Published: January 01, 2000
A number of different trends and influences are defining the way in which supply chain finance is developing within Latin America – and these do not necessarily mirror the trends in Europe and the US.
In recent years, supply chain finance has become an increasingly mainstream product with a simple goal, which is to enable companies to improve their working capital. The concept is straightforward: the purchasing company can extend the payment terms to suppliers, while suppliers receive early payment from the bank providing the programme. Supply chain finance is differentiated from other receivables financing solutions because it is initiated by the purchasing company rather than by the supplier. As such, suppliers can benefit from a lower cost of finance based on the credit rating of their typically larger and financially stronger customers as well as tapping into an alternative or supplemental source of liquidity.
Although the market for supply chain finance is reasonably well-established in Latin America, this is still widely regarded as a ‘new’ solution, and many companies, especially suppliers, are only just beginning to understand the benefits of a product that is driven by a bank’s relationship with a buyer versus a classical factoring solution. Nevertheless, supply chain finance is a hot topic in the region and there is significant and growing interest in this area.
The dynamics currently driving developments in Latin America’s supply chain finance market can broadly be divided into four trends: interest from the commodities sector, opportunities within the region, opportunities at a country level and the creation of new supply chain channels.
The first trend is the growing interest we are seeing in supply chain finance from the commodity space. Commodity prices have risen sharply in recent years, and while these might be softening at the moment, companies are still faced with the issue of how to finance a product that has gone up 20% or 30% in value. The same issue also impacts suppliers, who may be unable or unwilling to extend higher levels of credit to their buyer of commodities, which have increased in value even if actual sales volumes might not have changed. As a result, both sellers and buyers of commodities, particularly oil and gas where big ticket items are common, are looking at supply chain finance as a way to manage their different needs.
At the same time, we are seeing tenors of transactions that are being extended from say 30 or 60 days to as much as 180 days on many programmes and which in some cases may exceed the purchaser’s cash conversion cycle, in contrast to traditional loans where the conversion cycle may be a bigger factor in the bank’s lending decision. The longer the payment terms the greater the benefit to the purchasing company's days payable outstanding (DPO), although supplier's willingness to accept lengthier payment terms even when discounted with a bank varies depending on the market. Longer tenors have historically been a feature of the marketplace in Brazil, where payment terms of 360 days for an item that may be used or sold within 90/120 days is not that unusual. This isn’t as much the case in other countries in the region, though tenors of 180 days and over are becoming more common. [[[PAGE]]]
The second trend relates to opportunities for supply chain finance between the countries of Latin America and other so-called emerging markets. Whereas previously supply chain finance tended to apply to north/south trade flows, we are now seeing far more south/south trade – in other words, one emerging market trading with another. As local practices in emerging markets become more sophisticated, companies in these countries are interested in leveraging their experience with supply chain solutions in their north/south flows and applying them to their south/south transactions as well.
Supply chain finance within individual countries is the third trend, although this is at a more nascent stage. Companies in the region’s more developed countries – Peru, Colombia and Brazil – are increasingly sourcing goods from other companies located in-country, who are in turn importing from overseas. This is leading to a request for supply chain finance solutions between the purchaser of the product and the local importer, potentially mirrored by an equivalent need between the importer and the end foreign supplier. Until now these transactions have all been denominated in hard currencies – generally US dollar – but it’s not unthinkable that there will be demand for supply chain finance in local currency, which will open up an entirely new area of interest to banks in the region. This is also a solution that foreign banks who are unlikely, due to a more selective client base focused on larger international companies, to know all the players or have access to local currency, could partner with their correspondent bank clients in region which would have the benefit of adding a new dimension and depth to their relationships.
The fourth trend relates to the creation of new supply chain channels or conduits, which is also becoming more widespread. For example, a company importing goods may wish to extend its payment terms to an overseas supplier while the supplier is not keen on the concept for their own reasons. An increasingly popular solution is one facilitated by a financial institution which has its own commodity group or trading company. That commodity/trading company would have the capability to source and purchase products from the overseas supplier at the original terms and cost and then proceed to on-sell the product to the end purchaser at extended payment terms. The supplier is happy as it gets the same payment terms as in the past, the purchaser benefits from extended terms and improves its working capital, and the intermediary party collects a fee for its services.
The trading or commodity company will not generally have its own source of independent funding, so it will need to fund internally via its parent bank – or, likely given the sizes of the programmes, place paper with other financial institutions which therefore become de facto funders of the supply chain transaction on a disclosed/undisclosed basis. The challenge in a Basel II and III world is to find participating banks willing to use scarce capital to fund a transaction they might view as being originated by a competitor.
While these four trends are having a major influence on the development of supply chain finance solutions in Latin America, they do not necessarily mirror existing supply chain finance elsewhere in the world. For example, supply chain transactions originating in Northern Europe and the US are less likely to involve trading companies and commodity companies in the middle of a transaction and are unlikely to extend payment terms to the extent that we are seeing in Latin America.
There also tend to be fewer transactions by number in Latin America, but the value of those transactions tend to be larger, particularly because much of the growth in supply chain finance is commodity driven, as opposed to a US programme that might be more consumer product/retail oriented with smaller individual ticket items. So while programmes in the US and Europe often include many suppliers and numerous transactions, in Latin America the trend is for fewer but larger ticket transactions. While there will always be exceptions, it might be fair to generalise that supply chain finance within the Latin American region tends to be less of a programme and more an ongoing series of large individual deals.
This may change in the future. Payment terms can only be extended so far as there has to be a realistic link between terms offered in supply chain finance and terms one would see in a classical borrowing relationship. In some countries and market segments, payment terms have already been extended as far as reasonably expected and the pressure on banks to use scarce capital wisely will make them reluctant to extend them even further. So for companies looking to make further improvements to their working capital, the next logical step is to broaden the reach of their supply chain finance programme to include a larger number of suppliers. In Mexico, where local programmes, when utilised, typically encompass a very high percentage of suppliers, thereby getting closer to the US 'retail' model. [[[PAGE]]]
This approach does bring its challenges. Suppliers in-country, which tend to be smaller and less sophisticated companies, are not as familiar with the concept of supply chain finance than larger corporations in the region. As a result, onboarding suppliers becomes more difficult, time-consuming, and requires local language capability if not a physical presence. The need to amend legal documentation to allow for local law may also be a prerequisite for mass adoption by less sophisticated suppliers. This further adds to the challenge for financial institutions to educate suppliers about the benefits of the programme and convince them to sign up in sufficient numbers to make the programme worthwhile.
Despite the challenges, supply chain finance is inevitably set to become established within different client segments over the next few years, making suppliers more willing to take advantage of it, which leads to a virtuous cycle of activity and adoption. Companies in Latin America are more sophisticated than in the past and are ready to embrace best practices. There is increasingly a push by local domestic banks, driven by their awareness of supply chain finance on an international level, and the realisation that they need to seize the opportunities presented. In light of these catalysts, adoption of supply chain finance will continue to grow and thrive in the region.
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