A WHOLE NEW TRADE
Trade finance is morphing into new business that holds promise for better working capital management.
By Arthur Clennam

When Praveen Kadle, CFO of Tata Motors in Mumbai, talks about trade finance, he doesn't mention the words trade finance at all. For him, the words are synonymous with an overarching discipline: management of working capital. His company is the nation's leader in auto sales, with a 59 percent market in India, where Tata Sumos and Safaris contend in turbulent pageantry on India's highways. Its sales were up 123 percent year-on-year in its latest reported quarter, ending in June. With profits motored by a consumer boom among India's rising middle class, the US$4 billion company is going multinational, with an accent on Asian expansion.

A joint venture with Daewoo will start producing vehicles in South Korea next year. A deal with Iran Khodro, the Iranian state-owned carmaker, to outsource production is in the works. So with cars going like chapatis at home, and new relationships emerging around Asia, Kadle's main concern is that his company's increasingly complex supply chains will become a logjam for working capital.

But here's where he's experienced a pleasant surprise. "In fact, our working cap performance has greatly improved since our business turned around in the last three years," he says as if recounting a revelation. "A lot of it has to [do with] the changes in how we manage our supply chain - and how the banks have bought into what we're doing."

He says: "Our revenues have grown from US$2 billion to about US$4 billion in three years, and yet our performance on working capital has increased substantially," he says. "Receivables - except for government customers, are down to nine days on our books. That figure was 89 days three years ago. Inventories have come down from 75 to 34. We now have negative days working capital."

The reason behind this sea change? "We don't really need to borrow on account of working capital," says Kadle, "because the banks have looked at non-traditional sources to help us manage it better."

In one indicator that Tata was borrowing less, its interest cost was reduced 23 percent in the last reported quarter ending June, from one year ago. .

Going with the flow

Underlying Kadle's revelation is a broad shift in the forces bearing on trade in Asia - and a new company response to the pressures of demands for faster, smoother trade. It's no secret that intra-Asian trade flows have grown very quickly in the last three years, completely altering the traditional scenarios of Asia in its time-honored role as an exporter to the West. In the most obvious example of the shift, trade flows between the rest of Asia and China were at a surplus of US$21 billion in 1997 and clocked in at a deficit of seven times that much in the period between January and June 2004.

In the past three years, China's trade deficit with Asia has grown from US$6 billion in 2001, to US$50 billion last year, and then leapt to US$147 billion in the first six months of this year. To be sure, this widening deficit reflects a shift in manufacturing priorities, as a search for low-cost labor has meant that Western companies have selected China as hub with supply chains radiating throughout China's neighbors, near and far-flung. Ultimately, most of the goods produced are destined for the US and Europe. But the rise in intra-Asian trade isn't exclusively a matter of China acting as Asia's conduit to the West. Citibank reckons that in three years, intra-Asian trade has moved from 38 percent of total world trade to more than 47 percent.

The overarching pattern, says Andrew Au, regional trade head for Asia at Citigroup, "is that north Asia has established itself as the engine. China is becoming the gateway for manufacturing and onward sale to Europe and the US. Trade between Korea and Japan is huge." But he adds: "India has been growing rapidly, too, fueled by its domestic expansion."

Amita Jhangiani, Asia Pacific head of global trade finance for Deutsche Bank, reports a growth in non-traditional trade flows within Asia, and from Asia to the developing world. "These so-called 'south-to-south' trading patterns have developed quickly over the past three years. We've even seen a growth in trade between India and China." Trades that the bank facilitated with letters of credit (L/Cs) include an oil deal between India and Libya, and an immense shipment of cars, destined to be taxi-cabs, between a South Korean manufacturer and a purchaser in Kazakhstan.

Moreover, China can hardly be characterized as 'South' anymore. "China is moving beyond the exporter of simple products to exporting more complex types of products," says Bruce Alter, head of trade finance in Asia Pacific for JPMorgan, "often related to technology. And on the other hand, because of surging economic growth, companies in China have a voracious need to build up capital equipment, which brings in trade flows from the outside."

With this shift within Asia trading habits have changed. Says Au: "Major buyers are reducing the numbers of vendors in the emerging markets. The buyers are more experienced with the vendors and have more leverage on them." Au adds that along with this process, vendors see themselves as having to shoulder more risk. Many Western companies sourcing in Asia have made strong efforts to reduce the number of letters of credit in trade deals, concentrating on open-account transactions with vendors they know. JC Penny, the US retailer, announced three years ago, for example, that it wanted to dispense with L/Cs altogether in favor of open account deals supported by internet-based trading platforms such as TradeCard, which JC Penny now uses.

The move to open account was widely seen as the lower-cost option, and is being followed by many major companies that source their products in Asia. But to vendors accepting open account without the guarantees associated with an L/C, the danger of non-payment carries a palpable sting. The 2002 bankruptcy of Kmart, the US retailer that sourced most of its goods in Asia brought a worst-case scenario to within easy grasp. "The buyer has a lot more power and the order flow is bigger," says Au. "With the trend toward open-account trading, the demand on the vendor for risk management has grown."

Ken Stratton, the head of trade and supply chain services for Standard Chartered Bank, notes that the transfer to open account has, in some cases, relayed cost back to the buyers. "It's not just a simple case of removing the cost of L/Cs - and it ends there," Stratton argues. "Some vendors have a high cost of funds, and when they're forced to borrow to finance a shipment, that cost eventually translates into the cost of goods sold, and that is passed on."

