whitepaper trade finance re-evolution
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Trade Finance Re-Evolution
Authors
Shankar Sundaramoorthy
Practice Head - Banking Practice
&
Harishankar K
Consultant - Banking Practice
iGATE Global Solutions Limited
158-162 (P) & 165 (P) -170 (P) EPIP Phase II
Whitefield Bangalore -560066, INDIA
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Table Of Contents
I. Executive Summary............3
II. Trade Finance Cycle - Primary Players .....4
III. Key Challenges ..................4
IV. Global Trade Current Trends...............5
V. Trade Finance Re-evolution to Open Account Management.......5
VI. Open Account Management- Functional Approach....................10
VII. Trade Finance BPO Model......................12
VIII. Benefits...............................13
IX. Conclusion.................................14
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II. TRADE FINANCE CYCLE PRIMARY PLAYERSBuyers are the primary drivers of Trade finance. They are largely responsible for shaping
consumer demand for the products they wish to sell. They are also the first in the chain to feel
the pressure to reduce costs in a market. The raw material prices keep rising but consumers
expect prices to keep falling in this new world of large retail chains.
Suppliers need good trade finance in place. As the company that manufactures the goods,
they not only feel the current increases in the raw materials, energy, and labor costs but are
traditionally hurt the most since they need to bear the brunt of the cost and typically go the
longest between the initial outlay for raw materials, overhead, labor and the day they finally
get paid for producing the product.
Financing Institutions play the role of lender in global trade finance and offer various types
of financing. This includes a number of trade financing services including Letter of Credit,
Collections, Stand-by Letter of Credit, Pre and Post shipment finance, Bill Discounting and
Purchase, Bank Acceptances.
Transporters or Logistics providers cater to the physical movement of goods, and can
provide visibility to all the constituents by updating the transit records of the goods shipped.
Their internal systems when integrated to a trade finance solution can give an authenticated
record of the goods shipped. Their current location and expected delivery time enables not
only buyers and sellers to update their records but will also act as a risk mitigation tool for a
financial institution on the finance provided.
III. KEY CHALLENGES Lack of an integrated platform for all players.
High Turnaround time due to delay in physical transport of documents between
parties.
Difficulty in reconciling positions for Buyers and suppliers due to lack of a
dashboard which reflects current payables / receivables position, and a history of
recent transactions.
Value of Market Knowledge: KYC
Risk and Compliance
Cost-containment Pressure
High logistics costs.
Inefficiencies due to multiple documents and manual system of keeping records.
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IV. GLOBAL TRADE FINANCE TRENDS International logistics cost 6%-11% as a percentage of revenue.
Average transit times are 40+ days with 12 or more hand-offs creating logistics
black holes.
Variances to budget for landed cost are greater than 10% nearly half the time.
1 out of 5 international shipments are out of compliance with order or routing
instructions.
66% manage global trade using paper and spreadsheets.
Source: Aberdeen Group, Survey of 400 Companies engaged in Global Trade
V. TRADE FINANCE RE-EVOLUTION TO OPEN ACCOUNT
MANAGEMENT
OPEN ACCOUNT TRADING
End-to-end financing solutions are collectively referred to as supply chain financing.
Addressing complex commercial trade flows and multiple counterparties and various
geographical locations has not been the objective of traditional trade finance products.
Accordingly products, simplistic in structure like letters of credit, trade loans based on the
strength of one counterpart were used traditionally for financing these flows. Importers
however, notwithstanding the availability of these products as financing options, have
increased their demands for new answers that address the dynamically changing business
environment more holistically, for e.g. end to end financing and open account trading.
Incorporation of the banks into the trade finance process providing greater stability, flexibility
and transparency plus the complete integration of physical and financial supply chains are
major global trade market innovations in the industry today.
TRADE FINANCE TO OPEN ACCOUNT TRADING ROADMAP
With the growing trend of globalization, Corporates, increasingly sourcing from suppliers and
selling to customers far away from their traditional home markets has become a growing trend
with globalization. The concept driving this is called lowest cost country sourcing, where
corporates are willing to set out larger distances to procure goods or services at the lowest
possible cost. Advanced communications, Internet tools and ease of travel are opening up
fresh avenues for importers and exporters for identifying and carrying out businesses with far-
apart counterparties. Thus trade finance banks therefore are re-constructing their value
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proposals to meet the dynamic needs of their corporate customers, in this new global
environment.
