Whitepaper Trade Finance Re-Evolution

7/31/2019 Whitepaper Trade Finance Re-Evolution

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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


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Trade Finance Re-evolution

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Table Of Contents

I. Executive Summary............3

II. Trade Finance Cycle - Primary Players .....4

III. Key Challenges ..................4

IV. Global Trade Current Trends...............5

V. Trade Finance Re-evolution to Open Account Management.......5

VI. Open Account Management- Functional Approach....................10

VII. Trade Finance BPO Model......................12

VIII. Benefits...............................13

IX. Conclusion.................................14


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II. TRADE FINANCE CYCLE PRIMARY PLAYERSBuyers 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.


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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 far-

apart counterparties. Thus trade finance banks therefore are re-constructing their value


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

environment.

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 Documentary collection Open account

Post shipment finance

Confirmed acceptance LC: Exporter receivesnon-recourse payment on presentation ofcompliant documents.

Discounting accepted bill ofexchange: Exporter receivesearly payment.

Payer centric reversefactoring: Based on buyer-approved invoices, supplier sellsreceivables to bank withoutrecourse.

Deferred payment LC: Exporter receives non-recourse payment on presentation of compliantdocuments.

Advance against collections:Exporter receives with recourseadvance of a percentage ofcollection.

Supplier centric receivablesfinance: Bank discountsreceivables, often backed bycredit insurance.

Negotiating bill under unconfirmed LC:Exporter receives advance on presentation ofcompliant documents.

Discounting bank avalisedbill: Exporter receives non-recourse payment.

Export factoring: Exporteroutsources collection process tobank/factor and receivesadvances against a percentage

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


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of sales turnover.

Bill discounting under sight LC: Exporter ispaid at sight using proceeds from bill drawn byimporter on his bank.

Forfaiting: Exporter of capitalgoods receives up-front non-recourse payment againstpromissory notes or billsavalised by importer's bank.

Dealer finance: Exporter is paidon shipment, while dealers paylocal bank direct from salesproceeds. Significant local bankpresence advantageous.

Pre-shipment finance

Red clause LC: Exporter receives advance fora percentage of LC against specifieddocuments.

Confirmed purchase orderfinance: Exporter receivesadvance for a percentage of PO.

Receipt & undertaking LC: Exporter receivesadvance against receipt and undertaking.

Inventory finance

Import loan (at back end of sight LC) backedby warehouse warrants or trust receipts infavour of bank: Importer obtains advance topay exporter pending receipt of salesproceeds.

Event triggered finance:Logistics companies can controlgoods in transit to the order ofthe bank as security for finance.

Risk mitigation/Transactional control

Import LC: Importer only required to pay ifcompliant documents received by bank provinggoods shipped.

Documents against payment:Documents only released toimporter on payment of bill ofexchange.

Matching: POs, invoices andgoods received notes.

Confirmed export LC: Exporter receivesguarantee of payment from local bank againstcompliant documents proving goods shipped.

Documents againstacceptance: Documents onlyreleased to importer onacceptance of bill of exchange.

Tracking and control of goods:movement by logisticscompanies:

Transferable LC: Beneficiary can transfer LCto one or more new beneficiaries. Used whenfirst beneficiary acts as middleman/does notsupply goods himself.

Advanced Payment Guaranteeand or Progress PaymentGuarantee: protect importer whomakes advance payment beforecompletion of contract.

Back-to-back LCs: Two separate LCs wherefirst LC acts as 'security' for second LC aspotential source of repayment. Used by traderswho buy and on-sell goods

Standby LC: Enables open account trade,under bank guarantee to pay against specifieddocuments.

Efficient processing

Upload of electronic POs to create import LCs;on-line amendments.

Electronic advice, review andacceptance of documents.

E-invoicing, electronic POdistributions, PO flip; documentmatching.

Electronic advice and review of export LCs. Document scanning andelectronic archiving.

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


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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


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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.


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Hence we facilitate:

trade services transactional offerings to finance providers e.g. payments, factoring, asset-

backed 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 On-

Demand 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.


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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 pre-

condition 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 furtherdeveloped 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.


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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 throughoutsourcing consumer credit business processes, including:


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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.


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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 holisticproducts 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