Transaction services: MNCs hit by EM liquidity squeeze
Tighter funding in the emerging markets is beginning to affect even the largest multinationals. Banks are being forced to think on their feet to develop workable products to meet the new demands. Is distributor finance the answer?
Imagine you are the treasurer at one of the world’s biggest multinational corporations (MNCs). You are flush with liquidity and have banks falling over themselves to help you process payments between clients and suppliers. But you also have a global network of suppliers and dealer-distributors. Many of them are in developing markets, and right now, that is a headache.
Regulation, currency fluctuations, declining commodity prices and geopolitical risk are impacting on companies in the emerging markets and, therefore, the multinational companies for which they act as suppliers and distributors.
In this new climate, even the largest companies are facing problems that have traditionally been the preserve of much smaller, local enterprises. With local liquidity running dry, they are turning to their banking partners in search of help and are forcing their transaction service banks to step up their services.
The falling value of currencies is having an obvious impact, as Sameer Sehgal, trade head EMEA at Citi, explains: “Depreciating EM currencies cause a mismatch in payments in foreign currency and receivables in local currency, thereby creating liquidity and solvency issues for the SME. “FX fluctuations are hurting corporate value chains. No company is isolated, since even if the corporate is able to ring-fence itself, its SME dealers and suppliers are not immune and actually are quite seriously hampered.”
Some markets are feeling the strain more than others. “Liquidity is drying up, and with this, we are seeing pockets in areas such as the Middle East and Africa being affected by banks having to right-size their exposure or in some cases pull out completely,” says Sehgal. This is impacting on companies’ ability to make payments.
“Companies in some geographies are really concerned about their ability to pay on time and what the cumulative impact of late or missed payments could be,” says Sehgal. “In some markets, this is further accentuated by a severe paucity of US dollars, thereby causing further systemic delays.”
Nick Diamond, head of international corporate sales, transaction banking Europe at Standard Chartered, agrees that the impact of this is becoming an issue, especially when US dollar demand is causing headaches. “Liquidity being constrained is a hot topic in Africa, where there is a big squeeze, in particular in US dollar funding,” he says.
Dwindling reserves have seen central banks in countries including Nigeria and Ethiopia physically restricting access to dollars in an attempt to protect remaining stocks. The fall in commodity prices has had a big effect on the inflow of dollars into many countries, meaning stocks are not being replenished.
Some countries are prioritizing the release of dollars for select industries, with oil and food taking prime position. Zimbabwe has effectively started printing its own currency again after abandoning it in 2009, as supplies of hard currencies have dried up.
The falling supply of hard currency has been accompanied by the declining willingness of many banks to finance companies operating in emerging markets. And as some banks decide to withdraw their business from many of these jurisdictions altogether, gaps in financing are showing.
“Smaller-sized corporates are finding it difficult to obtain direct financing from banks,” explains Sehgal. “Balance sheets are being pruned, geographic presence is being rationalized to core markets and, overall, banks are just lending less.”
Banks also have concerns about the social and political climate in emerging markets. “The current geopolitical climate is also taking its toll on how many banks want to lend to EMs, especially as they go through challenging macroeconomic issues,” says Sehgal. “They are less willing to take that risk.”
The impact of Basel III on banks means that capital is becoming scarcer and lending more selective. This means even strong corporates are having difficulties. Large companies are finding their suppliers down the chain are feeling the effects of not being able to obtain the imports they need. They cannot continue to function to full capacity, which is hurting the multinationals.
Suddenly, solid relationships with trusted suppliers are starting to look shaky. “There is increased nervousness around the supplier’s ability to pay and changes to the credit outlook of all the corporates along the chain,” says Hakon Runer, head of risk and portfolio management, trade finance and cash management corporates at Deutsche Bank.
Diamond says the impact is felt across all industries and regions: “From the Standard Chartered perspective, the additional layer of emerging-market exposure focus means we are seeing clients looking for help with managing the risk element as well as cash flow.
"The demand goes across the breadth of importers and exporters. Any company with a major cross-border flow is likely to be looking for assistance.”
Part of the problem is that the constraints extend so far down the chain. “We see that the challenges with working capital management do not stop with the first-level supplier, but the second or third, or beyond,” says Diamond. “Some are facing challenges around how they can help to facilitate the entire supply chain with their clients.”