Risk-mitigation, cost reduction with aggressive financing options and transformation of
business process from paper-based trading towards cheaper electronic documents
processing and exchange are concepts where major trade banks have an important part to
play, considering todays global environment. The emergence of new attractive financing
techniques for the benefit of buyers and sellers from banks is an example of this evolution.
We will explore in this article the vital steps being adopted by todays banks for delivering
value to their corporate clients and dwell upon the concept and features of Open account
management.
At the outset, the below comparison puts in place the various trade functions performed
through traditional trade finance products and how the same can be adapted in the Open
account style.
Global Trade Solutions
Letter of credit Documentary collection Open account
Post shipment finance
Confirmed acceptance LC: Exporter receivesnon-recourse payment on presentation ofcompliant documents.
Discounting accepted bill ofexchange: Exporter receivesearly payment.
Payer centric reversefactoring: Based on buyer-approved invoices, supplier sellsreceivables to bank withoutrecourse.
Deferred payment LC: Exporter receives non-recourse payment on presentation of compliantdocuments.
Advance against collections:Exporter receives with recourseadvance of a percentage ofcollection.
Supplier centric receivablesfinance: Bank discountsreceivables, often backed bycredit insurance.
Negotiating bill under unconfirmed LC:Exporter receives advance on presentation ofcompliant documents.
Discounting bank avalisedbill: Exporter receives non-recourse payment.
Export factoring: Exporteroutsources collection process tobank/factor and receivesadvances against a percentage
Cash in
Advance
Doc
Collections
Letters of
Credit
Supply
Chain
Financing
Open
Account
Traditional Risk
Mitigation & Financing
Tools
New Risk Mitigation &
Financing Tools
Traditional to Open Account Global Trade and Supply Chain Finance
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of sales turnover.
Bill discounting under sight LC: Exporter ispaid at sight using proceeds from bill drawn byimporter on his bank.
Forfaiting: Exporter of capitalgoods receives up-front non-recourse payment againstpromissory notes or billsavalised by importer's bank.
Dealer finance: Exporter is paidon shipment, while dealers paylocal bank direct from salesproceeds. Significant local bankpresence advantageous.
Pre-shipment finance
Red clause LC: Exporter receives advance fora percentage of LC against specifieddocuments.
Confirmed purchase orderfinance: Exporter receivesadvance for a percentage of PO.
Receipt & undertaking LC: Exporter receivesadvance against receipt and undertaking.
Inventory finance
Import loan (at back end of sight LC) backedby warehouse warrants or trust receipts infavour of bank: Importer obtains advance topay exporter pending receipt of salesproceeds.
Event triggered finance:Logistics companies can controlgoods in transit to the order ofthe bank as security for finance.
Risk mitigation/Transactional control
Import LC: Importer only required to pay ifcompliant documents received by bank provinggoods shipped.
Documents against payment:Documents only released toimporter on payment of bill ofexchange.
Matching: POs, invoices andgoods received notes.
Confirmed export LC: Exporter receivesguarantee of payment from local bank againstcompliant documents proving goods shipped.
Documents againstacceptance: Documents onlyreleased to importer onacceptance of bill of exchange.
Tracking and control of goods:movement by logisticscompanies:
Transferable LC: Beneficiary can transfer LCto one or more new beneficiaries. Used whenfirst beneficiary acts as middleman/does notsupply goods himself.
Advanced Payment Guaranteeand or Progress PaymentGuarantee: protect importer whomakes advance payment beforecompletion of contract.
Back-to-back LCs: Two separate LCs wherefirst LC acts as 'security' for second LC aspotential source of repayment. Used by traderswho buy and on-sell goods
Standby LC: Enables open account trade,under bank guarantee to pay against specifieddocuments.
Efficient processing
Upload of electronic POs to create import LCs;on-line amendments.
Electronic advice, review andacceptance of documents.
E-invoicing, electronic POdistributions, PO flip; documentmatching.
Electronic advice and review of export LCs. Document scanning andelectronic archiving.
Source- www.gtnews.com
For successfully competing in todays global trade world, trade finance banks need to
innovate a wide-range of pre-shipment, in-transit and post shipment finance techniques. Open
account finance techniques are increasingly becoming popular along with the traditional trade
instruments to sustain actively in these scenarios. Such product delivery techniques
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combining traditional and open account management products leverage a lot on web-based
solutions for the benefit of importers and exporters.
