Asia is going through an important evolution that will push the region to greater efficiency as regional corporates become more sophisticated and move towards open account trading, where exporters ship goods based on an importer’s payment promises rather than through traditional letters of credit (LCs). While the region’s trade environment may take years rather than months to fully mature, it is evident that the landscape has already altered substantially, with significant implications for an expanding legion of traders.
Certainly, open account trading values (captured through the Factors Chain International (FCI) network) grew continuously in Asia from 2003 to 2008 – with an average increase of 25% each year over that period. And despite the region on average witnessing a halt to this growth in 2009 – as global trade flows in general were hit by the financial crisis – some Asian countries recorded increases in the value of open account trade regardless. In Singapore, for example, the value of such trade increased by 20%, whereas in China the increase was even more marked with a 24% increase.
This move to open account is attracting more and more attention across the region. Yet the slow pace of penetration of open account trading in Asia must speed up if the region is to continue to grow. With its ability to streamline processes by eliminating multiple parties involved in the global trade flows – while simultaneously reducing the amount of documentation required – open account trading must become more prevalent across the whole region in order to maintain trade volume levels with the US and Europe. Certainly, overseas importers have put tremendous pressure on Asian exporters to provide open account services in order to move away from the high costs of LC trade.
Furthermore, the transition is also fundamental to increasing the efficiency of intra-Asian trade – a key reason behind Asia’s emergence as the driver of global economic growth in light of the financial crisis. Yet numerous obstacles stand in the way of the move to open account. And perhaps of most significance is the underdevelopment of the region’s local financial services market, with stifling regulation and the lack of expertise or risk appetite of local banks meaning that many regional corporates are denied access to crucial open account and trade finance products.
Inefficiencies Driving the Trend Towards Open Account Trade
So far, the gradual transition to open account trading has been driven by necessity. LCs are ineffective both from an operational and cost perspective, and have as such created huge inefficiencies within the trading culture of Asia. Certainly, as a result of corporates having to deal with an extensive amount of trade documentation to meet the procedural requirements under LCs, the physical supply chain always flows faster than the financial supply chain. Take a transaction involving a shipment of oil from Singapore to Indonesia, for example. While the shipment itself may take only a day to be transported, the processing of documentation under a LC can often delay the completion of the financial transaction by up to a week.
The lethargy of this process is a major impediment to trade and can result in significant supply chain bottlenecks, idle capacity and avoidable costs. Indeed, in Asian countries where LC usage remains high, trade facilitation performance rates are among the worst in the world, with export procedures taking more than 75 days on average and at a cost of more than US$3,000. That compares to an average of 10 days and US$1,123 in the G7 countries – Canada, France, Germany, Italy, Japan, UK and US. Overall, the direct and indirect costs associated with such procedures are estimated to represent as much as 7-10% of the value of the trade itself.
Open account trade, on the other hand, enables a much more streamlined payment process – as payment is effected upon receipt of instructions to pay, not upon receipt of documents conforming to the terms and conditions of a LC. Basically the payment process is distinct from the documentation process, resulting in greatly improved efficiency and considerable savings in time and costs.
Additionally, countries that are established trade economies, and have fully embraced open account trading rate are some of the best trade facilitation performers in the world. The trade processes and machinery are well oiled and hence are more streamlined and efficient. Singapore and Hong Kong are good examples in this instance, where export procedures take an average of six days or fewer, and cost less than US$650.
Initial Barriers to Growth
Yet while Asia’s import and export community is becoming increasingly aware of the efficiency benefits of open account trade – with many moving to make it the dominant payment method in their cross-border supply chain – there are still some key barriers remaining to the transition. And perhaps the biggest of these is regulation. Some countries, predominantly in southeast Asia, retain laws requiring the mandatory usage of LCs for specified exports – a result of governments being keen to strengthen their foreign exchange (FX) reserves by encouraging the repatriation of export proceeds. Yet these economic practices are clearly prohibitive to growth in open account trade and hence to the region’s economic development as a whole.
The lack of standardisation in open account trading also warrants a mention. With more than 10 providers and formats available – including those offered by SWIFT, individual banks and various vendors – corporates, who in Asia are already somewhat wary of changing their payment method, do not know where to turn for their open account offerings. What the market is crying out for is some kind of standard around open account.
The Provision of Credit Insurance
And the move to open account settlement creates several other issues for corporates to contend with. For while open account trading is less complex than traditional LCs, this simplicity brings with it increased operational and credit risk, since there is less protection built into the process. Corporates trading on an open account settlement basis therefore need to find other ways of obtaining payment security.
