The recent global crisis has had major supply chain implications for both large regional, and multinational, trading companies active in the Middle East, as well as major manufacturers. LIZ SALECKA gets the bankers’ perspective
Greater currency fluctuations have become a concern to large exporters of oil and oil-related products as well as commodities such as steel. Trading companies importing large ticket items, such as cars, for pan-regional distribution have also been aff ected.
“Currency fluctuations continue to be a key risk,” says Arup Roy, head of transaction banking, Saudi British Bank.“Keeping in mind the sizeable and growing amount of euro-denominated trade, large manufacturers are concerned about the volatility of the euro and the recent developments in the Eurozone.
“One of the common upstream risks faced by trading companies is shipment delays, which can delay the supply chain and exacerbate the eff ect of currency fluctuations,” he continues.
“However, there are alternative overseas suppliers that trading companies can switch to. For example, the Japanese yen’s appreciation has led to a shift towards importing more cars from Korea, and this has also helped to meet consumer demand for cheaper cars with similar features.”
However, according to Jeremy Shaw, head of trade services, JP Morgan, the risks faced by companies involved in international trade do not end there.
“One of the big risks is being able to finance these transactions in the currency required,” he says, identifying a shortage of “hard currency funding” in the region.
“Companies that are importing from the Far East need US dollars or Japanese yen to make a payment. They may want to push out payment terms, but also need to secure that currency at the best possible cost of funding.” He adds that global banks are working with local banks to provide foreign currency fi nance to trading companies at competitive rates.
Intra-regional trading issues
Many of the Middle East’s large trading companies also face downstream supply chain risks.
Roy explains that companies are more aware of the importance of assessing country risks – in particular political risk, which has been re-emphasised by recent events in the region.
“They are also concerned about bank risks. For example, many clients come to us to mitigate risks in letters of credit if they do not know the issuing bank well.”
Weaker regional demand for imported goods has also made it harder for trading companies’ pan-regional distributors to sell stock on and pay for it on time, and this has resulted in the lengthening of payment terms. Trading companies are also exposed to the greater possibility of failure by smaller regional distributors and buyers.
“We have witnessed the stretching of credit terms, which has become more widespread across the region, limited larger corporates’ ability to collect cash on time,” explains Farooq Siddiqi, head of transaction banking, MENA, Standard Chartered Bank. “As inventory is not as easy to sell as in the past, many companies are sitting on it.
Their distributors are also sitting on inventory and not ordering more, so major trading companies are not in a position to import newer models. “All this has a cascading effect on working capital cycles, and the problem has become more acute over the past two years.” He adds that, as a result, many large trading companies are themselves now seeking longer payment terms and discounts from their overseas suppliers.
Growth in receivables financing
To date, many Middle Eastern trading companies have sought to address cashflow issues by taking advantage of packaged supply chain finance-type solutions, which typically include letters of credit alongside some form of early financing. “By and large, a lot of supply chain finance-type facilities are provided in the form of loans and working capital loans alongside letters of credit and bills of exchange,” explains Shaw.
Faraz Haider, head of trade, Middle East, treasury and trade solutions, global transaction services, Citi, also notes a strong movement towards the use of receivables financing by all Middle Eastern companies.
“Companies are moving towards securing some form of receivables financing so that they can generate liquidity more quickly,” he says, pointing out that the structuring of such facilities depends largely on exact needs, as well as the size and strength of both the buyer and the supplier.
“If the supplier is the stronger company, it generally starts discussion by requesting a letter of credit, under which it can easily get its receivables discounted by its bank,” he explains, adding that MNCs, trading locally, typically ask their buyers’ banks for such facilities.
“Where the buyer is a large and strong company, it is in a better position to extend its payment terms. Here, there is a real need for a supplier’s bank to come in, assume the buyer’s risk, and provide the supplier with an early financing solution.” The growing popularity of receivables financing is also evident among suppliers to large local manufacturing companies as well as smaller Middle Eastern businesses generally.
“There is a lot more nervousness on the part of local suppliers. Many of them are looking to sell to their buyers on cash terms, as opposed to offering credit, and they are also approaching banks to see if they can pay them up-front for goods they are selling, and take on the credit risk presented by buyers,” says Siddiqi. “Many companies are also taking out insurance, and then approaching banks to see if this will help them to monetise their receivables.” However, there are doubts whether receivables financing alone will prove sufficient in the longer term.
“We are now seeing a working-capital squeeze, and there is a need for more financial capacity so that companies can grow,” says Shaw, pointing out that many trading companies are also now looking to export goods to North Africa and sub-Saharan Africa.
“There is also a movement towards open account trading, and this is creating a need for other types of supply chain-based lending.There are opportunities to finance shipments but many companies need to change their procedures to secure finance at low costs.”
Role for buyer-led financing
Many large manufacturers also recognise the need to help their smaller suppliers eliminate supply chain risks – especially if they themselves are seeking to extend credit or payment terms.
“Some large companies have their own internal finance divisions and offer suppliers opportunities to borrow,” says Roy. “Others encourage their suppliers to approach banks and ask for supply chain finance facilities based on the strength of the buyer.”
Haider adds, “Some buyers are also looking at doing this directly for critical suppliers by putting in a more structured financing solution under the Supplier Finance Programmes.
“In situations where the supplier’s credit risk is weaker than that of the buyer, it can benefit from credit arbitrage. The buyer can extend its payment terms, while the supplier is provided with access to receivables financing at a lower cost than if it had to arrange overdraft facilities itself to cover its working capital needs.”
However, to date, only a handful of Middle Eastern banks are actively offering modern-day supply chain finance facilities to their corporate customers.
“Local banks prefer to deal with traditional vanilla instruments such as letters of credit and standard discounting as this is a business which they understand reasonably well,” says Haider. But he notes, “Many local banks recognise that trade-related financing is much more capital efficient than traditional lending, which is important as we move towards the adoption of Basel II and then on to Basel III. This will surely force them to move in this direction to better manage their capital allocation needs.”
Roy is very optimistic about the future. “Local banks remain fairly aggressive in the area of trade finance and recognise the benefits of this type of business. They are capable of competing head to head with global banks,” he says.
“Local banks are also exploring various options to facilitate the provision of supply chain finance, and are making greater investments in technology to achieve this.”