For sellers on the sourcing end of the supply chain, says Alistair Currie, HSBC's head of trade services for the Asia Pacific, "the problem becomes risk mitigation." He adds: "When the receivables concentrate on the balance sheet, the companies run into caps, which constrain sales." Increasingly, he says, "they come to us to look for the proper structure to take advantage of what they could be doing.".

Withering away

The pattern here is that the pressures of global economics are causing the business, once dependent almost entirely on L/C financing, to morph into something far more resourceful: a basket of services that provides bankers with the ability to inject risk mitigation and working capital management into the trade finance process. Services to mitigate the risk accumulating against suppliers in Asia have emerged as a whole new market in bank trade finance. `

Another phenomenon has grown in tandem with it. Banks can introduce financing options to the suppliers in markets where the cost of capital was previously too high for them to contemplate local funding. In a word, they're financing the supply chain in a much more comprehensive way.

Tata's Kadle has seen this unfold to his advantage in India over the past three years. The banks that work with the company buy up the receivables of the suppliers, allowing quick cash repayment to the vendor. (Banks are able to pool receivables with those stemming from similar arrangements with other clients and syndicate them - although the varying credit quality of different customers can prove an impediment in some cases.) This allows vendors to immediately devote the cash to meet new production costs.

"Since the repayment on the receivables needs to be made to the bank," says Kadle, "the liability of the supplier is transferred over to the bank."

Financing options address the opposite end of the supply chain, as well, servicing the needs of Tata's dealers, which sell the Sumos and Safaris into the market. If dealers pay in cash in advance of a shipment directly to the bank, they're awarded a substantial discount and a lower rate of interest, says Kadle. In his view, options like these build an incentive for financial discipline within his own company - and with the dealers, as well. "It enforces management discipline throughout the supply chain," says Kadle, "and the result is that the overall cost of funding the supply chain has come down significantly." One benefit to the banks, he says, is that it puts them in contact with new, non-traditional sources of fee revenue.

The unsaid portion of this seemingly virtuous circle is that the banks have allowed themselves to shoulder risks that they have never before fully accepted. They diffuse this risk in traditional ways, with public and private insurance providers, which can guarantee large portions of transactions. Trade finance bankers say that collaboration with insurers is growing. But bankers also say that the technology interface with companies has allowed them to monitor the risk profile of a given client more closely. Stratton, for one, argues that the risk to the bank can be managed effectively through better technology.

In the case of Tata, which works with Standard Chartered in supply chain services, Kadle says the banks are able to access data all along the supply chain. "We can track the movement of the vehicles all through the supply chain," he says, "and we share this with the bank, with a goal of complete transparency." He adds: "For example, the banks have direct monitoring of the dealers' retail sales," giving the banks a better idea of the dealers' cashflow position.

Along the spectrum

While this kind of financing is becoming standardized throughout Asia, it's unlikely to become a commodity business because it demands close understanding of the particular circumstances of each individual business. The irony of changes in the trade finance arena is that technology has, as it has in the businesses of global custody and some cash management functions, obviated the need for the hands-on approach by bankers. On the evidence, customers appreciate the ability to deliver flexible solutions. According to Stratton, when Standard Chartered researched the redesign of its trade finance platform starting four years ago, it polled 800 customers, asking them how they saw the future interaction between banks and trading partners. "They responded," says Stratton, "that they wanted more than a technology solution. They also wanted a consultative approach from the banks."

HSBC's Currie sees the consultative approach as the natural focus of his trade finance department. He describes the range of bank services that apply to the changing landscape of trade finance in the region as a spectrum of offerings, flexible enough to respond to changing market conditions. The spectrum stretches from the more basic end of the business, including L/Cs, to the more 'heavy gauge' type of customized services associated with structured trade or commodity deals. "On the most basic end," says Currie, "are the plain vanilla, non-documentary payments that relate to trade. Moving toward the middle, you get collections, documentary credits, and longer-tenured transactions. At the far end, there's bigger ticket and commodity trade deals and then project finance, like the seven-year financing of a power station."

One of the phenomena of recent years, he says, is a migration of services from the 'heavy gauge' side of the spectrum, which would typically involve larger companies and bigger deals, to more basic services. Driving the migration is better communications technology, often internet-based, that allows the banks transparency into client ERP systems. "Half the people out here," he says, waving to what looks like a trading-room floor, "spend their time devising customized solutions related to technology."

He adds: "What has happened in the last ten years [is that] sophisticated technology, specifically on the internet, has levelled the playing field in communications. It's been a big drop in barriers." Banks started connections to the enterprise software of the biggest players in the Fortune 500. There was a movement, driven by them, to take costs out of the business. "When companies endeavor in a more sophisticated way to use technology to underpin what they're doing, it generally starts at the bigger-company end, and then eventually moves to the middle-market space." In the most simple terms, the shift in documentary credit in trade finance transactions involving US buyers sourcing in Asia once was done almost exclusively by purchase orders issued in the US at US financial institutions. Technology, which has added transparency along the supply chain, has facilitated this into a high-volume business centered mostly in Asia. On the finance side, the use of public and private credit insurance, is "slowly and carefully", in Currie's words, moving into more common use toward the middle of the spectrum.

In the end, CFOs have the last word. While there would appear to be something for every company of every size in the cross-border arena from these developments, Jake Vigoda, CFO of KC Precision, a Thai provider of components to the computer storage industry, says that his bankers approached him with wonderful solutions two years ago. "But they were more complex, and, I suspected, more expensive than the plain-vanilla ones we needed." He opted for basic services. Kadle at Tata Motors, however, can hardly wait for the next innovation. "The banks are listening," he says.

Arthur Clennam is a journalist specializing in back-office operations who divides his time between Asia and the Middle East.