gtnews’s 2009 trade finance survey, in which 267 corporates were polled, exposes trade finance as an area of particular weakness that undermines efforts to optimise working capital. Corporate attitudes to trade finance highlight a significant difference between how companies manage their trade finance activity, and the way they manage and monitor other cash flows.
It emerged that, while treasury departments have implemented processes and policies – often on a global level – to ensure they have visibility and control over their cash flows, this level of monitoring and access to real-time data is often absent in trade finance. If treasurers and financial controllers are to have a complete picture of their company’s cash (thereby reducing risk, improving the accuracy of cash flow forecasts and maximising working capital) then they need to enforce centralised policies and invest in advanced technology for trade finance.
1. Management Structure
The survey showed that 20% of the companies manage their trade finance operations on a global basis while 31% have regional autonomy with global oversight. Forty-three per cent of companies manage their trade finance regionally or locally. According to Lars Millberg, global head of trade finance at SEB, far more than 20% of companies should have a global trade finance management structure. By contrast, the percentage of companies that have global control over their cash management is likely to be much higher – nearer to 75%. He says that the centralisation of trade finance management needs to rise to this level: “Companies should focus on trade flows as much as on their other cash flows. There is a pressing need to improve the global structure for trade finance.” Some of the negative consequences due to lack or limited centralisation are non-homogeny process and procedures leading to higher cost of operation plus diminishing competence.
One of the survey’s respondents corroborated this, saying: “The main challenge we currently face is the inability or unwillingness of regional members to cooperate on trade finance policies.” Another respondent admitted that there were “poor adherence to standards and poor communication policies” within his/her company.
The major benefits companies would see from the centralisation of their trade finance process are:
- Enhanced control, attained when one individual or department takes responsibility and has an overview of the whole company’s process.
- More consistent implementation of risk mitigation policies – again achieved when one individual overseas the process.
- Ability to leverage their buying power with banks, enabling them to obtain better transaction pricing and, to a certain extent, risk pricing.
According to the survey results, the regions most likely to have a global management structure in place are North America and Western Europe (with 27% and 24% of respondents respectively from those regions saying they have a global management structure). Other regions are far more likely to have a locally autonomous trade finance management structure, possibly because there are a higher proportion of smaller companies outside Western Europe and North America, which are more likely to run their business in a fragmented way.
Companies with a turnover of less than US$10m are far less likely to have a global trade finance management structure (or regional autonomy with global oversight) in place: 35% of them do so. This figure for companies with a turnover greater than US$10bn is 60%.
Trade finance has traditionally been managed at a local level because people have seen it as being closely connected to the product that is being produced, for example at a factory or export/import depot. According to SEB’s Patrik Zekkar, head of trade finance sales Sweden, there is no real justification for this being the case when it comes to the finances, rather than the logistics, of trade. His advice to treasurers is that they need to make it their business to gain control over trade finance and they need to understand how the LC works, and how that process can be improved from a working capital point of view. If the existing trade finance operations of your company are managed locally, then it is imperative for companies to impose a global management structure.
Zekkar insists it is quite possible for treasury departments to gain greater control over their trade finance flows: “It is not difficult to achieve this, but it needs to be a top-down decision. It also needs to be a cross-divisional operation, involving logistics, accounts, sales etc. The treasurer needs to get approval from the board, but it is important that corporate treasuries take this step to get control and visibility of trade flows. In the end it will save the company money.”
2. Integration Between Trade Finance and Cash Management
Size of company may dictate whether management is regional or global to a certain extent, but it does not seem to have a bearing on whether the trade finance function is integrated with cash management. On the contrary, with the structure of many large blue chip companies consisting of highly specialised departments, it is more likely that smaller companies have better integrated financial processes, partly because one department (or person) may take on several roles.
While 27% of companies admitted to having no integration at all, SEB’s Millberg fears that the figure may actually be far higher: “In my experience, most companies have a lot to learn about the benefits of combining oversight and processes for cash management and trade finance. Most companies have vast improvements to make.” By contrast in cash management, timing is of the essence for the customer, particularly since ever more efficient processes, such as the SEPA direct debit, have been introduced.
However, in many trade finance processes, delays and errors are rife. Millberg questions why so many companies accept two-week delays in payment or documentation processing, saying: “In most cases, suppliers seem to be happy just to get paid – but in that case, why not get paid 16 days earlier by looking at your process and improving it?” Many banks now provide tools and expertise to enable companies to integrate their cash management and trade finance processes, systems and policies.
3. Trade Finance Policies
The survey found that 43% of companies say their trade finance processes are heavily influenced by internal risk mitigation policies, which is not surprising since a letter of credit (LC) is itself a risk-minimising tool. Internal risk policies apply particularly when trading in emerging markets. One-third of the companies indicated that their preference for trading partners also dictated their trade finance policies (for example, some suppliers stipulate that an LC must be used for the transaction).
