Trade & Supply Chain

Trade winds

Published: Apr 2016
Old windmill at dawn in Australia In recent years, trade growth has failed to outpace the rate of global economic growth, for the first time since 1985. The impact of this has been felt in Asia especially, as the world’s most vibrant trading region, impacting both its economies and companies alike. In this article, we look at what corporate treasurers can do to navigate the business through these difficult times, and also how new technology is transforming trade finance.

The MSC Oliver – the world’s largest containership – is a feat of human engineering. At just under a quarter mile in length and with a payload of 19,224 twenty-foot equivalent units (the standard size of a shipping container) – 39,000 cars in real terms – the liner bookmarks another chapter in the race to build bigger and better vessels. It was built partly to meet the expected increase in global trade volumes, or at least that was the expectation when the ship was ordered a few years previous in 2013.

At that point the Baltic Dry Index (an indicator of the cost of moving major raw materials by sea, and an index intrinsically linked to world trade volumes and the health of the global economy) had been steadily climbing, reaching its highest level since 2010. But since then, the index has fallen to its lowest level since the 2007-08 crisis (see Chart 1 below). The result: bigger vessels, but less cargo to ship.

Chart 1: Baltic Dry Index 388.00 0 (0%)

Chart 1: Baltic Dry Index 388.00 0 (0%)


The slowdown in global trade stems from numerous areas including the drop in commodities prices and the general malaise of the global economy. Asia’s economic slowdown in particular is having a detrimental impact on global trade given its position as the world’s most vibrant trading region. The impact on corporate profits has been noticeable and many are now refocusing their efforts to ensure the business can successfully navigate these choppy waters.

Shifting Asian trade

Since the late 1980s trade has undergone a seismic shift, the likes of which have not been seen since the industrial revolutions in Europe and the US. Central to this has been Asia and its emerging markets (EMs), which have opened up their economies to trade and looked to leverage technological advancements to allow their businesses to grow. Many have specialised in certain areas, to become a vital part of global supply chains – particularly around low-value areas.

Corporates around the world have been incredibly receptive to these developments, and the low cost of labour offered in EMs. They have transformed their supply chains, adopting the vertical supply chain model. In this model the basic functions of the production cycle are outsourced to countries with low labour costs, whilst the higher-skilled functions are kept in traditionally more developed countries.

Apple’s world famous supply chain provides a good example of this method. Its products are designed in the US, the components and materials are sourced from various countries around the world including, Thailand, Malaysia, the Philippines and Japan, to name but a few. These are then shipped to China where the product is assembled before being shipped around the globe.

China, with its vast population, has been at the heart of this trend. Corporates from around the world, like Apple, have therefore extended large parts of their supply chains to the country, seeing it now produce nearly 25% of global goods and account for roughly 11.5% of global exports. The rise of China as a trading behemoth is staggering: in the 1990s the country produced less than 3% of global manufacturing output by value. However, since joining the WTO in 2001, which proved to be the catalyst for economic and trade policy reforms, China has propelled itself into being the world’s biggest exporter and third largest importer.

But, with the vertical supply chain model being built on low-cost labour and materials, an interesting phenomenon has been created where manufacturing shifts once a country reaches a certain economic level. This has already seen Korea and Taiwan, for instance, morph from low-cost manufacturing centres, to developers of sophisticated products and services.

China is now arguably at this stage as it looks to reinvent itself to a country focused on investment and domestic consumption, subsequently reducing its reliance on manufacturing and trade. We may therefore begin, and in some cases are already, seeing trade flows gradually shift east towards ASEAN and the Indian-subcontinent and perhaps eventually even out of Asia and into Africa and Latin America – in some instances, there is already evidence of this with Nike being one of many businesses to move some of its manufacturing to Vietnam from China.

Corporate cover

Although corporates have undoubtedly reaped many cost benefits from the vertical supply chain model, it has also increased their complexity and risk, especially when dealing with companies in EMs. Non-payment, fraud, corruption, geopolitical disruption and natural disasters are just a handful of the potential threats a company can be exposed to. As a result, corporate treasurers have placed an increasing emphasis on understanding their trade flows and counterparties and the trade instruments that they use both to finance trade and to mitigate risk.

Although globally speaking trade is moving towards the open account as a result of the strategic nature of the supply chain, in Asia, the letter of credit (LC) remains a fundamental tool to mitigate the risk. This is especially true, according to Shivkumar Seerapu, Regional Head of Trade Finance, Asia Pacific at Deutsche Bank, when one leg of the trade involves an EM company and is of significant value. “If there is a big commodity company exporting its product to a Chinese company which they are unfamiliar with, then they would likely use an LC,” he explains. “This enables the exporting company to mitigate any counterparty risk and also put financing structures in place if required. In doing so, corporates can bridge the credit risk but also mitigate any financing or working capital issues.”

SWIFT data, as outlined in the ICC Global Trade and Finance Survey 2015, confirms this, highlighting that LCs are used in Asia more than any other region, accounting for 70% of global LC imports and 76% of LC exports. The countries that used the LC instrument on SWIFT the most are Bangladesh, China, South Korea, India and Hong Kong (see Chart 2 below).

Chart 2: SWIFT MT700 import and export traffic by region

Source: ICC Global Trade and Finance Survey 2015 and SWIFT data

But LCs come at an operational cost and can be burdensome for the corporate treasury – one of the reasons that many have shifted to open account. However, for those deals that require the cover offered by an LC, a more efficient option is available, the Bank Payment Obligation (BPO). These instruments provide the benefits of an LC, but with the efficiency of digital solutions due to data being matched electronically using ISO 20022 messages and SWIFT’s Trade Services Utility (TSU).

