A COVID-19 strategy approach to supply chain finance

by David Irish | April 21, 2021

Many people were highly sceptical about the efficacy and safety of the COVID-19 vaccines being able to be developed and approved by regulators in less than a year. But if you speak to immunologists, they will tell you that no vaccines before this have been developed based on so much data; both in terms of volume and diversity, and with such widely peer-reviewed clinical trials.

The reason for this:

  • Global pharmaceutical companies and research institutions opened their data and clinical trial results to each other and shared development and safety protocols.
  • Regulatory bodies began working with the vaccine researchers and developers from the beginning in order to enable the approval process to run alongside development, significantly reducing approval timelines; and
  • the various regulatory bodies collaborated with each other so that the vaccines could be approved around the globe as quickly as possible.

Large corporations and governments did this because there was a higher imperative than their own short-term profit and bureaucratic independence. It was an international state of emergency.

In South Africa we called it a “state of disaster”.

There are many other “states of disaster” in our country that are causing as much and even more harm to our people and economy. But with every disaster comes massive opportunity. The SME sector is one of these “states of disaster” that is currently facing extreme adversity but brings with it a huge opportunity to transform our economy, create jobs and grow wealth if all stakeholders adopt a COVID-19 strategy.

The area I would like to focus on here is supply chain finance (SCF).

In my view, if the various key players in the supply chain finance arena would collaborate in this way and with the continuous fintech innovation we can see happening, the South African supply chain finance space could be revolutionised. This would lower risk, lower costs, reduce document flow and validation “friction”, as well as transaction value transfer time. The benefits would accrue to everyone involved and beyond.

what is supply chain finance?

At a broader level:

Supply Chain Finance (SCF) is the use of financing and risk mitigation practices and techniques to optimize the management of the working capital and liquidity invested in supply chain processes and transactions. Visibility of underlying trade flows by the finance provider(s) is a necessary component of such financing arrangements which can be enabled by a technology platform.

Source: Global Supply Chain Finance Forum

At a more focussed level, and for the purposes of this discussion:
Supply chain finance is where a buyer (usually a large corporate) approaches its financial provider for the establishment of a receivables discounting line for its suppliers to use and discount the invoices they issued to that buyer. This technique is sometimes called reverse factoring or payables finance.

Source: The International Trade and Forfaiting Association (ITFA)

But in recent times it has also involved suppliers (again, usually large corporates) initiating the financing structure for their customers.

what is the process:

dynamic discounting

Dynamic discounting has the same fundamental principles as traditional supply chain finance except that the participating corporate acts as the source of funding (although funding may also be supplemented by other providers). For example, a corporate buyer might make an early payment to their supplier using their own excess cash. In exchange, the supplier provides their goods and services at a discounted price.

Typically offered by fintech-led third party platforms, dynamic discounting enables a large buyer to extend financial support further to include its smaller suppliers who might not be able to access bank-driven SCF.

Similarly, corporates can establish a dynamic customer finance mechanism whereby allowing customers to pay later in return for a premium.

By combining the two (dynamic discounting and dynamic customer finance) corporate treasurers can significantly enhance the agility of their cash flow management and strengthen their relationships with both customers and suppliers.

A global example of such a solution is C2FO (www.c2fo.com) who through the COVID-19 pandemic has managed to facilitate working capital finance for SME’s through a combination of buyers, sellers and bank and non-bank financiers using their “dynamic” online platform.

what are the benefits:

To the buyer:

  1. Increases a buyer’s negotiating power and market reach vis-a-vis its suppliers.
  2. Allows it to benefit from better credit terms. Buyers may get credit from their suppliers at a lower cost than bank finance, etc.
  3. Enables streamlined invoice payment procedures (supply chain finance tends to be made available through online platforms)

To suppliers:

 

  1. Allows them to shorten their receivables cycle for re-investment into the operating cycle.
  2. Lower finance costs. Suppliers don’t need to finance based on their own credit rating as the finance is largely based on the buyer’s balance sheet/credit rating.

what are the risks to be mitigated

Some of the key risks in international trade finance include:

  • Country Risk: This includes the current political climate in the country, the state of the local economy, the existence of reliable legal structures, the availability of hard currency liquidity, etc.
  • Credit Risk associated directly with the buyer.
  • Commercial Risk: Commercial risks refer to potential losses arising from the underlying trade. This would include quality of the goods, contractual disputes and pricing issues, etc.
  • Fraud Risk: For example, forged documents and insurance scams.
  • Documentary Risk: Missing or inaccurate documents can cause delays in shipments and ultimately delays in payments.
  • Foreign Exchange Risk
  • Transport/Logistics Risk: About 80% of the world’s major transportation of goods is by sea. Storms, collisions, theft, leakage, spoilage, cargo theft, scuttling, piracy, fire and high sea robbery are just some of those risks.

Obviously, several of these are not directly applicable to many businesses that source and supply locally but their supply chain may be affected in some way down the line.

How does technology fit in?

