Treasury Today Country Profiles in association with Citi

The new trade paradigm in ASEAN

Abstract technology background

Here marks the beginning of a new dawn for companies trading in the ASEAN region. China may remain the dominant player across most markets in South East Asia – for now. But the upsurge in intra-ASEAN trade has been the biggest story in the region over the past few years. With the imminent arrival of ASEAN Economic Community, this trends looks to accelerate even further in the years to come. In this article, we ask what the new trade paradigm will mean for corporates and the demand for trade solutions in the region.

Later this year there will be an economic shake-up the like of which has never been witnessed before in Asia. Yet, for all the excitement around the birth of the ASEAN Economic Community (AEC) and the prospect of greater intra-regional trade on the horizon, the economic data appears to indicate that this ambition will not be realised overnight.

Boosting intra-ASEAN trade is important, for obvious reasons. All countries that – like China and India – boast a high share of global trade have one thing in common. The share of business being done with countries in close proximity to them is considerably higher than their counterparts. In the European Union (EU) and the North American Trade Association (NAFTA), for example, intra-regional trade currently averages around 50%. In ASEAN, the figure is not even half that.

Speaking about the soon-to-be established AEC at a recent trade summit, the Singapore Foreign Affairs and Law Minister, K. Shanmugam acknowledged this reality, and called upon the region’s leaders to step up to the challenge and make the elimination of trade barriers a priority of the new AEC in the coming years.

“What does [the AEC] mean for our people?” K. Shanmugam asked delegates. “It must increase trade. It must increase the economic relationship.”

Breaking down barriers

Although the ultimate goal is still some way off, recent ASEAN trade figures should make encouraging reading for K. Shanmugam. Ahead of the birth of the new AEC, an area which promises the freer flow of goods, services, investment and labour, trade between ASEAN economies has been rising. In fact, in recent years it has grown at a considerably faster rate than extra-ASEAN trade, boosted by the fact that the promise of integration has led a number of the region’s large multinationals to establish offices in regional hubs to support their trading activities. Faster intra-regional growth can be seen as a positive sign, even if it’s building, of course, from a much lower base.

“Countries in the ASEAN region seem to be buying and selling more to one another,” says Sonal Priyanka, Regional Head of Trade for South East Asia, India and the Middle East at Societe Generale. “It is being driven partly by the promise of ASEAN integration under the Asean Economic Community and the consequent loosening of trade barriers in some of the markets.”

New trade flows

Economic integration is only part of the story however. To gain a better understanding of how and why ASEAN trade flows are changing, one must look at another macroeconomic trend taking place in the region; a shift in the types of goods being exported from ASEAN.

For much of the early part of the millennium, export of intermediate goods – products used in the eventual production of a finished good – was the dominant trade flow from ASEAN. This is now changing. “There is a lot more export of finished products from ASEAN now, as more and more multinationals (MNCs) are using ASEAN directly as part of their international supply chains,” says Priyanka. And this is all leading, she explains, to “a shift from the sale of unfinished goods to finished goods.”

Countries in South East Asia are no longer simply sub-contracting from main suppliers in China, sending their intermediate goods for final assembly in China. As China becomes less attractive to some MNCs as a supplier of finished products, these MNCs are looking for alternatives, and ASEAN is rising as an alternate low-cost producer to China.

This trend is part of the region’s natural economic evolution, explains Simon Constantinides, Regional Head of Global Trade and Receivables Finance Asia Pacific at HSBC. “ASEAN is an economy with $2.4 trillion of GDP and 640 million people. It has vast natural resources and considerable manufacturing capacity. And now you’ve got good pricing from a labour cost perspective also,” he says. “I think that is driving a lot of the activity we are seeing combined with certain government intervention to improve FDI opportunities and promote a more flexible environment for cross border trade. So I think it is the natural evolution and growth of the emerging markets within the ASEAN block.”

As ASEAN’s role in the international supply chain changes, new trade relationships are beginning to blossom. Japanese investment in South East Asia, which has boomed in recent years, is one example, explains Priyanka. It’s been a remarkable resurgence. According to Dealogic, the value of mergers and acquisitions executed by Japanese companies –auto industry firms particularly – in ASEAN rose to $8.2 billion in 2013, a level not seen since the mid-1990s. “We are seeing growing Japanese interest in the region at the moment,” she says. “A lot of Japanese corporates are now setting up their manufacturing operations here, away from the traditional manufacturing hub of China, due to cost and other reasons.”

Despite the recent excitement around Japan, there is still only one economic powerhouse when it comes to trade in the region. ASEAN is now the fourth largest destination for outward investment from China, accounting for more than 60% of the country’s foreign direct investment (FDI) volume. Given the structural changes being witnessed in both ASEAN and China the nature of the goods being exchanged has changed, but China’s importance as a trading partner has never waned. On the contrary, increased trade flows can be seen in some countries. Trade flows between Malaysia and China, for example, grew from RMB 128 billion in 2009, to over RMB 203 billion in 2013. More broadly, annual bilateral trade between China and ASEAN’s ten member states is expected to rise $1 trillion by 2020.