Cost (chosen by 32% of companies) was also a major determining factor in trade finance policies, with some companies in the market perceiving LCs to be expensive. According to Zekkar, it is essential that companies balance the cost against their risk coverage. He says: “One of the current problems is that companies don’t have a model to assess risk versus cost. Also, companies see the face value of an LC, but they don’t consider the unseen cost of not optimising their working capital (which can lead to greater funding costs, for example).”
For companies with revenues below US$10m, the most important factor is ‘preference of trading partners’. For companies with revenues between US$10-500m find ‘bank trade solutions offering’ the most determining factor, but the larger companies with revenues over the US$500m all opted for ‘internal risk policy’ as their main determining factor in determining the relevant trade finance policy/policies.
4. Measuring Discrepancies
Measuring discrepancies is a key part of using LCs, since their purpose is to safeguard against any error in the transaction, both from a financial and a logistical point of view. If companies are not checking up on discrepancies then they should probably not be using trade finance instruments. It is surprising therefore that 28% of companies admit that they do not measure their trade documentation mistakes at all. Western Europe and North America were among the regions who measured discrepancies least, possibly because open account trading is more common in those regions.
According to Millberg, lack of care in monitoring and measuring documentary discrepancies can lay the company open to various risks, which can be as extreme as the buyer dropping out. While 65% of companies do measure errors either actively or on an ad hoc basis, Millberg believes this figure should be nearer to 100%.
5. Mapping Processes
As many as 41% of the survey’s respondents admitted that they did not map their trade finance processes, which would entail monitoring document types, keeping track of members of staff involved in any part of trade finance, as well as recording turnaround times, unit cost and risk assessment. Millberg noted that companies are actually wasting their money on LCs if they are not then following up by monitoring or mapping all processes related to the documentation.
Thirty per cent of companies with a turnover less than US$10m said they did not map their trade finance processes. However, this figure was considerably higher for larger companies. Smaller companies are more likely to map their processes because they have smaller, multi-tasking departments and are better able to oversee all aspects of the trade finance process. Larger companies with specialised, siloed departments may find it more difficult to map their processes.
One respondent to the survey, a senior manager from a small-cap firm in North America, also noted that mapping processes, while essential was a challenge for this company. He said: “Collecting real-time data and making effective use of it regarding manufacturing status, shipping status, costs, financing and receipt is one of our major concerns.”
6. Extending DPO and DSO Through Trade Finance
One thing that became evident from the survey results is that far too many companies do not consider trade finance to be part of their cash management. They do not see trade finance as a tool that can help them to maximise their working capital, for example by optimising the terms of their day’s payables outstanding (DPO) and the day’s sales outstanding (DSO).
Forty-one per cent of companies said they do not use trade finance documentation or processes to extend their DPO or reduce their DSO. According to Millberg, it is surprising that so many corporates don’t use the tools that banks are able to provide to them. He agrees that there is a great need to educate corporates about how to use LCs as a tool for achieving greater working capital efficiencies within the company.
7. Integration of FX Hedging Policies
While 48% of companies said that their FX hedging policy is integrated with their trade finance policy, 41% said that no such integration existed within their company. According to Zekkar, one of the difficulties in the integration of currency hedging with trade finance policies is the lack of control that those responsible for FX risk management (often the treasury) have over trade finance. He called for a better understanding of trade finance policies in treasury and also more control over all the cash flows in trade finance. Better control over trade flows will enable companies to hedge more effectively.
He says: “There is no reason why trade finance cannot be managed centrally, with policies including FX hedging and process mapping done from company headquarters.” Companies will have to invest in new technology to achieve centralised control, but once one department is able to oversee the process company-wide, this will make it easier to see and control the trade finance flows and therefore hedge currency risk according to need.
Companies in the Asia-Pacific and Middle East & Africa regions seemed to show higher levels of integration of their FX hedging and trade finance policies than other regions, due possibly to the greater acceptance, understanding and use of LCs.
8. Using KPIs to Reduce Lead Times in Document Transfer
While 65% of companies said they actively work to reduce lead times in document transfer, and many of those use key performance indicators (KPIs) to help them with this process, one-quarter of respondents said they did not actively try to reduce lead times at all. This last figure is very surprising because, by not trying to reduce delays in document processing and transfer, companies are in fact losing out on valuable working capital.
As the size of trade with emerging markets increases globally, treasuries have to keep an ever closer eye on the timings involved in trade payments. KPIs can help to monitor lead times by setting benchmarks for best practice – these can be provided by your relationship trade finance or cash management bank. Banks can also help their customers with technology that will reduce or eliminate the need to physically post original documents. By scanning the documents electronically, lead times can be reduced by 10 days or more.
