking at more innovative ways of helping parties trade with each other and creating efficient vertical channels, with firms such as ExWorks augmenting the toolset and working with the client to enhance the firm’s financial risk management.
About the author
Christopher Ash is managing director of ExWorks Capital UK, a leading provider of domestic, import, and export trade finance products.
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