Trading Out of the Crisis

Published: February 01, 2012

Trading Out of the Crisis

by Helen Sanders, Editor

“Colleagues, these are tough times for the world economy and there is no early end in sight. Debt levels and the volatility of financial markets are rising and low growth levels persist. There is a slowdown in trade and a drop in foreign direct investment flows, volatility in food and fuel prices and high unemployment levels also persist. The economic crisis is further aggravated by perceptions that the political responses of governments have so far been insufficient to convince markets about credible exit strategies.”

With these opening words at the recent World Trade Organisation (WTO) Conference (21 December 2011) Olusegun Olutoyin Aganga, Trade & Investment Minister, Nigeria articulated the challenges that face every corporation, bank and government globally. Pascal Lamy, Director General of the WTO followed by saying,

“We need to look at the real drivers of today’s and tomorrow’s world trade, at today’s and tomorrow’s obstacles to trade, at today’s and tomorrow’s trade patterns, at how to keep transforming trade into development, growth, jobs and poverty alleviation.”

We will not talk ourselves out of crisis, and politicians will not do it for us. Instead, as corporations, we must continue doing what we should do best: create wealth, jobs, economic sustainability and improved societies by producing and selling competitive products and services that meet the demands of individuals and organisations around the world. To do this successfully requires the right financial frameworks that allow every buyer and seller to manage their risk and liquidity. So are we, as treasurers and finance managers, putting the company in a position to trade out of the crisis? In this article, we are delighted to feature trade finance experts Pravin Advani, Global Trade Executive, Asia Pacific, J.P. Morgan Treasury Services, based in Hong Kong, and Martin Knott, Head of Trade, GTS EMEA, Bank of America Merrill Lynch, based in Europe.

Changing behaviours, constant objectives

Pravin Advani, J.P. Morgan Treasury Services summarises that the prospect of improving economic conditions until relatively recently had changed the behaviour of some trading partners,

“Over the past two years, we have witnessed a gradual economic recovery which has led to an increase in demand for open account compared with the aftermath of 2008-9 when traditional trade instruments were more attractive. However, as the situation in Europe continues to cause concern, the past few months have been more challenging, and again, our clients are seeking trade instruments and confirmation of LCs as well as supply chain tools.”

Martin Knott, Bank of America Merrill Lynch explains that while the choice of instruments may fluctuate over time, managing risk appropriately has (or should have!) become an imperative for corporations, not only in terms of direct counterparty risk, but looking at risk across the entire supply chain,

“There is a growing focus on risk mitigation, so companies are seeking to increase the resilience of their supply chain by more actively supporting their suppliers. Natural disasters and market turmoil can have a huge and rapid impact on the supply chain as the past few years have illustrated. In order to mitigate risk and to respond promptly, firms need a risk management framework to help model different scenarios, and provide a detailed execution plan that sits behind that framework. The better a company knows its suppliers, the more prepared it can be to react quickly in light of the challenges of today’s volatile times.”

Furthermore, he explains,

“Despite the economic slowdown, which has inevitably resulted in a deceleration of trade finance volumes, we continue to see increasing demand from our clients, particularly in areas such as supply chain finance. Companies that may have introduced regional programmes in the past are now looking to roll these out globally.”

Pravin Advani, J.P. Morgan concurs,

“Clients are increasingly looking at their risk profile as a whole, including both buyers and sellers, and managing both sides very closely. Consequently, our clients are seeking a range of solutions across traditional trade and open account to match their risk management needs.”[[[PAGE]]]

The full picture

This broader approach, that takes into account risk, liquidity and the wider financial value chain, is increasingly reflected in the way that treasurers’ objectives are set, and how their performance is measured, as Martin Knott, Bank of America Merrill Lynch outlines,

“Treasurers’ performance is now increasingly measured using working capital and risk management key performance indicators (KPIs) so in order for these to be meaningful, supply chain finance and trade finance structures need to be within treasurers’ sphere of influence and decision making.”

No longer, therefore, are trade, cash and risk management siloed disciplines, but integral elements of an overall financial management framework. This integrated approach is being matched in the way that banks organise their service delivery models, as Martin Knott, Bank of America Merrill Lynch continues,

“Our clients remain at the centre of the solutions we develop and the services we provide. While trade finance may be one element of their requirements, we look across their whole business from working capital optimisation to risk mitigation. By focusing on the total client relationship, we provide flexible solutions based on what’s best for the client.”

He continues,

“For example, working capital optimisation and safeguarding liquidity is an essential component of the Treasury Dashboard which is pushing trade finance solutions towards closer integration with the overall treasury function.”

Pravin Advani, J.P. Morgan agrees,

“We will continue to see a convergence of trade, cash and foreign exchange, so we are aligning our services accordingly.”