Banks know they cannot afford to stand still in the face of these big changes now transforming the region. The new trade paradigm that can be seen emerging is creating new demands for trade solutions in the region. To meet these demands, banks have had to respond with a range of new solutions using a broader range of currencies and new forms of financing aligned with new ways of settlement.

New trade flows demand new solutions

In ASEAN, like in much of the rest of Asia and the world, there has been a pronounced shift from traditional instruments such as the Letter of Credit (LC) to Open Account settlement. “There has been a steady growth in the documentary trade business, with a rise in Open Account trade amongst Asian corporates,” says George Fong, Asia Head of Trade Product Management and FI Advisory at J.P. Morgan.

Although this trend is not unique to ASEAN (80% of trade is now settled on Open Account globally), Fong believes it to be closely linked to recent developments on the ground, such as the growth in intra-ASEAN trade and the new financing needs this is generating amongst both Western and, increasingly, Asian multinationals. “We definitely see those local factors helping switch the terms of trade from instruments like the LC to Open Account or other negotiable trade instruments.”

But despite the ongoing decline of the LC, one of the biggest impediments to intra-ASEAN trade remains paper documentation. Trade finance in ASEAN remains highly paper-intensive, something which obviously slows down the whole settlement process. Electronic trade solutions, meanwhile, can offer both better business flows and improved security for corporates in the ASEAN region.

In 2013, the announcement of new International Chamber of Commerce rules to govern the use of the Bank Payment Obligation (BPO) raised industry hopes that such archaic instruments may soon be consigned to the history books. However, almost two years on, it is clear that this was never going to happen overnight. For the time begin at least, the BPO is only being used by a select handful of large corporates – mostly in the commodities space – and for everyone else with trade finance needs, manual, paper-based processes remain very much the order of the day. “Paper-based trade most certainly dominates still,” says HSBC’s Contstantinides. “The BPO is not a widely adopted capability within ASEAN yet,” he adds.

Why are electronic trade solutions such as the BPO finding it so difficult to get off the ground? Now that there is more legal certainty around the solution following the creation of the ICC rulebook, answers must be sought elsewhere.

Global banks have, on the whole, been very supportive of the BPO. That is all very well if you’re a treasurer for a company that is banking with one of these large, sophisticated organisations. But that’s far from the norm in ASEAN, MACT’s Azmi Abdullah, Group Treasurer of Genting Bhd and Malaysian Association of Corporate Treasurers (MACT) committee member points out. “The regional banks that dominate the banking scene in ASEAN will have to step up their efforts to automate some of these trade finance solutions in the coming years,” he says. “The global institutions, who are very selective in their clientele, still lead the business of providing trade solutions.”

The dematerialisation is certainly an important issue for corporates in the region of all shapes and sizes and it’s one which we will return to and explore in more depth in the next issue of Treasury Today Asia. Now, though, we will consider how trade in ASEAN is becoming less dollar-centric, shaped by China’s supremacy in the region and the recent efforts of its regulators to gradually liberalise the renminbi (RMB).

Rise of the redback

For any company doing business in China today – ASEAN domiciled or otherwise – settling trade transactions in RMB might make a lot of sense since it can reduce risk naturally, offering opportunities for hedging without having to go through a third currency.

It’s not surprising then that, given the growing opportunities for corporates to move RMB in and out of China now, settling in RMB is becoming an increasingly popular option. This phenomenon is bigger than China, of course. Ask any treasurer in the world today and most will tell you that the RMB is assuming an ever greater role in trade settlement. This anecdotal evidence is reinforced by recent data. The RMB now stands as the seventh-ranked global payments currency and accounted for 1.72% of global payments, an all-time record (see Chart 1). In September 2014 alone, the value of RMB global payments increased by 13.2%, well above the average 8.1% growth for all currencies.

Chart 1: RMB as world payments currency in value
Chart 1: RMB as world payments currency in value

Source: SWIFT Watch

ASEAN has been a part of the RMB’s rise, as much as any other country. RMB usage by ASEAN countries has, according to data supplied by Bank of America Merrill Lynch, doubled (+103%) year-on-year with an estimated FY value close to RMB 2.6 billion. “This is a significant move in anyone’s language and it shows that ASEAN trade is supporting RMB internationalisation confidently,” says Kuresh Sarjan, Head of Trade and Supply Chain at BofA Merrill. “Overall, the RMB has consistently strengthened its position in a relatively short period of time,” he adds.

Tomorrow’s ASEAN

In less than 12 months’ time, ASEAN will open a new chapter in the history of its economic development with the creation of the AEC. Significant obstacles still stand in the way of this ambition, however, with the region still notorious, of course, for economic protectionism and stringently regulated financial markets.

But the incentives for ASEAN nations to overcome these obstacles are truly enormous. If the promised AEC succeeds in accelerating recent growth in intra-regional trade, the benefits it will bring for businesses operating in the region will be very significant indeed. Recent analysis conducted by the McKinsey Global Institute (MGI), for example, found that greater integration could translate into productivity benefits worth up to up to 20% of the cost base for some ASEAN manufacturers.

Corporates, of course, will want to be prepared as much as possible for the new opportunities that will be coming their way after 2015, looking at how changing regulation might impact the currencies they can and cannot use and the trade solutions available to them. It’s going to be a busy year for treasurers.