Trade Finance Re-Evolution

Authors

Shankar Sundaramoorthy
Practice Head - Banking Practice

&

Harishankar K
Consultant - Banking Practice

iGATE Global Solutions Limited 158-162 (P) & 165 (P) -170 (P) EPIP Phase II Whitefield Bangalore -560066, INDIA

Trade Finance Re-evolution _____________________________________________________________________

Table Of Contents I. II. III. IV. V. VI. VII. VIII. IX. Executive Summary............3 Trade Finance Cycle - Primary Players .....4 Key Challenges ..................4 Global Trade Current Trends...............5 Trade Finance Re-evolution to Open Account Management.......5 Open Account Management- Functional Approach....................10 Trade Finance BPO Model......................12 Benefits...............................13 Conclusion.................................14

Page 2 of 14

Trade Finance Re-evolution _____________________________________________________________________

I.

EXECUTIVE SUMMARY

Trade financing is evolving owing to ever changing global patterns as well as alterations in supply and demand. The banks trade finance activities have had a significant impact with the emergence of trade finance growth in Asia and Latin America. According to Celent, In the year 2008, world trade growth decelerated to 4.5 percent, down from 5 percent in the third quarter of 2007. Consumer and business demands, in developed economies, have been falling continuously along with the weakening of the industrial growth. It is contrasting to note however that in developing countries, the growth rate is currently around 7 percent, with more than 40 percent contribution to global output growth in 2007.

The volume and value of global trade over the past decade has extraordinarily augmented owing to globalization and the inter-dependence between trade finance partners to enhance service and reduce working capital requirements has also increased. A recent Aberdeen report found that 90% of companies surveyed viewed their global supply chain technology as inadequate for today's needs.

Through packaged technology, most of the commercial functions like MRP, CRM, ERP, eProcurement are now available for automation and trade and supply chain finance represents the last upholder of manual processing. A holistic Open Account Management model is the obvious solution that the banks need to shift to, today which allows for increased visibility of transactions and supplementing documents to all parties in the trade world. Traditional silo functions viz. operations and treasury can now be integrated to offer expected cross-organizational processes enabling smoother operations, an ability granted by the visibility virtue. This phenomenon, addressed as transactional trade finance is where every document in the trade finance and supply chain process can be associated with a financing event.

Credit availability is becoming more restricted and risk capital requirements are rising and therefore trade financing techniques need to transform. The favorite choice for trading firms and the demand from more and more clients to their banks seems to be Open accounts trading.

This paper scrutinizes the progression of innovative trade flow patterns and the prospects for banks presented by the Open account management model.

Page 3 of 14

Trade Finance Re-evolution _____________________________________________________________________

II.

TRADE FINANCE CYCLE PRIMARY PLAYERS

Buyers are the primary drivers of Trade finance. They are largely responsible for shaping consumer demand for the products they wish to sell. They are also the first in the chain to feel the pressure to reduce costs in a market. The raw material prices keep rising but consumers expect prices to keep falling in this new world of large retail chains.

Suppliers need good trade finance in place. As the company that manufactures the goods, they not only feel the current increases in the raw materials, energy, and labor costs but are traditionally hurt the most since they need to bear the brunt of the cost and typically go the longest between the initial outlay for raw materials, overhead, labor and the day they finally get paid for producing the product.

Financing Institutions play the role of lender in global trade finance and offer various types of financing. This includes a number of trade financing services including Letter of Credit, Collections, Stand-by Letter of Credit, Pre and Post shipment finance, Bill Discounting and Purchase, Bank Acceptances.

Transporters or Logistics providers cater to the physical movement of goods, and can provide visibility to all the constituents by updating the transit records of the goods shipped. Their internal systems when integrated to a trade finance solution can give an authenticated record of the goods shipped. Their current location and expected delivery time enables not only buyers and sellers to update their records but will also act as a risk mitigation tool for a financial institution on the finance provided.

III.

KEY CHALLENGES
Lack of an integrated platform for all players. High Turnaround time due to delay in physical transport of documents between parties. Difficulty in reconciling positions for Buyers and suppliers due to lack of a dashboard which reflects current payables / receivables position, and a history of recent transactions. Value of Market Knowledge: KYC Risk and Compliance Cost-containment Pressure High logistics costs. Inefficiencies due to multiple documents and manual system of keeping records.

Page 4 of 14

Trade Finance Re-evolution _____________________________________________________________________

IV.

GLOBAL TRADE FINANCE TRENDS

International logistics cost 6%-11% as a percentage of revenue. Average transit times are 40+ days with 12 or more hand-offs creating logistics black holes. Variances to budget for landed cost are greater than 10% nearly half the time. 1 out of 5 international shipments are out of compliance with order or routing instructions. 66% manage global trade using paper and spreadsheets.