Companies in CEE and also smaller or mid-sized companies were more likely to be actively seeking to optimise lead times.
9. Treasury Influence
Just 14% of companies claimed that their treasury department had a ‘leading role’ when it comes to decisions regarding emerging market transactions. Although 65% of the respondents said that the treasury department has either ‘partial influence’, is ‘occasionally consulted’, or is ‘part of the project’, the 14% who are actually taking a lead in emerging market cash flow decision-making is worryingly low.
As Millberg points out: “It is treasury’s job to influence and improve cash flow management everywhere in the company – and that includes trade finance globally. Corporate treasury needs to be aware of the size of flows in emerging markets. It is important because they need to be able to view DPOs and DSOs for cash flow forecasting. They need to ask questions and be very much on top of this.”
10. Including Trade Finance Data in Cash Flow Forecasting
Very few corporates – just 9% – said that they fully automate the inclusion of emerging market trade flows into their treasury’s cash flow forecast. Although 43% claimed to incorporate the data manually, and 32% had some level of automation, lack of full automation leaves room for data errors – and too many Excel spreadsheets. One of the survey’s respondents, a Brazilian treasury director, confirmed this, saying: “Nowadays the main challenge is to adapt the cash flow forecast to our new economic reality, thinking how we can improve the working capital for our region.”
Millberg says that companies should try to ensure that trade finance data is fully incorporated: “The higher the quality of data, the better decisions you are able to make. Otherwise treasurers risk ending up with too much capital on their accounts.” Advanced banking technology available today can help companies to vastly improve the data feeding into their cash flow forecasts.
The most common challenges cited by companies include:
- Risk management, including FX risk.
- Technology investment, including collecting real-time data and cash flow forecasting.
- Shortage of liquidity and difficulty in obtaining funding/credit.
- Problems with trading partners (from communication to uncertain creditworthiness).
- Regulations, including local bank account rules and transfer pricing.
- Communications within the company.
- Finding an appropriate partner bank.
Risk management, including FX risk hedging, is a prime function of trade finance documentation and, given the current market volatility, it is not surprising that it is one of foremost challenges for companies. Treasurers need to seek advice from their partner banks on how to manage these risks and ensure that internal risk policies are integrated with trade finance policies.
Another common challenge is that of technology, which comprises implementing a new system, ensuring data security and timeliness, or enabling a smooth and reliable transfer of data into cash flow forecasts. One respondent, a financial controller at a small-cap European company, says: “Our main challenge is in implementing an intranet to link and integrate financial processes and information,” while another points to: “Integrating the physical and financial supply chains to get a clear understanding of the total landed cost of goods.”
Many respondents referred to their need to improve not only technology but also communications within the company, particularly between local units and headquarters, and between different company departments. One senior manager at a small-cap North America firm expressed his company’s need for a better understanding and integration of all of the trade transaction components: “If we could improve understanding between finance, insurance, tax, freight and accounting, that would help us to structure the most secure and cost efficient transaction structure.”
The gtnews 2009 trade finance survey brought to light several interesting findings, but the most salient is that treasury really needs to close the current gap in its control and influence over trade finance. Some of the key figures from the survey include:
- Only 14% of company treasuries have a leading role in trade finance.
- Only 20% of companies have a global management structure for trade finance.
- Just 9% have an automated process for feeding emerging market trade data into their cash flow forecast.
- 27% of companies have no integration at all between trade finance and cash management.
- 28% of companies do not measure their trade finance discrepancies at all.
- 41% do not map their trade finance processes, seek to optimise their DPO or DSO, or integrate their FX hedging policies into their trade finance policies.
These figures tell a story of far too many companies with not enough communication between separate departments, and treasuries without sufficient data and systems to influence trade flows. It is imperative for treasuries to take control of their trade finance operations by implementing company-wide policies and processes as well as advanced technology to provide real-time data for cash flow forecasting. This can be achieved by seeking the expertise of your bank, who can provide the required systems. Company treasurers should also seek approval from the board to introduce a financial structure that will bring trade finance firmly within the realm of treasury.
313 readers of gtnews took part in an online survey between November 2008 and January 2009. The survey consisted of 11 questions and 267 of the respondents were corporates. The results are based on the answers of those 267 corporates. The survey had a global response, although corporates from Western Europe made up 35% of the respondents, with 27% from North America, 22% from Asia-Pacific, 8% from the Middle East and Africa and 4% and 3% from Latin America and Central and Eastern Europe (CEE) respectively. There was an even cross-section of companies participating in the survey in terms of size – roughly one-fifth had a turnover of less than US$10m and one-fifth had a turnover of more than US$10bn with an equal distribution of middle-sized companies in between. The majority of respondents work at executive board or director level (42.3%), while just over a third are middle management and 23% are operative staff.
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