The last two decades have seen a seismic shift in global trade corridors. Where once trade was conducted primarily between developed western nations; today, emerging markets, and more specifically Asia, are now at the heart of those flows. So with trading relationships extending further afield and encompassing a broader range of companies than ever before, what has the impact been on international treasurers?

Over the course of history, global trade flows have continually shifted. For instance, in the 1800s, Asia sat at the heart of global trade until the industrial revolution propelled North America and Europe ahead, eroding Asia’s share to a fraction of what it was before. Western nations continued to dominate trade up until the 1990s when another shift began to occur, this time towards emerging markets (EMs).

EMs now account for nearly half of world exports – up from one fifth in 1990. And according to the IMF one-third of the $15trn of global trade is now conducted between emerging and developing economies, known commonly as south-south trade.

At the heart of these new (or in many cases re-opening) global corridors is Asia. UNCTAD figures suggest that Asia now accounts for over 80% of all south-south exports and that nearly three-quarters of this figure can be attributed to Asian countries trading with each other. China is the engine of the region, accounting for 11.5% of global exports – surpassing the United States in 2013 as the world’s largest trading nation.

North becomes South

The changes in global trade flows cannot be attributed to one key factor; instead they are the result of a variety of shifts and events in the wider world over the past few decades. For starters, geopolitical developments such as the break-up of the Soviet Union and the opening up of emerging economies have played a significant role. Improvements and a reduction in the price of communication technology, thanks to the rise of the internet, has also played an important role in making the world smaller and more interconnected, while the creation of trade bodies such as the WTO in 1995 has looked to regulate global trade and allow it to flow freer and fairer.

Using these developments as a springboard, EMs have blossomed as their governments have liberalised trade, recognising the economic benefits afforded to them by adopting an export-led economy. For instance, countries such as China have been able to build up their capital account balances, drive international best practices domestically, improve the productivity and standards of local firms, bring more jobs and FDI and also increase their competitiveness on the global stage.

Regional and bi-lateral trade agreements, which have proliferated in recent years, have been used to further widen the new trade corridors. Agreements such as ASEAN in 1992 and NAFTA in 1994 and the creation of the single currency in the Eurozone in 1999 are some of the headline announcements. But bi-lateral agreements between emerging nations, whilst not always widely spoken about in the mainstream press, have been just as vital. As Nick Diamond, Head of Global Corporates, Transaction Banking Europe at Standard Chartered explains: “These agreements not only offer a number of benefits including a reduction in tariffs and tax charges, but underneath the agreements there is also a clear indication by these countries to allow investment and make it easier for corporates to do business there.”

With it now easier to do business in many EMs around the world, corporates have taken the opportunity to transform their supply chains and trade policies, adopting a model known as the vertical supply chain. In a vertical chain the basic functions in the production cycle are outsourced to countries with low labour costs and the higher skilled functions are kept in traditionally more high-skilled countries – Apple’s goods, for instance, are designed in California and assembled in China.

The other popular method, the horizontal supply chain, sees parts sourced from countries with similar wage levels where specialist skills are sought after. Aeroplane manufacturer Boeing is a prime example of this, as the company imports many of their parts from highly developed western economies such as the UK, as well as Japan, before assembling the plane in the US.

Changing trade instruments

Although corporates have undoubtedly reaped many cost benefits from the vertical supply chain model, it has also increased their complexity and risk. Supply chains of today often involve dozens and sometimes thousands of suppliers located around the world. This risk is magnified when one considers how many of these suppliers are located in emerging Asian markets.

Of course, dealing with companies in EMs can be a risky business. Non-payment, fraud, corruption, geo-political disruption and natural disasters are just a handful of the potential threats a company can be exposed to. As a result of this, corporate treasurers around the world are beginning to place increasing emphasis on understanding their trade flows and counterparties. “Historically in Europe treasurers touched on trade – but many didn’t see it as something core to their function,” says Peter Jameson, Co-head of Product Management, Global Transaction Services for EMEA at Bank of American Merrill Lynch (BofAML). “In the last few years however, we have really begun to see our clients think of risk mitigation solutions through trade as a requirement.”

Corporates are placing increasing focus on the trade instruments that they use both to finance trade and to mitigate risk. Although the new corridors haven’t changed the products which are available that much – letters of credit (LCs), risk mitigation techniques, guarantees and receivables solutions are all still widely available – there has been a change in the popularity of certain products. As Baihas Baghdadi, Managing Director, Head of Trade and Working Capital International at Barclays explains: “Some decades ago, LCs and bank guarantees were the most widely used trade instruments, no matter the size of the counterparty. Today, however, they are secondary in the conversation.” The most popular solution that corporates ask Barclays for now is the open account.

It may seem peculiar that the general trend in global trade, even sometimes in risky markets, is away from LCs – tools traditionally used to mitigate risk – and towards open account transactions where there is no protection. But there is a good reason for this. Kuresh Sarjan, Head of Asia Pacific Trade and Supply Chain Finance at BofAML, explains that “we have seen lots of clients bolster their own credit functions in recent years, as a result of this they have turned counterparty risk into an art form.” In doing so, corporates have been able to move away from pricey and document-heavy LCs and towards open account. “Should there be any question marks corporates might look to use risk mitigating products such as insurance, for the extra piece of mind.” It is worth noting, though, that whilst LCs are arguably decreasing in popularity, they are still a crucial factor in trade and also can serve as collateral in transactions.