Source: Aberdeen Group, Survey of 400 Companies engaged in Global Trade

V. TRADE FINANCE RE-EVOLUTION TO OPEN ACCOUNT MANAGEMENT

OPEN ACCOUNT TRADING
End-to-end financing solutions are collectively referred to as supply chain financing. Addressing complex commercial trade flows and multiple counterparties and various geographical locations has not been the objective of traditional trade finance products. Accordingly products, simplistic in structure like letters of credit, trade loans based on the strength of one counterpart were used traditionally for financing these flows. Importers however, notwithstanding the availability of these products as financing options, have increased their demands for new answers that address the dynamically changing business environment more holistically, for e.g. end to end financing and open account trading. Incorporation of the banks into the trade finance process providing greater stability, flexibility and transparency plus the complete integration of physical and financial supply chains are major global trade market innovations in the industry today.

TRADE FINANCE TO OPEN ACCOUNT TRADING ROADMAP

With the growing trend of globalization, Corporates, increasingly sourcing from suppliers and selling to customers far away from their traditional home markets has become a growing trend with globalization. The concept driving this is called lowest cost country sourcing, where corporates are willing to set out larger distances to procure goods or services at the lowest possible cost. Advanced communications, Internet tools and ease of travel are opening up fresh avenues for importers and exporters for identifying and carrying out businesses with farapart counterparties. Thus trade finance banks therefore are re-constructing their value

Page 5 of 14

Trade Finance Re-evolution _____________________________________________________________________

proposals to meet the dynamic needs of their corporate customers, in this new global environment.

Cash in Advance

Doc Collections

Letters of Credit

Supply Chain Financing

Open Account

Traditional Risk Mitigation & Financing Tools

New Risk Mitigation & Financing Tools

Traditional to Open Account Global Trade and Supply Chain Finance

Risk-mitigation, cost reduction with aggressive financing options and transformation of business process from paper-based trading towards cheaper electronic documents processing and exchange are concepts where major trade banks have an important part to play, considering todays global environment. The emergence of new attractive financing techniques for the benefit of buyers and sellers from banks is an example of this evolution. We will explore in this article the vital steps being adopted by todays banks for delivering value to their corporate clients and dwell upon the concept and features of Open account management. At the outset, the below comparison puts in place the various trade functions performed through traditional trade finance products and how the same can be adapted in the Open account style.
Global Trade Solutions Letter of credit Post shipment finance Confirmed acceptance LC: Exporter receives Discounting accepted bill of Payer centric reverse non-recourse payment on presentation of exchange: Exporter receives factoring: Based on buyercompliant documents. early payment. approved invoices, supplier sells receivables to bank without recourse. Deferred payment LC: Exporter receives non- Advance against collections: recourse payment on presentation of compliant Exporter receives with recourse documents. advance of a percentage of collection. Supplier centric receivables finance: Bank discounts receivables, often backed by credit insurance. Documentary collection Open account

Negotiating bill under unconfirmed LC: Discounting bank avalised Export factoring: Exporter Exporter receives advance on presentation of bill: Exporter receives non- outsources collection process to compliant documents. recourse payment. bank/factor and receives advances against a percentage

Page 6 of 14

Trade Finance Re-evolution _____________________________________________________________________

of sales turnover. Bill discounting under sight LC: Exporter is Forfaiting: Exporter of capital paid at sight using proceeds from bill drawn by goods receives up-front nonimporter on his bank. recourse payment against promissory notes or bills avalised by importer's bank. Pre-shipment finance Red clause LC: Exporter receives advance for a percentage of LC against specified documents. Receipt & undertaking LC: Exporter receives advance against receipt and undertaking. Inventory finance Import loan (at back end of sight LC) backed by warehouse warrants or trust receipts in favour of bank: Importer obtains advance to pay exporter pending receipt of sales proceeds. Risk mitigation/Transactional control Import LC: Importer only required to pay if Documents against payment: Matching: POs, invoices and compliant documents received by bank proving Documents only released to goods received notes. goods shipped. importer on payment of bill of exchange. Confirmed export LC: Exporter receives Documents against Tracking and control of goods: guarantee of payment from local bank against acceptance: Documents only movement by logistics compliant documents proving goods shipped. released to importer on companies: acceptance of bill of exchange. Transferable LC: Beneficiary can transfer LC to one or more new beneficiaries. Used when first beneficiary acts as middleman/does not supply goods himself. Back-to-back LCs: Two separate LCs where first LC acts as 'security' for second LC as potential source of repayment. Used by traders who buy and on-sell goods Standby LC: Enables open account trade, under bank guarantee to pay against specified documents. Efficient processing Upload of electronic POs to create import LCs; Electronic advice, review and E-invoicing, electronic PO on-line amendments. acceptance of documents. distributions, PO flip; document matching. Electronic advice and review of export LCs. Document scanning electronic archiving. and Advanced Payment Guarantee and or Progress Payment Guarantee: protect importer who makes advance payment before completion of contract. Event triggered finance: Logistics companies can control goods in transit to the order of the bank as security for finance. Confirmed purchase order finance: Exporter receives advance for a percentage of PO. Dealer finance: Exporter is paid on shipment, while dealers pay local bank direct from sales proceeds. Significant local bank presence advantageous.