Asian banks have been leading the charge in this space, including ANZ and Westpac who were the first banks involved in a BPO+ transaction – a BPO that utilises straight-through electronic documentation end-to-end. Despite initial growing pains, it is hoped that the solution will gain more traction and become more relevant to corporates of all shapes and sizes in the coming years.

Shortening the supply chain

Away from paying close attention to the instruments that are used to mitigate the risk in trade transactions, corporates are additionally ensuring their supply chains are not creating unnecessary risk for the business. Over recent years in Asia, there have been numerous events that have caused disruption to the supply chain for businesses including the political uncertainty in Thailand and also the devastation caused by Typhoon Halong, which reportedly impacted corporates to the sum of over $10bn.

As a result of the increased risks, some firms have begun to question whether the costs of outsourcing certain essential stages of the production process may outweigh the benefits. “Counterparty risk and ensuring the integrity of the supply chain has become a major focus area for businesses,” says Seerapu.

To counteract this, Seerapu sees some corporates implementing strategies to mitigate the risk. “Some clients are looking to consolidate the supply chain and focus on one, or a small number of key suppliers,” he says. To date this has been a prominent trend in the technology sector, but “other sectors have begun to follow suit allowing them to focus on their key suppliers and affording them the ability to better manage these relationships and the risk associated with them.”

Improving supply chain efficiency

That being said, a supply chain can only be shortened so far. And for many businesses the benefits of a virtual supply chain far outweigh the costs – it is estimated by Forbes, for instance, that it would cost Apple $4.2bn to onshore iPhone manufacturing to the US. But, with the current market environment increasingly forcing corporates to focus on the top line, something has to be done.

“If you assume that the current downturn is here to stay, for the short term at least, operating efficiency becomes even more critical to business operations,” says Vishal Kapoor, Asia Pacific Regional Trade Head, Treasury and Trade Solutions at Citi. “Corporates need to focus on improving efficiency, particularly around cash flow and working capital management (WCM).”

A prudent way to achieve this, according to Kapoor, is through implementing a supplier finance solution – which many in the market refer to under the generic banner of ‘supply chain finance’ (SCF) – as a way to improve WCM efficiency whilst also helping to maintain the health and integrity of the supply chain.

Whilst these solutions appear in many guises and with slightly different names, their primary aim is to be a win-win for both the buyer and supplier through utilising the buyer’s credit rating (which often tends to be stronger than that of the supplier) to extend finance from the bank to its suppliers. As a result, the seller agrees to an extension in payment terms – thus helping improve the buyer’s days’ payables outstanding (DPO) metrics without financially impacting the supplier. It also offers the opportunity for the corporate to be much more strategic in their approach to supply chain management and often fosters stronger relationships.

Asia at present, however, is in a unique position. Despite the economic downturn and the slump in demand the region is awash with liquidity, as banks that are having limited opportunities in their home markets are turning to Asia. And trade, being one of the most familiar products that a bank can offer, is where banks are focusing their efforts, compressing spreads and allowing corporates of all shapes and sizes to access cheap bank funding.

On-boarding onto SCF solutions may therefore not be a top priority for a supplier at present. But Kapoor suggests that this should not deter corporates. “The value of these solutions will become even more prominent when the liquidity dries up because SMEs will find it hard to access cheap funding.” Act now is the message. “These programmes take time to set up, you have to build the solution and get internal and external buy-in to the programme. There needs to be a long-term vision when developing trade financing solutions,” adds Kapoor.

Trade goes digital

It is not only market realities that are boosting the usage of SCF solutions. The broader digitisation of the trade space is also having a significant impact. “Real-time visibility over cash flows across multiple jurisdictions has become a key requirement for corporate treasurers,” says Michael Lim, Head of Trade at ANZ. “Corporates have therefore invested in digital products that provide this visibility, primarily over their cash and payments, through a single window.” Lim points out however, that the heavy use of paper in trade finance means that, for the most part, treasurers are unable to view their trade activity in the same way, requiring the data to be manually uploaded and managed.

As a result of this, banks and corporates have only been interested in offering SCF solutions to their key counterparties. The remainder, which are dealt with in lesser volumes, were excluded, as the benefits did not outweigh the costs. To bridge this gap a number of fintech companies have developed digital platforms enabling corporates to manage their trade finance and deal with multiple banks through a single window – making it easier to penetrate further into the supply chain.

Lim advises that corporate treasurers look to leverage this technology to create further efficiencies and reduce risk. “Corporates who have adopted digital trade solutions have been able to reduce payment cycles by a significant number of days,” he says. “Moreover, adopting these solutions and pushing them down the supply chain will drive down the associated costs, making them more accessible to the mid-market and small and medium enterprise – ultimately benefiting the industry as a whole.”

Banks, according to Lim, also need to focus on this space more broadly. “These fintech companies are rapidly evolving their solutions which can potentially reduce the amount of direct interaction between banks and their customers,” says Lim. “As an industry, banks are beginning to understand that only by investing in digital trade solutions, will they continue to play a significant role in intermediating international trade. Digital trade solutions also offer banks increased visibility over the end-to-end physical and financial supply chain, making it possible to intermediate in the chain at a much earlier stage than they do today, thereby giving them a greater role in the process.”

Whilst this is digitisation that corporates can take advantage of now, there may be further even more revolutionary products entering the market soon. As Lim explains, “Distributed ledger has the potential for banks to settle trade transactions on a real-time basis. This will be a game changer in trade finance – making it more efficient for corporates. However, this technology is still nascent and we are at least a couple of years away from a working large scale solution.”

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