Insight & Analysis

No more risky business

Published: Sep 2022

A new trade and export finance guide produced by UK Export Finance and the Department for International Trade offers some useful guidance for businesses that need to formulate a trade finance strategy.

Business person stopping jenga bricks to knock down the rest

Earlier this month, Trade Finance Global published a guide to trade and export finance in conjunction with the UK government’s export credit agency and the government department responsible for encouraging export trade.

One of the most interesting sections relates to the risks and challenges of trade finance. One of the first steps in any trade finance strategy is to determine the financial health of the companies that are being traded with. This analysis should focus on their credit rating and any history of defaults, either through non-payment or non-delivery or deficient delivery of goods.

At this point, commercial risk factors such as the quality or adequacy of the goods being traded (or the robustness of the contracts and pricing terms) should have already been carefully reviewed and amended as required.

Companies using trade finance need to check the accuracy of documentation carefully, not only because failing to do so can leave them exposed to receiving forged documents, falling victim to an insurance scam or even unknowingly engaging with a fraudulent counterparty. Missing or incorrectly prepared documents can also cause delays in shipments and ultimately delays in payments.

Risks associated with doing business with counterparties based in a foreign country mean companies need to consider the political climate in the country they are looking to do business in as well as the state of the economy, the existence of reliable legal structures, and the liquidity of the currency.

Fluctuations in exchange rates can dramatically affect payments and receipts in foreign currency.

Unless such risk is hedged, a trader has no control over the impact of exchange rate volatility and in a worst case scenario, such volatility could wipe out the entire profit and more that would have been accrued from the trade transaction.

Disruption to transport caused by the pandemic has heightened awareness of supply chain risk. Around 80% of the world’s transportation of goods is carried out by sea, which gives rise to a number of risk factors including storms, collisions and spoilage as well as theft.

Brexit is another obvious risk factor. Since the end of the official transition period, supply chains have become more diversified and inventory stockpiling has become more commonplace – both of which have led to increased use of payables finance and inventory finance.

The report also looks at the impact of digitisation, noting that artificial intelligence (AI), the Internet of Things (IoT), and distributed ledger technology (DLT) have begun to penetrate trade, supply chains, and trade finance.

Companies may be familiar with the abbreviation IoT, but might not fully understand where it fits into the trade finance landscape.

IoT describes physical objects with sensors, processing ability, software, and other technologies that connect and exchange data with other devices and systems. On their own such devices have minimal value, but when combined with the secure transmission capabilities of DLT and the analytical capabilities of big data analytics tools enabled by AI they can deliver meaningful and actionable information.

Digital technologies (in particular the combination of big data, new algorithms, and cloud computing) have driven the rise of new platforms and what is now referred to as the ‘platform economy’.

According to the report authors, the platform economy is reshaping global trade. Many of the most valuable companies globally are now based on a platform business model – such as digital marketplaces like Amazon or Alibaba – that enable groups to interact and transact. When it comes to micro, small and medium enterprises (MSME) financing, particularly for trade finance, many projects take the form of platforms.

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