Source- www.gtnews.com For successfully competing in todays global trade world, trade finance banks need to innovate a wide-range of pre-shipment, in-transit and post shipment finance techniques. Open account finance techniques are increasingly becoming popular along with the traditional trade instruments to sustain actively in these scenarios. Such product delivery techniques

Page 7 of 14

Trade Finance Re-evolution _____________________________________________________________________

combining traditional and open account management products leverage a lot on web-based solutions for the benefit of importers and exporters. Delivering the Greatest Value through Open Account Management The key elements of trade finance are: Working capital gap needs to be bridged using bank finances to improve cash flows for sellers and buyers. Control of trade finance transactions and Risk mitigation with respect to country risk and counterparty risk. Foreign exchange services and cash management of international payments and collections. Post the negotiation of the sales contract, the buyer and seller generally agree to the International terms and guidelines of trade Finance. Views of risk are however opposing for the importer and exporter because the terms of trade satisfactory to one party may involve high risk for the other party. The below Risk Ladder illustrates the existing natural tension between importers and exporters objectives depicting that the measures of transactional control or security for the seller and the buyer are diametrically opposite in nature. Risk Ladder

Source- www.gtnews.com

Page 8 of 14

Trade Finance Re-evolution _____________________________________________________________________

The terms of trade adopted would also be importantly influenced by the commercial practices in the countries involved, e.g. EU and US normally practices open account whereas LCs are more popular in Asia, Middle East, Africa and Latin America. Increased movement towards open account and shifting away from the usage of traditional LCs and documentary collections (accounting now for not more than 20% of international cross-border trade) is one of the remarkable trends identified in the recent global trade scenario. The Open account management architecture needs sound understanding mechanisms to support the needs of large-scale aggregation and distribution of information arising from business documents (orders, invoices) and physical events (inspections, certification). iGATE has abundant expertise in these Open account management concepts and understanding the interfacing of the Open account management with the Trade Finance application. iGATE strongly recommends a Trade Finance solution premeditated to be run as a service, rather than positioned as organization software. Hence we are uniquely fitting for strategic partnerships with Financial Institutions and other organizations such as trading groups.

We support the provision of secured and reliable visibility to trade transactions for multiple interested parties through the aggregation and matching of business documents across multiple organizations.

Page 9 of 14

Trade Finance Re-evolution _____________________________________________________________________

Hence we facilitate: trade services transactional offerings to finance providers e.g. payments, factoring, assetbacked lending for multiple transactions improved supply chain finance management to buyers provision of speedy working capital sources through new avenues to vendors depict pipelines of transactions to finance providers for offering proactive services to customers

VI. OPEN ACCOUNT MANAGEMENT MODEL FUNCTIONAL APPROACH

Open Account Management is key to the holistic view of trading events: it is what allows service providers to predict and offer Trade Finance Requests as needed and on an OnDemand basis. If the bank is the provider of the Open Account service, then the bank has the unique ability to provide the trade financing based upon the data and documents available. Furthermore, the automation of the full Open Account process enables service providers to move beyond process outsourcing and offer exception-based visibility services. In the years to come there will be a paradigm shift from a paper-based, batch based model to an exception-based, on demand model and the services need to start now based on current technologies.

iGATE supports a Trade Finance Information associated solution that can be deployed across multiple companies and organizations in order to track location-wide business documents and events work-flows through the construction of a demand model. Service providers would be enabled through such technologies to present Open Account Management services beginning with undemanding processes like invoices matching and then expanding to full suite of Open Account Management services. The whitepaper also aspires to describe briefly a similar solution and observe the merits of deployment of such a concept.

Requirements of each individual customer should be the main dependency criteria while rolling-out any Trade Finance Information. Aggregation of business and physical documents from multiple locations in order to construct a documents repository to be matched against a well-defined and configurable workflow pattern (reconciliation) is one of the major requirements. Additionally, it is also required to define for trade transactions, an n-level workflow as a preparation for matching and reconciling the occurrence of events during each trading step.