Amongst many more examples of technology-based innovations:

  • Digitising previously paper-based risk transfer and validation instruments. Existing examples include the use of digital signature platforms like DocuSign and digital FICA platforms like DocFox. Blockchain technology has a key role to play here.
  • Data analysis and artificial intelligence to identify risk profile changes timeously and initiate digital response protocols.
  • The establishment of online portals where all trade finance data and processes can be aggregated, and participants can interact seamlessly to facilitate a transparent and secure trade finance ecosystem.

What are the obstacles?

Historically banks seem to fear that broadening business-centric supply chain finance or dynamic discounting will encroach on their traditional trade finance business. According to Eleanor Hill, Editor of Treasury Management International, one of the main concerns some (not all) banks have is that dynamic discounting programmes will take away from the popularity – and commercial success – of the supply chain finance (SCF) programmes that they do offer.

This is short-sighted. In 2017 the Asian Development Bank estimated the trade-finance financing gap (the amount of trade finance to be rejected) to be US$1.6 trillion. Without intervention this is estimated to grow to $2.5 trillion by 2025. With the use of technology and collaboration to improve trade finance risk mitigation tools, the opportunities for everyone in this space to grow their business is huge.
One of the silver linings coming out of the COVID-19 crisis has been to stimulate a collective push towards the digitisation of international trade finance. According to Aoife Wallace, Head of Trade & Working Capital Europe, Barclays in Treasury Management International: “In the past, one of the barriers to digitisation has been the alignment of stakeholders. The pandemic has put everyone on the same page: digitisation is no longer a nice-to-have, it is a must-have. Collaboration is accelerating as a result, and practical solutions are emerging in rapid timeframes.”

A global example of the kind of collaboration I am talking about is Trade Information Network. Founded by ANZ, BNP Paribas, Citi, Deutsche Bank, HSBC and Standard Chartered, Trade Information Network is open for buyers, suppliers, and banks. The Network enables the provision of financing deeper into global supply chains. Through the Network, corporates can communicate their trade information and raise finance requests in a trusted and secure way to participating banks of their choice.

According to Bruno Francois, Deputy Global Head of Trade Finance at BNP Paribas in Treasury Management International, the whole trade finance ecosystem is changing. “Corporates have always wanted to extend their payment terms, to pay their suppliers later without damaging their supply chain. This is where banks would traditionally step in with a financing solution. However, the banks were limited in how much trade finance they could provide, given the risks in the market. So, the much talked-about ‘trade finance gap’ began to appear.

Against this backdrop, we saw some new actors step into the game alongside the banks, such as transport companies, port authorities, fintechs, and even governments. They began entering the financing world in order to help keep supply chains moving. And this has been extremely positive from a corporate’s point of view – opening up more perspectives and increasing the fluidity of flow through digital initiatives.

In terms of the competitive dynamic, fintechs are not replacing the banks, rather they are complementing them in this evolving ecosystem. There is a lot more interaction in the market today. Banks have progressively learnt how to collaborate with new entrants to the market, and even with each other. There are numerous consortia – groups of 10 or 15 banks working together with fintechs and fully involving their clients to ensure that they are meeting corporate needs. The agile way of thinking and operating that fintechs have brought to the industry is also a positive thing, given how slow-moving trade finance has traditionally been in terms of innovation.”

So, we are seeing increased collaboration globally, but the key question is: how are South African participants getting involved so that our unique characteristics are accommodated or adjusted to achieve the ultimate goal of increasing SME access to growth inducing working capital finance? I have discovered several individual corporate, banking, and fintech initiatives and projects in South Africa but they tend to be operating in their own silos without much collaboration (inter-corporate, inter-bank, and inter-fintech). It is encouraging though, to note that four major South African banks are members of ITFA, The International Trade and Forfaiting Association. But significantly more collaboration is needed.

who are the key role players that need to collaborate?

  • Banks
  • Non-bank financiers
  • Large corporates
  • Business leadership organisations
  • SME associations
  • Fintechs
  • Regulators
  • Port authorities
  • Logistics companies
  • Professional firms (lawyers, accountants)
  • Anyone else who feel they can contribute.

According to MoneyWorks’s Thandeka Zondi in CFO Magazine: “South Africa has a mature corporate market with an established and tested credit history. It is now time to use these credentials to build and support our much-needed SMEs. It would cost big business nothing, but it will bring access to cash flow financing, a much-needed solution for sustainability and growth of SMEs. And an added bonus to big business is B-BBEE points from early payments of SMEs.”

My intention is to publish a series of supply chain finance articles delving deeper into each of the elements raised here.

My hope is that you will follow me on this journey of discovery as to how the various stakeholders are progressing in broadening the availability of fairly priced and efficiently delivered trade financing solutions to our SME sector in particular. And to advocate for, encourage and “prod” these stakeholders to collaborate in the way global stakeholders have collaborated in the fight against COVID-19.

If this resonates with you, please make contact and let’s share ideas.

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