Delivering the Greatest Value through Open Account Management
The key elements of trade finance are:
Working capital gap needs to be bridged using bank finances to improve cash flows
for sellers and buyers.
Control of trade finance transactions and Risk mitigation with respect to country risk
and counterparty risk.
Foreign exchange services and cash management of international payments and
collections.
Post the negotiation of the sales contract, the buyer and seller generally agree to the
International terms and guidelines of trade Finance. Views of risk are however opposing for
the importer and exporter because the terms of trade satisfactory to one party may involve
high risk for the other party. The below Risk Ladder illustrates the existing natural tension
between importers and exporters objectives depicting that the measures of transactional
control or security for the seller and the buyer are diametrically opposite in nature.
Risk Ladder
Source- www.gtnews.com
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The terms of trade adopted would also be importantly influenced by the commercial practices
in the countries involved, e.g. EU and US normally practices open account whereas LCs are
more popular in Asia, Middle East, Africa and Latin America.
Increased movement towards open account and shifting away from the usage of traditional
LCs and documentary collections (accounting now for not more than 20% of international
cross-border trade) is one of the remarkable trends identified in the recent global trade
scenario.
The Open account management architecture needs sound understanding mechanisms to
support the needs of large-scale aggregation and distribution of information arising from
business documents (orders, invoices) and physical events (inspections, certification). iGATE
has abundant expertise in these Open account management concepts and understanding the
interfacing of the Open account management with the Trade Finance application. iGATE
strongly recommends a Trade Finance solution premeditated to be run as a service, rather
than positioned as organization software.
Hence we are uniquely fitting for strategic partnerships with Financial Institutions and other
organizations such as trading groups.
We support the provision of secured and reliable visibility to trade transactions for multiple
interested parties through the aggregation and matching of business documents across
multiple organizations.
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Hence we facilitate:
trade services transactional offerings to finance providers e.g. payments, factoring, asset-
backed lending for multiple transactions
improved supply chain finance management to buyers
provision of speedy working capital sources through new avenues to vendors
depict pipelines of transactions to finance providers for offering proactive services to
customers
VI. OPEN ACCOUNT MANAGEMENT MODEL
FUNCTIONAL APPROACH
Open Account Management is key to the holistic view of trading events: it is what allows
service providers to predict and offer Trade Finance Requests as needed and on an On-
Demand basis. If the bank is the provider of the Open Account service, then the bank has the
unique ability to provide the trade financing based upon the data and documents available.
Furthermore, the automation of the full Open Account process enables service providers to
move beyond process outsourcing and offer exception-based visibility services. In the years
to come there will be a paradigm shift from a paper-based, batch based model to an
exception-based, on demand model and the services need to start now based on current
technologies.
iGATE supports a Trade Finance Information associated solution that can be deployed across
multiple companies and organizations in order to track location-wide business documents and
events work-flows through the construction of a demand model.
Service providers would be enabled through such technologies to present Open Account
Management services beginning with undemanding processes like invoices matching and
then expanding to full suite of Open Account Management services. The whitepaper also
aspires to describe briefly a similar solution and observe the merits of deployment of such a
concept.
Requirements of each individual customer should be the main dependency criteria while
rolling-out any Trade Finance Information. Aggregation of business and physical documents
from multiple locations in order to construct a documents repository to be matched against a
well-defined and configurable workflow pattern (reconciliation) is one of the major
requirements. Additionally, it is also required to define for trade transactions, an n-level
workflow as a preparation for matching and reconciling the occurrence of events during each
trading step.
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Such an approach would assure below benefits:
Completeness and improvement in terms of visibility into the trading and shipping activities
Capability for creation, management and distribution of business and physical documents to
shore up Open Account Management services
Ability for reconciling during each of the n-step trade events in the business processes
Enhanced transactional clarity and detection acting as a basis support for financial activities
Key milestones in the trade cycle which can potentially serve as triggers for finance include:
Purchase Order (PO) issuance.
Manufacturing status verification
Inspection and content verification of independent goods.
Transit of goods (i.e. bill of lading/air waybill).
Goods Warehousing.
Issuing of invoices.
Note for Goods Received.