There are few banks today that promote cash, trade and supply chain finance as distinct divisions within their business; however, the degree of integration varies, and treasurers with a significant demand for integrated cash and trade solutions may wish to review whether one team is accountable for an entire solution, and how support is organised.

Treasurers have other demands from their banks in addition to providing integrated solutions. In particular, they need to act in an integrated and cohesive way not only within the bank, but also in the way that they co-operate with other banks. As Martin Knott, Bank of America Merrill Lynch discusses,

“Some clients are seeking multi-bank participation in their supply chain and trade finance programmes. In some cases, this is driven by their own credit concentration risk policies, in others, the growth of these programmes means that the value of dollars outstanding can exceed a single bank’s capacity to support their needs. Corporates are therefore seeking greater interoperability between banks not just from a funding perspective but also from a technical perspective.”

External drivers to integration

A major driver towards a more integrated approach to treasury and trade solutions is Basel III, which could bring significant changes for treasurers in the coming years. As Martin Knott, Bank of America Merrill Lynch describes,

“Another major source of uncertainty is the impact of regulatory change, such as Basel III. While we have seen modifications to the regulation with respect to trade finance which includes changes to the one-year maturity and sovereign floor caps, going forward, there may well be some changes in the way that banks deliver trade finance solutions. We continue to actively participate in ongoing discussions around Basel III to ensure we represent the interests of our clients, the bank and its shareholders.”

Pravin Advani, J.P. Morgan continues by explaining that some of these discussions have borne fruit,

“Recent changes announced by the Basel Committee will allow banks to set aside less capital for short-term letters of credit provided to importers and exporters to finance trade. They will also reduce the amount of capital that confirming banks have to hold against letters of credit issued by lenders in low-income countries, which will ultimately help promote the trade of goods, and import and export business, in emerging markets.”[[[PAGE]]]

However, there remain ongoing challenges and uncertainties about the cost and availability of trade finance products under Basel III. Much will depend on which banks announce compliance with Basel III first and what precedent is set with regards to pricing. Inevitably, ensuring sufficient levels of capital is only one factor that contributes to the cost of trade finance solutions; in addition, banks will increasingly need to focus on the full breadth of a customer relationship, with that customer’s value to the bank calculated at an overall level, rather than by individual product. While potentially higher pricing is never good news, the prospect of banking discussions across the full spectrum of a treasurer’s needs is a positive outcome.

Looking East

To be successful in supporting international trade requires not only the right financing approach, but also risk, financing and trade solutions that meet both local requirements and the wider interests of the company. China is now firmly established as a major focus region for many importers and exporters alike. Regulatory restrictions still disallow many of the same risk and liquidity solutions that are familiar in other regions; however, initiatives such as the development of the cross-border trade settlement scheme illustrate the Chinese government’s desire to promote trade in RMB, in order to protect the interests of Chinese companies, and ultimately to develop RMB as an international reserve currency. As cross-border trade transactions can now be settled in RMB by eligible entities (which any company in China can now apply for) a question that is growing in importance for their foreign counterparts is whether transactions should be conducted in USD or in RMB. Pravin Advani, J.P. Morgan summarises,

“The government is actively promoting the RMB as a currency for trade, borrowing and investing, and we would expect to see further moves as the RMB travels its path of internationalisation. The road ahead, though, will be long. While cross-border settlement in RMB is substantial, it still accounts for little more than 10% of total cross-border trade, with only 67,000 designated exporters to date, and while the capital markets side of the equation is off to a promising start, there remains significant potential in terms of the further deepening and broadening of investment channels and instruments, both of which will be key drivers in the take-up of the currency.”

With continuing restrictions on currency convertibility, cross-border liquidity management and investment, there are still major questions that treasurers need to consider, but the right choice of currency potentially has major competitive, as well as risk and liquidity management implications. Looking ahead, treasurers will need to work closely with their banks to determine if, and when, settling trade transactions in RMB brings value to their business.

Risk, liquidity and managing change

To support a company’s trade activities successfully, treasurers need flexible financing products that reflect the degree of risk associated with each country and counterparty, which is likely to include both open account and traditional trade transactions. Furthermore, treasurers’ view of risk extends across the entire supply chain, which may necessitate co-operation across a panel of banks to support large, complex supply chain finance programmes. Perceptions of risk, key focus regions, and liquidity requirements are not static, and solutions need to be flexible to accommodate changes in the market and in corporate requirements over time. Martin Knott, Bank of America Merrill Lynch concludes,

“Looking ahead, we expect market uncertainty to continue for some time. As the past few years have demonstrated, change can happen very quickly, so treasurers, finance managers and their banks need to be in position to respond immediately. This is a major focus of our activities, including detailed scenario planning, both for the bank and our clients, to ensure we can provide the necessary support through these challenging times.”

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Article Last Updated: May 07, 2024

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