Stepping outside of the finance-box, a widely-accepted definition of the term ‘dematerialisation’ is provided by the United Nations Environment Programme (UNEP), which describes it as the “reduction of total material and energy throughput of any product and service, and thus the limitation of its environmental impact.”
Taking a closer look, it becomes obvious that this environmental definition is anything but far-fetched from the treasurer’s situation in business-to-business (B2B) trade finance. The increasing spaces which technology, co-operative B2B networks and the first legal initiatives leave for dematerialisation provide the treasurer with powerful tools to increase the stability of the financial supply chain, optimise both working capital and capital costs, and manage financial risks.
The extent of dematerialisation in the procure-to-pay process can vary significantly, often ignoring long-established boundaries that have traditionally separated the realms of treasury management and trade finance. With the ever-closer alignment of technology, supply chain management and finance, levels of integration may start with modest initiatives such as payables digitalisation and archiving, evolve to the next stage by electronically integrating the whole order to cash (O2C) cycle and eventually lead to a full integration of trade processes in multi-party purchase-to-pay (P2P) platforms.
The higher the level of integration and automation, the higher the resulting level of end-to-end visibility of the finance and risk status of the trade activities or so it appears at first glance. This assumption is, however, only partly true. Simply moving away from paper invoices, freight documents and so forth by means of automated document scanning and archiving doesn’t entirely do the job. To allow data aggregation to make a contribution to true visibility and transparency, that data needs to be extracted and compiled in a consistent manner so that it can be processed by and exchanged between existing systems regardless of their technology, platform or format.
Consistent with this line of reasoning, the European Commission (EC) Expert Group on Electronic Invoicing (E-invoicing) excludes the mere transmission of an electronic image of an invoice document from the e-invoicing definition. Dematerialisation in this context should be understood as the transformation of paper-based or other physical information into generally accepted, interoperable electronic formats.
Dematerialisation and Risk Mitigation
Instant, accurate and detailed information about the customer and supplier status and trends in the trade relationship fosters risk mitigation both upstream and downstream. Aggregated historical data allows buying organisations to assess performance as well as the risk of fraud, while the supplier can enhance credit risk management and collections via automatic reminders, e-dunning, direct debits and the like.
New platform solutions facilitate such efforts. P2P platforms offer a variety of features that provide for electronic and automatic processing of some or all administrative steps, from sourcing to payment, in a consistent, exchangeable data format. Examples are electronic generation and matching of purchase orders and acceptances, electronic creation, signing, issuing and filing of bills of lading and peripheral documents, electronic invoice presentment, approval and payment or automated documents/payments reconciliation. SWIFT’s Trade Services Utility (TSU)/bank payment obligation (BPO) initiatives are prime examples of the concept.
In the B2B finance context, risk mitigation through dematerialisation has its highest leverage when a financial institution is put into play. Banks did their homework and converged the former silos of cash management and trade finance into integrated, end-to-end supply chain finance (SCF) solutions that can interconnect with the data streams generated by dematerialisation. The above-mentioned electronic avenues substitute for former manual steps and physical information allowing banks to fine tune their risk assessment with the actual risks encountered in the different stages of trade. Consequently they may serve as triggers for injecting liquidity into the supply chain at minimal cost.
Impact on Approved Payables Finance
To satisfy the liquidity needs of B2B supply chains, banks and other providers offer approved payables finance (APF) programmes. APF allows suppliers to sell their receivables to a bank at a discount once the buyer has approved them. This allows the buyer to pay at the normal invoice due date and the seller to receive early payment. The bank relies solely on the creditworthiness of the buyer, who usually is investment grade or higher, so that his or her approval of the invoices consequently allows for very attractive pricing towards the suppliers. The supplier optimises working capital through early cash flow leading to reduced days sales outstanding (DSO), while the buyer can benefit from extended payment terms, thus increasing days payables outstanding (DPO).
Speed Matters, Volume Counts
As it is the buyer’s approval that triggers the financing opportunity, it becomes apparent that the benefits the trading partners can realise from these programmes fundamentally depend on the buyer’s ability to approve invoices quickly. As trade receivables are short-term receivables, material working capital optimisation both for the buyer and his supplier base requires the buyer to approve an invoice for payment within a matter of days. The window of opportunity for the sale of confirmed receivables to a bank thus is determined by the fast and efficient processing of all trade-related documents and information. This requires automated accounts payable (A/P) processes based on reliable, electronically available data. Any kind of statistically relevant data volumes will help to introduce new risk assessment, based on an advanced rating approach for transaction-based finance.