Page 10 of 14

Trade Finance Re-evolution _____________________________________________________________________

Such an approach would assure below benefits: Completeness and improvement in terms of visibility into the trading and shipping activities Capability for creation, management and distribution of business and physical documents to shore up Open Account Management services Ability for reconciling during each of the n-step trade events in the business processes Enhanced transactional clarity and detection acting as a basis support for financial activities Key milestones in the trade cycle which can potentially serve as triggers for finance include: Purchase Order (PO) issuance. Manufacturing status verification Inspection and content verification of independent goods. Transit of goods (i.e. bill of lading/air waybill). Goods Warehousing. Issuing of invoices. Note for Goods Received. Invoice(s) reconciliation against PO and Goods received note. Invoices approval. Future-dated payment files approval.

Undoubtedly, the two most accepted trade event triggers, amongst the above possible milestones have to be: Purchase Order Issuance for Pre-shipment finance Post shipment finance through approval of invoices

In cases where at the issuance of the PO, the importer confirms his acceptance to pay the contracts face value is known as Finance against confirmed Purchase Order. The bank thereby is enabled to advance a percentage of Purchase Order value to the exporter, which the latter utilizes to for procurement of raw materials and goods manufacturing (in agreement with the Purchase Order). This is a type of pre-shipment finance which can become a precondition for the exporter to accept a movement towards Open Account thereby replacing Letters of Credit used to obtain local finance. Event-triggered finance can be further developed into Goods-in-transit financing where the location of the goods in a distribution center or in-transit is controlled and monitored by a logistics company (using its transportation capabilities). Here again the importer can mitigate his risk in providing finance for the goods thus making this type of a transactional control a competitive financing method.

Page 11 of 14

Trade Finance Re-evolution _____________________________________________________________________

VII.

TRADE FINANCE BPO MODEL

IGATE extends the scope of BPO merits further than mere cost improvements to a financial institutions overall competitive advantage and is also a high-value deliverer. Cost-efficiency, high-level industry business competency, and equipment with assets, tools for a customized BPO solution for specific organizations are some of our salient capabilities.

iGATE offers substantial cost savings and quality improvements that can be realized through outsourcing consumer credit business processes, including:

Page 12 of 14

Trade Finance Re-evolution _____________________________________________________________________

Improved quality of work and reduced re-work by drawing from a college educated labor pool. Reduced operating expenses by leveraging lower cost offshore labor and infrastructure. Faster turnaround times by utilizing offshore resources during off-peak/dark hours in the home market. Improved capacity management by re-aligning onshore resources to more complex tasks and load balancing volumes across multiple shifts. Recurring cost/quality improvements through continuous improvement utilizing process best-practices and new technologies. Benefit from more effective processes in customer service and collections.

VIII. BENEFITS FOR FINANCIAL INSTITUTIONS

Collaborative relationship Banks can build a stronger collaborative relationship with clients, by widening the scope of their services to cover their customers end-to end Trade Finance. This enables banks to improve their bottom lines, by exploring new revenue streams and provide scope to innovate customized funding solutions. Enhance customer retention - Customers provided with end-to-end solution which integrates with their internal applications and workflow will become completely attached to the Bank, as any shift of allegiance will shake up their entire procurement & collections processes. Increased reach & customization - Our solution is a scalable model. With an integrated solution system in place it is possible to build customization across various types of business. It also provides for standardization of specific industry segments which if Bank requires can become a niche player. Expand the product portfolio offered in Trade Finance With a clear visibility of document movement & physical movement of items. It is possible for banks to offer structured financing solutions to their clients. Funding can be staggered to meet the finance requirements at various stages of physical goods flow i.e. Customs clearance, duty payment, freight payment etc. Risk Mitigation - The biggest challenge in an open account trade is in confirming the authenticity of transaction, and in obtaining the correct picture of the flow at any given moment. With visibility provided by movement of trade documents through a Banks portal, Banks are well assured on these, which reduce their risk exposure.

Page 13 of 14

Trade Finance Re-evolution _____________________________________________________________________

IX.

CONCLUSION

In todays changing world, trade finance banks are struggling hard to re-identify their role. Although still there is an important role for traditional trade finance instruments in many geographical markets and at beginning stages of a new trading association between parties in distant locations; it is also undisputed that there is a shift towards open account in certain markets and verticals. In order to compete in the dynamic international trade scenario, today's primary trade finance banks need to offer a full suite of pre-shipment, in-transit and post shipment finance solutions. Trade Finance and Cash management activities are undoubtedly merging within banks, a reflection of the customers own activities. The current demands of the customers for open account trading solutions like e-invoicing, reverse factoring financing etc are compelling the banks to adopt and upgrade their banking solutions. Only those banks that provide holistic products through a complete range of trade finance and open account management solutions notwithstanding liquidity management and payment capabilities will be competent to meet the dynamic needs to customers and remain successful in the industry. Whichever be the market of operation, bringing sine qua non success to both buyers and suppliers is the elixir for survival today. References:
Celent.com Gtnews.com Tradeevolution.com

Page 14 of 14