This has forced MNCs to explore other methods of ensuring they have the requisite liquidity in place; invoice discounting is becoming an increasingly important solution. Also known as distributor finance, this allows a company to obtain funds ahead of an invoice being paid.
The treasurer can access a percentage of an invoice before it is settled, with some providers offering up to 90% of the invoice value. Once the customer settles the invoice, the remaining percentage is released by the provider, minus the agreed fee.
Although it is not a new product, it has found a new lease of life in this climate. “Invoice discounting as a product has been around for years as a plain vanilla offering,” says Sehgal. “Its use is more pronounced now as companies realize sources of liquidity are drying up and they need to propel their value chain through other sources.”
Sehgal says the companies he has seen using it are of size: “Of the Fortune 500 companies, I would estimate 25% to 30% have actively engaged in a product like this in the last six to nine months.
“Two years ago, you could have counted the numbers on your fingers. The trend will likely continue. Like supply-chain finance four or five years ago, distributor finance is picking up momentum very quickly, and the next few years look very bright.”
The experience has been felt across the banks with a foot in the emerging markets. Standard Chartered’s Diamond agrees: “We are definitely seeing a growing demand for working capital-management solutions from the large global multinational clients.”
Vivek Gupta, head of supply chain finance, transaction banking at ANZ, says the increased demands from senior management for companies to improve their working capital has further pushed the move to implementing the programmes.
The outcome is, says Gupta, a win-win situation: “For the large client it means improved working-capital metrics; for the suppliers it means a cost-efficient way to access timely working capital despite longer payment terms.
"We have seen significant success in our home markets of Australia and New Zealand and in select Asian markets around our payables financing proposition.”
Lasma Orlovska, head of open account products at Barclays, says the rising use of these products is partly down to greater visibility: “Lack of awareness of invoice discounting and its benefits has historically translated into relatively low product penetration.
"As businesses look for more efficient and cost-beneficial methods to manage their supply chain and indeed their own cash-flow requirements, we continue to see an uptick in demand.”
The advantages can be wide-reaching within the company, beyond meeting the current market issues. “Invoice discounting can offer a number of different benefits to a treasurer as well as other parts of the business,” says Orlovska.
“Invoice discounting has the potential to provide greater cash flow, allowing the treasurer to utilize cash within the company, or indeed group of companies, to their advantage. Additionally, as the facility is linked to the debtor book, it allows the treasurer to leverage other assets as and when required.
"For many treasurers and auditors, invoice discounting is considered to be a credit-risk mitigant.”
Beyond bank debt
Corporates are looking beyond bank debt. Says Diamond: “Corporates are looking towards a diversification of their funding options, with effective working capital-management continuing as a high priority for them as they focus on their cash flow. Having as much diversity in these options is critical in driving this forward.”
That can also mean expanding the number of relationship banks. “In the face of changing regulation, clients want to be sure they are not reliant on one source of funding. They want to be more thoughtful and diverse,” adds Diamond.
Citi’s Sehgal believes the growth of the product suite is likely to be rapid over time: “Look at a huge international company that can make hundreds of billions in sales. A few percentage points on that sales base works out to be billions. And when you aggregate it across the MNC base, we are confident the demand for distributor finance is here to stay and grow.”
There are further hurdles to overcome. One of them is to educate insurers about the new products and their risks. “Insurers know and understand channel finance and what it means to take on the dealer-distributor risk,” says Sehgal.
“They are comfortable with the credit risk, based on their understanding of the flow from the MNC to the distributor and the relevance of the product to the geography being serviced by the distributor. However, insurers want to know how banks would be covering the operational risk.”
Insurers want more information, and banks need to provide it. Sehgal says: “What comforts and mitigants do the insurers want to see? Do they need an option at the end of it if the dealer-distributor doesn’t pay?
This space is relatively new and evolving in size. There are some insurers who understand the risks better, while others see this as a new product to get into. It’s therefore safe to say, while the product has huge promise, it has a long evolutionary cycle ahead of it.”
Sehgal says from Citi’s experience it has been eight years since the relaunch of supply-chain finance and three years since they expanded into commodities. “It is exciting building a new product,” Sehgal says.
“Every few years we do go back to the drawing board and think of innovative areas to grow into. The journey of identifying something new, which meets a latent need of the client, helps them grow faster or manage their risks better, is an extremely fulfilling one.”