The bank payment obligation (BPO) however, may be a tool which will radically transform the trade landscape. The solution functions similarly to the traditional LC, but utilises fully automated electronic transmissions to increase efficiency and enhance risk mitigation. Since the first BPO transaction took place between BP Aromatics and Oman-based Octal Petrochemicals in 2011 progress has been slow, despite the International Chamber of Commerce issuing rules to govern the solution in 2013.

Yet, in recent months the BPO has once again moved into the headlines, thanks in part to the recent BPO+ transaction which utilised full electronic documents to complete the transactions. With these new developments it is hoped that the solution will gain traction.

The case for flexibility

Away from the instruments corporates can use, there has been an increasing focus in the years following the financial crisis around stable and sustainable supply chains as well as the need for flexibility. “Every change in the global environment brings along new opportunities but also new challenges,” says Barclays’ Baghdadi. For example, the recent political troubles in Thailand may have caused disruption to some supply chains, especially in the technology sectors. As a result of the increased risks, some firms in developed economies have begun to question whether the costs of outsourcing certain essential stages of the production process may outweigh the benefits.

“Corporates are therefore placing increasing emphasis on diversifying their supply chains and, in some cases, onshoring elements of the production process. This reduces the dependence on these suppliers and can save costs at times when oil prices are high due to the reduced need to transport the goods,” says Baghdadi. This may also be occurring, according to Baghdadi, due to the changing nature of consumer behaviour and the desire to reduce the time to market in the fast moving consumer goods sector.

Onshoring is something that Bart Ras, Global Head Business Development, Global Trade and Receivables Finance at HSBC is also seeing occur in the market. But this is not to say that offshoring is a thing of the past. “Corporates are developing hybrid supply chains that are extremely flexible. Some companies, for example, may decide to have 80% of the production process offshore to reap the benefits that this offers. Twenty percent may then be left closer to the market.” Ras is also seeing some corporates being strategic in their procurement as a way to reduce dependence on certain suppliers. “Some of our clients look to procure large volumes of stock from core suppliers, this gives them a buffer should the supplier suffer from difficulties, be it financial or otherwise. Dual-sourcing or even multi-sourcing where possible are other possible strategies.”

The changing demographics and economic situations of many Asian economies may also see corporates once again change their supply chain philosophy. As these markets modernise and become more consumer orientated, it may be pertinent to keep some manufacturing in these markets despite the increasing costs. The reason: these regional supply chains will help reduce the impact of currency volatility and also match the speed of change in client and consumer requirements. For Ras, it is those companies who really think about their supply chain and turn it into an art form that are the most successful in today’s world.

Supporting the supply chain

However, for corporates and their supply chains, there may be another risk looming. The glut of regulation that has been placed on the financial services industry, not least Basel III, has reduced the ability for banks to lend to smaller players, leaving a significant, and growing, financing gap. In Asia alone, the Asian Development Bank estimates that the gap is as much as $425bn. With key players in supply chains therefore struggling to keep their heads above water, what can larger corporates do to ensure of the health of their supply chain?

“We have seen an increased focus on the management of working capital since the financial crisis,” says HSBC’s Ras, “but what is becoming more important for more clients is the health of their supply chain, both up and down stream.” Corporates are beginning to actively monitor their counterparties’ liquidity positions and working capital to ensure they know if others are suffering from financial difficulties. This also provides insight into whether production can be accelerated or decelerated without causing difficulties.

One of the implications of Basel III, and shrinking bank lending, is that the responsibility of supporting supply chains financially is increasingly falling onto corporates. As a result, supply chain finance (SCF) is a product that many treasurers of large organisations are eager to explore. “In Asia, there is a fundamental shift towards SCF,” says BofAML’s Sarjan. “Often corporates are sitting on large cash reserves and are looking at ways to optimise this cash and in turn ensure the sustainability of their supply chain.”

The increasing interest in SCF is also occurring in Europe. “We are having lots of dialogue around the solution with our clients,” says BofAML’s Jameson. “It can be a long process and many clients have to spend a lot of time considering what it means for them, their customers and their suppliers.” Jameson is also keen to point out that in Europe there can be an important reputational angle to SCF and its impact on suppliers.

An ever-changing world

Whilst there may be a level of uncertainty around SCF, what is certain is that the importance of trade looks set to increase and corporates must make the most of changing dynamics. Big four consultancy firm EY expects that the value of global trade will continue to proliferate, predicting the total of goods traded to reach around $35trn in 2020, two and a half times the value of trade in 2010. EY also expects that the changing nature of global trade patterns, which increased following the global financial crisis, will continue.

As mentioned earlier, emerging Asia will play an ever-more critical role in global trade with manufacturing moving into the ASEAN region and the Indian subcontinent. Trade flows between China and India, for instance, are expected to account for one-fifth of global trade by 2020. We can also expect to see activity in Latin America and Africa increase as these regions continue to develop. “Africa has the potential to cause a seismic shift in global trade flows, but this will be down to a continued social, political and economic stability,” says BofAML’s Jameson. There are also lots of questions that remain around whether Africa can position itself as a low cost manufacturing region, in addition to the existing flows driven by infrastructure investment and flows of natural resources.

Of course, with the landscape continuing to evolve, support will be needed. “Every country is trying to promote trade,” says BofAML’s Sarjan. “So corporates need to be aware of the benefits and challenges posed by each market and ensure they are taking full advantage of these by adopting the correct solutions.” With this in mind, corporates should take extra care when choosing banking partners for their trade transactions, to ensure that they can support the organisation across these key markets.