- Ana Kube
- Managing Director, Regional Trade and Product Management Executive, Global Treasury Solutions - Latin America and the Caribbean, Bank of America Merrill Lynch
by Ana Kube, Managing Director, Regional Trade and Product Management Executive, Global Treasury Solutions - Latin America and the Caribbean, Bank of America Merrill Lynch
Supply chain finance (SCF) in Latin America could be about to experience a new dawn. While SCF has been widely adopted in Mexico, largely because of the close integration of its economy with the US, and, to a lesser extent, in Brazil, it has struggled to gain momentum in other major countries in the region, such as Chile, Colombia and Peru [1]. Now, changing economic conditions across Latin America could be poised to give SCF a boost.
According to the World Bank, growth in Latin America and the Caribbean slowed markedly to 0.8% in 2014 – a third of the level enjoyed in 2013 and the slowest in over 13 years, with the exception of 2009 [2]. While there are significant differences in the prospects of individual countries, domestic problems, reinforced by falling global commodity prices and the slowing Chinese economy (which is a major buyer of Latin American exports), are hampering the prospects of some of the largest economies in the region.
Weaker conditions in major Latin American economies could create challenges for domestic banks in the region, with consequent effects on the price and availability of finance. In some instances, it could also lower the credit quality of suppliers across Latin America, further exacerbating the challenges they face in securing cost effective finance. All of these developments should spur enthusiasm among suppliers in the region to take part in targeted SCF programmes whereas previously they might have balked at a programme they didn’t always perceive as being to their advantage.
Roadblocks to SCF
Within Latin America, it is important to differentiate cross-border SCF from other supply chain focused financing solutions, such as factoring and invoice discounting. While the latter have been enormously successful, true cross-border SCF has struggled in many countries in the region since international banks began to introduce it in the 2000s. The slow adoption of SCF in many Latin American countries in the past can be attributed to a number of factors.
Firstly, outside Mexico and Brazil, the vast majority of Latin American companies are modest in size, and in SCF size does matter. Of interest is the fact that some of the largest companies in the world are the ones who have most aggressively adopted SCF due to the significant cash flow improvements their sheer size can generate, reportedly up to $1bn in some cases.[3] The more modest the company size the smaller the cash flow improvements and many either don’t have the scale necessary to initiate SCF programmes or the knowledge, experience and ambition that encourages Mexican and Brazilian corporates to emulate US and Europe multinationals. From a supply chain perspective, Mexico also clearly benefits from both its proximity and integration into much of US manufacturing and its consequent integration into US supply chains as SCF necessarily mirrors existing relationships. Other regional economies do not have similar levels of integration with more developed markets.
Secondly, the diversity of Latin America in terms of regulations and markets has discouraged many international banks, which most often implement cross-border SCF solutions, from marketing the solution widely outside Mexico and Brazil. Different legal environments and financial systems mean that banks have to tailor the mechanics of SCF to each country. Given potentially more limited business prospects in many Latin America markets, the region as a whole is less of a priority for international banks than Europe, the US, or parts of Asia.
Thirdly, and perhaps most importantly, the disparity in credit quality – with buyers having superior credit quality (and, therefore, the ability to borrow more cheaply than suppliers) – that ordinarily drives the adoption of buyer-driven SCF seldom exists in Latin America. Traditionally, SCF uses the superior credit quality of buyers to enable suppliers to get paid sooner than usual by financing their receivables below their usual borrowing cost via arrangements with the buyers’ bank. In return, buyers increase their payment terms allowing them to extend their days payable outstanding. In Latin America, the disparity in credit ratings between buyer and supplier is rarely marked and, therefore, the potential savings in terms of financing costs is more limited.
Lastly, the macro-economic outlook of the region can hamper growth of SCF as banks tighten up on lending, especially to smaller firms. And without bank lending to step into the gap created by longer terms, the programmes struggle to be as successful as anticipated.
Notes
[1] All products and services may not be available in all jurisdictions and are subject to change without notice.