As such, the increase in the number of credit insurance products available on the market – which has been a focus for banks and insurers over the past five to 10 years – has been a major boon to open account growth globally. While global corporates would previously have had to turn to LCs to mitigate trade risk, they can now buy credit bureau reports, obtain credit protection or insurance of receivables finance (factoring) or even receive export working capital financing, all under open account terms.
But, with the dramatic increase in importers and exporters participating in international trade, there is a corresponding need for these types of risk mitigation on not just a global, but also a regional and local scale. Unfortunately, the depth and penetration of banks and insurers willing or able to offer these products in Asia remains incomparable to that of the west. It goes without saying that, if you are a corporate exporting out of a small town in China, you are still much more likely to obtain trade finance under a LC than you would under open account.
Again regulation rears its head as a barrier here. The region’s insurance industry is highly regulated and numerous Asian countries have rules restricting global or even international insurers from offering credit insurance in certain markets. It is therefore left to the local players to take up the slack.
Unfortunately, most local banks and insurers in Asia have neither the capabilities nor the expertise to be able to offer credit insurance. While they clearly have an in-depth understanding of the local markets in which they operate – and the importance of this should not be underestimated – they have little knowledge of foreign markets to which a local exporter may wish to export. Logically, this is to the detriment of their risk appetite – an insurer operating in Bandung, Indonesia, for example, would be reluctant to offer an exporter risk mitigation to cover a transaction with an importer in Spain as they would have little information on the creditworthiness of their Spanish counterpart.
Overcoming the Barriers
First of all, it is imperative that all industry stakeholders lobby central banks and local authorities to remove preventative, and quite frankly unhelpful, regulation. Certainly, there have already been signs that governments are prepared to sit up and take notice of such action. In April 2009 in Indonesia, for example, the government issued regulation that would have required commodity exporters to use LCs for export payments, in a move intended to support the local rupiah currency by ensuring that revenue from exports of commodities – including palm oil, cocoa, coffee and mining products – were kept onshore. Yet, in July this year – in the wake of strong opposition from exporters who feared that the mandatory use of such LCs could scare away buyers – the government backtracked and shelved any such plans.
In terms of standardisation, technology is clearly a key enabler. SWIFT’s Trade Services Utility (TSU), for example, can offer corporates the efficiency of open account trading but with most of the risk-mitigation benefits of LCs. Unfortunately, despite being pushed by the financial services industry collective as the standard format for open account trade for sometime, it has yet to gain traction. Hopefully, the anticipated endorsement from the International Chamber of Commerce (ICC) for TSU as the standard of open account trade finance may help.
Yet while technology may be an enabler, at the moment it remains unlikely that innovation such as TSU will penetrate past the big cities like Singapore and Hong Kong and into the smaller regions where it is so desperately needed. Being too remote to be offered a financial product is clearly a concept that is inconceivable in the west, and Asia as a region needs to work hard to reach a similar stage of development. And the onus is clearly on the large international banks – which have the global footprint to offer trade risk-mitigation products to exporters and the capabilities to develop new open account platforms – to take a lead in developing the open account and insurance markets in smaller Asian towns and cities.
International banks should therefore form strategic partnerships with local banks in order to bring a level of sophistication to their business, while still leveraging their knowledge of local markets and traders. Forming partnerships with national or regional insurers may also help in this respect. Indeed, last year, Standard Chartered Bank signed a partnership with the China Export & Credit Insurance Corporation (SINOSURE) to provide trade financing services to Chinese exporters, hence allowing them to develop their business with more competitive financing cost and supporting the expansion of China’s export trade.
Undoubtedly, this is a long journey and there are many steps to take before essential financial services can be accessed in the most remote regions of Asia. Yet it is imperative that governments, insurers and banks alike take the right steps if Asia is to fulfil its potential to sit alongside the US and Europe at the top tier of the world’s trading regions.
When Mark Cuban declared that "Data is the new gold" he highlighted why information is possibly the most valuable asset a business has. APIs are the unsung heroes that make it possible to extract that value.
The revised Payment Services Directive regulation, regarded as one of the most disruptive in Europe’s financial services sector, will begin to make an impact on January 13, 2018.
The cost of compliance efforts for banks has increased exponentially in recent years. This is especially true for those banks that are active in the global trade finance domain, where the overwhelming expectation is for compliance requirements to become even more complex, strict and challenging over time.
This year promises to further the regulatory compliance burden imposed on financial institutions. How are firms in the sector responding to the challenge?