The second prerequisite for attractive gains on the working capital side is volume. In a world of manual paper handling, supplier finance can be a high administrative burden, and the value gained by APF needs to be sufficient to outweigh the costs. This can present a problem, particularly in environments where large numbers of low-volume transactions must be processed. Dematerialisation over a B2B network provides for a full automation of the SCF activities between corporates and banks. This unlocks the full potential of buyer-driven SCF programmes, by making them available on transactions of much lower value than has traditionally been the case.
Dematerialisation of B2B finance thus gives the treasurer possibilities of unprecedented large-scale working capital optimisation and further fosters the collaborative dimension of working capital financing.
Dematerialisation and Pre-shipment Finance
Pre-shipment finance models offer additional benefits to exporters looking to support their suppliers. In these programmes, financing is made available to a supplier based on a purchase order received from a buyer. This ensures that suppliers get access to inexpensive working capital even earlier in the trade lifecycle, so they can cover all the related working capital needs including raw materials, wages, packing costs and other pre-shipment expenses. Compared with post-shipment finance, both buyer and bank need to pay special attention to supplier performance and fraud risks.
Dematerialisation can help also here to alleviate risk. As it enhances data accessibility, accuracy and actuality, it will help the supplier’s bank to support its credit assessment by increasingly taking into account transaction-related data for the judgment of the supplier’s ability to fulfill his contracts.
Furthermore, dematerialisation provides for automated pre-shipment finance models making use of the BPO that SWIFT is introducing to supply chain participants. Until now, pre-shipment finance was often based on traditional letters of credit (L/Cs). BPO allows for bank intermediation using electronic flows instead of processing paper documentation and thus can smoothly integrate into a dematerialised world of collaborative, multiparty SCF.
While today’s collaborative SCF, both pre-shipment and post-shipment, is not yet the standard, the onset of B2B finance automation and the increasing interoperability of supply chain networks mean that it is likely to become the de facto trade finance standard over the next decade.
In the past, several areas have managed to inhibit widespread adoption of the described SCF models on a large scale. As these significantly overlap with the barriers that dematerialisation efforts have to cope with, dematerialisation and collaborative SCF will move towards the future hand-in-hand. This future looks bright. Already many of the barriers are in the process of being eliminated by the growing popularity of open B2B networks, which foster trust, interoperability and widespread acceptance.
Another important driver is the onset of the Basel III regime, which will increase capital ratios and calculations of risk weighted assets (RWA). This will lead to significant cost increases in plain-vanilla working capital facilities driving the trading partners towards better-adjusted solutions, which allow for a transaction-based risk assessment.
Format fragmentation and a lack of clarity on document standards stymied the popularity and utility of broad based B2B networks. For e-invoicing, the International Organisation for Standardisation (ISO) has recently released a global e-invoicing standard based on the ISO 20022 format, which evidences that generally accepted formats are within reach. In addition, as platform providers and banks now provide services that are able to handle the existing multitudes of formats, the lack of a single global standard ceases to be a practical inhibitor.
Finally, in the legal field, dematerialisation as well as SCF currently stands at the crossroads of several areas of legislation such as VAT, payments, data protection and authentication. Although only a handful of clear international regulations, harmonised laws or even administrative practices are yet in place, there are clearly visible trends to harmonise country compliance requirements – above all in Europe and especially in the field of e-invoicing. With the EC’s initiative to support e-invoicing likely to be the predominant method of invoicing in Europe by 2020, European-wide penetration is expected to exceed 50% as early as 2017 for the B2B segment.
The developments described foster the re-intermediation of platform providers and banking partners with supply chains around the globe. Banks are in an particularly well-positioned to build and support these key supply chain networks due to their well-established customer base and far-reaching geographic penetration. The symbiotic fusion or full integration of electronic invoice presentment networks with transaction-based lending solutions and services open new avenues for working capital optimisation, supply chain stabilisation and, almost incidentally, greatly improve supply chain visibility, control and efficiency.
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