Research guide: Global supply chain trade finance solutions
By David F. Conroy, managing director, head of global trade sales, Citigroup and Michael Guralnick, managing director, head of EMEA client management, corporate and public sectors, Citigroup.
Supplement: Technology in Treasury Management Guide
Sponsored by Citigroup
Trends in global trade
As the number of companies participating in cross-border trade continues to increase, so does the need for risk mitigation, and efficient document processing financing across the supply chain. According to the WTO, the world’s total annual import/export volume in merchandise and commercial services increased by more than 40 per cent in the past five years: from US $14.4 trillion to US $20.5 trillion. Projections indicate that even these levels will increase substantially over the next three years.
Trade participants around the world are seeing the shrinkage of their communities of suppliers and customers. With increased penetration of the internet into emerging markets, suppliers who once relied on faxes and phone calls to accept and complete orders are now engaging fully with the customers on the other side of the world. State-of–the-art order-to-cash, purchase-to-pay fulfillment platforms have made it possible to speed and secure their trade flows.
Furthermore, the trade marketplace has undergone a dynamic shift in transaction formats from both ends of the supply chain, affecting importers and exporters alike. Specifically, there has been a noticeable transition from letter of credit (LC) to open account trading, which has enabled savings and enhanced efficiency throughout the purchasing cycle.
Within domestic markets, open account trading has always existed. Until recently, however, major barriers such as a lack of transparency and apprehension about cross-border risk have limited international open account trade. But these concerns have now been greatly diminished thanks to increased financial knowledge, and, again, technological advancements: both buyer and seller recognize the benefits that include reduced costs and improved efficiencies through cross-border open account trading. This transition to open account has seen greatest movement within the Europe, Middle East, and Africa (EMEA) region, particularly within the EU and the new accession countries including Poland, Hungary and the Czech Republic.
The market dynamic towards open account is supported by the latest *SWIFT data which shows negligible growth in the trade letter of credit message category, at a time when overall global trade has substantially increased. Combined with the large increase of import/exports globally, this supports the argument that global trade, and the corresponding corporate supply chains it supports, is moving aggressively to open account. Feedback from the marketplace indicates that manufacturers and retailers on the buy-side of the sourcing relationship no longer want to use existing credit facilities and inefficient LC processes for purposes of procurement. Clearly the “pull model” emerging around the world, whereby vendors hold goods on their own balance sheet, means many companies are manufacturers in name only - outsourcing as much of the supply chain as possible.
Importance of supply chain management
Research over the past ten years indicates a direct link between effective supply chain management and corporate operating results. Major corporations identified as having best-in-class supply chain management have consistently shown market capital growth of between ten and twenty per cent above their industry peer group.
Senior executives have focused on supply chain efficiency to reduce cost, stimulate sales, gain market share and manage risk. Financial services and trade product offerings, which directly impact these supply chain objectives, are the focal point for our clients and for Citigroup’s product development efforts.
Citigroup Global Transaction Services
Citigroup’s Global Transaction Services unit is developing a wide range of trade finance and trade services capabilities, which address global trends in trade and supply chain management. Our approach compliments the way our corporate customers manage their global supply chains. In addition, the deployment of trade capabilities within the corporate supply chain addresses two primary goals for driving our customers’ business.
The first of these is the injection of liquidity into the supply chain to balance the conflicting goals of importers (buyers) and exporters (sellers) and to facilitate inventory management objectives. The second is to provide risk mitigation related to either counterparty or country risk.
The ultimate goal for Citigroup is to integrate trade based products into the way that clients acquire, move, monitor and pay for goods in the supply chain. Successful deployment of financial supply chain solutions requires close coordination with multiple stakeholders including procurement, logistics, finance, accounting, risk and treasury. In addressing the financial supply chain objectives of our clients the Citigroup approach segments the goals of both our importer and exporter clients.
Strategically, the plan to connect buyers and sellers is what drives the development of the technology foundation and innovation investments. In time, all links within the supply chain will be able to see the flow of purchase orders, measure vendor operational efficiency opposite those orders and then track the flow of the inventory through the supply chain until the goods are with the final buyer. But the need to build, own, and operate is a thing of the past, and has now been replaced with a focus on leveraging the core competencies of alliance partners who specialize in aspects of supply chain logistics management. Through their technology platforms, these partners will give global access to information about the flow of goods and support worldwide order management processes.
Exporter view – velocity in the supply chain
Some of the traditional concerns regarding risk mitigation felt by sellers around the world have always had to be balanced against sales growth, and these concerns still remain. However, for sellers, the global supply chain is becoming an increasingly important source of alternative financing. Just like the buyer’s perspective, a seller’s strategy of approaching the financing of its supply chain needs to be driven by a clear understanding of where that seller sits within its own global supply chain. This will, in turn, lead to consideration of a range of strategies that can be deployed to support its sales requirements.
Broadly speaking, there are three main concerns that drive the strategic direction of the financing alternatives that can be deployed. These concerns are: risk mitigation, sales growth and liquidity. For those companies who do not require liquidity, it is more aptly described as increasing the velocity of the order-to-cash cycle. What we are seeing is the convergence of all three areas into holistic trade finance solutions for sellers.
A vendor who is selling to a customer that is better-rated than itself has the option of raising liquidity by selling the underlying assets - such as receivables and inventory – that it holds. These will ultimately be repaid by the buyer who has a significantly lower cost of capital. The vendor could sell these assets and raise capital at its buyer’s cost of capital.
By doing so the seller can improve its key covenants with financial institutions, such as debt TNW (total net worth). It can also deploy the cash against an investment strategy that will yield an effective economic cost of capital rate of return. Finally, if they are in a high growth-rate industry, it enables them to finance that growth rate without consistently raising more equity or getting caught in a classic over-trading trap.
The improved metrics that will result from this exercise leads to an increase in the velocity of the enterprise, which has a proven historical enhancement to equity price performance.
However, to achieve the kind of results that companies expect, companies are being forced to look beyond the traditional tools of factoring and securitization. The reason for this are broadly three-fold. The first is that key buyers in almost all global supply chains are becoming more concentrated, with the result that securitizations are becoming increasingly over-collaterized relative to the amount of funding that can be extracted from them.
Secondly, the large well-rated buyers are almost always strategic accounts. Very few sellers are keen to relinquish control over credit and collections activities on these accounts to a factoring company. And third, the global supply chain is not only sourcing from, but selling into, the emerging markets. Indeed an examination of the sales patterns and forecasts of OECD sellers shows that emerging markets are the fastest growing.
Understanding your challenges in a competitive marketplace
As companies develop and analyse their strategies to optimise the flow of cash and goods in their supply chains, the need to manage counterparty risk effectively at every stage in the financial operating cycle has never been more pressing.
Globalisation has compelled corporate financial teams to take on the role of change agents in order to drive value creation, with the efficient mobilization of working capital viewed as an essential competitive tool.