[2] ‘Global Economic Prospects’, World Bank, January 2015
[3] New York Times, April 6, 2015
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Creating an appetite for supplier-driven SCF
It is important to note that, unlike in the rest of the world, the majority of SCF in Latin America has been driven by suppliers rather than buyers. This is largely because of the nature of the region’s economies, which are primarily based on commodities or basic goods.
One of the oft stated attractions for buyers in implementing an SCF programme is the ability to strengthen their supply chain by deepening relationships with suppliers. The need for stable supply chains is especially important in industries where components that are critical to a final product are sourced from third parties on a just-in-time basis, as is often the case with manufacturing suppliers. However, the role played by Latin American suppliers is usually different: rather than supplying critical components, most Latin American suppliers provide basic or commodity products in deals that are transactional rather than relationship-based and can be potentially sourced from multiple providers. As a result, there is little incentive for foreign buying companies to support SCF programmes. Instead, programmes implemented in Latin America (outside Mexico and Brazil) are usually instigated by suppliers.
While some suppliers might still view SCF as a buyer’s way of generating cash flow at their expense, in an uncertain economic environment and with tighter direct bank-provided lines of credit, suppliers have realised that selling their receivables can not only improve their own working capital and strengthen their balance sheet (by turning the receivables into cash thereby shortening the cash conversion cycle) making their stand-alone credit more attractive to their traditional local lenders, but also crucially mitigate risk. Risk reduction could prove increasingly attractive to suppliers as the risk environment changes as a result of worsening macro-economic conditions. By improving their balances sheets, suppliers may also find it easier to obtain credit from their traditional banks at more attractive rates. Moreover, the sale of the receivable enables the supplier to enter into a new transaction with the same buyer and increase sales and profit as they churn their internal credit limits faster.
Challenges remain
Changing economic conditions are not going to result in an overnight boom in SCF. However, if credit becomes harder, and more expensive, for suppliers to access from domestic banks, the ability to leverage foreign buyers’ credit lines will become more attractive. A wider gap between buyer and supplier credit ratings could prompt suppliers to more actively consider SCF as a financing tool.
Moreover, while weaker credit conditions could make SCF more attractive for suppliers in the region, there is no guarantee that buyers will be willing to play along. After all, an SCF programme uses up buyers’ credit lines, although international banks may be willing to provide supplementary credit lines given the short-term nature of receivables and limited default risk. To achieve success, suppliers must be willing to do extensive preparation and be able to present a strong rationale for the buyer to implement a programme, much as a buyer would in a buyer-driven programme. As often said, the better tailored an SCF programme can be to a win-win, the higher the adoption rate and the robustness of the programme.
With a buyer driven programme the credit focus is almost exclusively on the buyer - the client of the funding bank. Ideally, under a supplier driven programme, both parties should be clients of the same bank, as few banks would be comfortable taking on direct credit or recourse risk on companies that they’re not familiar with. And while a supplier-driven programme has no hard cost for the buyer as the supplier pays the interest expense, suppliers must make sure that it also places as few, if any, burdens – in terms of documentation, for example – on the buyer as possible. Suppliers also need to develop a plausible case detailing why they are critical to the buyer’s business and how the buyer would benefit from a deeper relationship with them.
Choosing the right provider
In conclusion, the gathering clouds over some Latin American economies could increase the attractiveness of SCF in the region. However, adoption and perception challenges remain for both buyers and sellers and companies need to ensure they work with a bank that has both a deep understanding of the regional market where SCF is to be implemented and the home market of buying companies. It is critical that the bank implementing the programme has strong relationships with both buyers and suppliers: local banks are generally unable to meet this requirement due to the limitations of their geographic footprint.
Buyers (and suppliers) seeking to implement an SCF programme should ensure the bank they choose to work with has a strong commitment to investment in SCF, and a robust platform that is flexible for both buyers and suppliers and can incorporate any mix of documentation, from manual to fully electronic invoicing. Latin America remains a complex, diverse and challenging region. Advanced technology and a broad market footprint can help to overcome some of these challenges, lower costs associated with implementation, and deliver effective support.