Invoice(s) reconciliation against PO and Goods received note.
Invoices approval.
Future-dated payment files approval.
Undoubtedly, the two most accepted trade event triggers, amongst the above possible
milestones have to be:
Purchase Order Issuance for Pre-shipment finance
Post shipment finance through approval of invoices
In cases where at the issuance of the PO, the importer confirms his acceptance to pay the
contracts face value is known as Finance against confirmed Purchase Order. The bank
thereby is enabled to advance a percentage of Purchase Order value to the exporter, which
the latter utilizes to for procurement of raw materials and goods manufacturing (in agreement
with the Purchase Order). This is a type of pre-shipment finance which can become a pre-
condition for the exporter to accept a movement towards Open Account thereby replacing
Letters of Credit used to obtain local finance. Event-triggered finance can be furtherdeveloped into Goods-in-transit financing where the location of the goods in a distribution
center or in-transit is controlled and monitored by a logistics company (using its transportation
capabilities). Here again the importer can mitigate his risk in providing finance for the goods
thus making this type of a transactional control a competitive financing method.
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VII. TRADE FINANCE BPO MODEL
IGATE extends the scope of BPO merits further than mere cost improvements to a financial
institutions overall competitive advantage and is also a high-value deliverer. Cost-efficiency,
high-level industry business competency, and equipment with assets, tools for a customized
BPO solution for specific organizations are some of our salient capabilities.
iGATE offers substantial cost savings and quality improvements that can be realized throughoutsourcing consumer credit business processes, including:
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Improved quality of work and reduced re-work by drawing from a college educated
labor pool.
Reduced operating expenses by leveraging lower cost offshore labor and
infrastructure.
Faster turnaround times by utilizing offshore resources during off-peak/dark hours
in the home market.
Improved capacity management by re-aligning onshore resources to more complex
tasks and load balancing volumes across multiple shifts.
Recurring cost/quality improvements through continuous improvement utilizing
process best-practices and new technologies.
Benefit from more effective processes in customer service and collections.
VIII. BENEFITS FOR FINANCIAL INSTITUTIONS
Collaborative relationship Banks can build a stronger collaborative relationship with
clients, by widening the scope of their services to cover their customers end-to end Trade
Finance. This enables banks to improve their bottom lines, by exploring new revenue streams
and provide scope to innovate customized funding solutions.
Enhance customer retention - Customers provided with end-to-end solution which
integrates with their internal applications and workflow will become completely attached to the
Bank, as any shift of allegiance will shake up their entire procurement & collections processes.
Increased reach & customization - Our solution is a scalable model. With an integrated
solution system in place it is possible to build customization across various types of business.
It also provides for standardization of specific industry segments which if Bank requires can
become a niche player.
Expand the product portfolio offered in Trade Finance With a clear visibility of document
movement & physical movement of items. It is possible for banks to offer structured financing
solutions to their clients. Funding can be staggered to meet the finance requirements at
various stages of physical goods flow i.e. Customs clearance, duty payment, freight payment
etc.
Risk Mitigation - The biggest challenge in an open account trade is in confirming the
authenticity of transaction, and in obtaining the correct picture of the flow at any given
moment. With visibility provided by movement of trade documents through a Banks portal,
Banks are well assured on these, which reduce their risk exposure.
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IX. CONCLUSION
In todays changing world, trade finance banks are struggling hard to re-identify their role.
Although still there is an important role for traditional trade finance instruments in many
geographical markets and at beginning stages of a new trading association between parties in
distant locations; it is also undisputed that there is a shift towards open account in certain
markets and verticals.
In order to compete in the dynamic international trade scenario, today's primary trade finance
banks need to offer a full suite of pre-shipment, in-transit and post shipment finance solutions.
Trade Finance and Cash management activities are undoubtedly merging within banks, a
reflection of the customers own activities. The current demands of the customers for open
account trading solutions like e-invoicing, reverse factoring financing etc are compelling the
banks to adopt and upgrade their banking solutions. Only those banks that provide holisticproducts through a complete range of trade finance and open account management solutions
notwithstanding liquidity management and payment capabilities will be competent to meet the
dynamic needs to customers and remain successful in the industry. Whichever be the market
of operation, bringing sine qua non success to both buyers and suppliers is the elixir for
survival today.
References:
Celent.com
Gtnews.com
Tradeevolution.com