Trade Finance facilitates import and export activities and international trade transactions. It allows corporates and S.M.E. to access a wide range of financial products. Small and medium sized companies use trade finance products to access working capital. Hence, obtaining liquidity to make investments, pay suppliers or pay salaries.
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Why do companies need trade finance?
It is a standard practice on domestic and international trade to sell on payment terms. Thus, allowing the buyer (the debtor) to delay the payment of the invoice. Hence, generating revenues before settling the supplying invoice. Having access to trade finance helps to mitigate cash flow imbalances.
For example, the shipping of goods can take several weeks before reaching the purchaser’s warehouse. Thus, this represents a perfect opportunity to ask for a delay in payments. Imagine if you order a few containers of shoes from China delivery to Europe. The cargo would take circa 45 days to be delivered.
If you could agree with your supplier to pay on the 60th day, wouldn’t this be helping your cash flow? The answer is undoubtedly “YES”.
Likewise, in a well-established business relationship, the buyer could ask for longer instalments.
Generally speaking, for large suppliers waiting does not represent an issue. They get liquidity from different sources and have streamlined cash-flow. However, no matter how large the business is, most companies engaged in international trade, try to access trade finance solutions.
On the contrary, smaller suppliers struggle to withstand the payment terms. Their cash lifecycle is short. The money gets in and out quickly. Thus, being able to access credit terms would help to stabilise the cash flow.
In recent years, more and more small sized companies are able to access trade finance. The reasonably new ecosystem of FinTech companies such as Velotrade have made trade finance accessible to small and medium size companies.
Trade Finance Solutions and Products
Trade finance products make it safer for both importers and exporters to make international transactions. The financial i issues those products to facilitate global trade and commerce.
Following the increased demand for marketplaces like Lazada, eBay and Amazon, alternative financiers created the e-commerce finance solution. Likewise, Chinese’s Alibaba, J.D. and Taobao have seen an increase in users shopping thru their eCommerce platform.
Through E-Commerce finance, e-commerce shops can access funds within few clicks. The applicant is the eShop owner that sells through the e-commerce marketplace. Generally speaking, the financing company issues (and renews) revolving loans. The allowance is calculated on the estimated revenues of the supplier. Once the supplier pays back the initial investment, new credit is issued.
In conclusion, technology and digitisation played a vital role in the growth of eCommerce finance. A completely new ecosystem has born to support the full development of online e-commerce activities.
Purchase Order Financing
PO Financing is part of the Trade Finance pre-shipment solutions.
The financial institution usually advances a certain percentage (between 30% to 70%) of the Purchase Order notional amount. The advanced funds are used to pay the supplier directly.
Supply Chain Finance
Supply Chain Financing (S.C.F.) is probably the most popular source of funding in international commerce. It adds efficiency for the Import & Export activities of the parties involved.
Most importantly, supply chain finance helps unlock funds tied in the supply chain tiers. The tiers include: forwarding, intermediaries and other parties involved.
Discount finance is becoming more affirmed as a way to access funds for businesses. Invoice discounting is already very popular in the U.K. and the U.S.A. where big banks like Barclays, Citi Bank and Chase have invoice discounting solutions.
However, in recent years, numerous small Asian sellers are using invoice discounting as an alternative source of funding. Nowadays, not only banks like HSBC, O.C.B.C., Hang Seng, N.A.B, offer to discount invoice service. In fact, many invoice discounting facilities are helping businesses to grow in Asia.
The financing process and invoice discounting meaning are well explained in this example. On the manual, you will also find the discounting costs and the advantages and disadvantages of using the service.
Accounts receivable are claims for payments. Those legally enforceable documents (the invoices) are held by a business who sold goods. However, the client (the debtor) has received the goods but has not paid yet.
From an accounting point of view we have two categories and the difference depends according to whom is due to pay:
- Account payable: the company (buyer) owes to the supplier.
- Account receivable: is the money that is owed to the corporate.
Letter of Credit
The letter of credit is a document issued by a bank. Letter of credit is a well-known, widely used trade finance instrument. It adds protection to international trading activities.
There are several letters of credit available, depending on if for personal purposes or business requirements.
The Trade Finance Mechanism and The Players Involved
In economic terms where demand and supply for goods or services exists, then there is a market. According to Investopedia: “A market is a place where two parties can gather to facilitate the exchange of goods and services.” Through the law of demand and supply, the price is discovered.
The same concept applies to Trade Finance. The buyer and the seller get together in the marketplace to match their expectations. One is looking for funds to finance its business operations. The other has excessive liquidity that would like to invest in return of a yield.
Financial institutions are companies specialised in dealing with financial products. Those products include investments, loans, deposits and more. In trade finance, financial operators advance funds to corporates in need of financing. To do so, they must hold the required licenses to operate.
While specific requirements depend on the jurisdiction, others are globally required. For example, money lending and anti-money laundering licenses enable institutions to handle money. Every money lender engaged in trade finance activities, must have the necessary licenses to operate.
Moreover, if dealing with securities in Hong Kong, the S.F.C. Type 1 license is also required. The Securities and Futures Commission is the regulatory body that gives the Type 1 licence. Find out more about what implies to be an S.F.C. regulated entity in Hong Kong.
Likewise, the Hong Kong Monetary Authority trade finance department regulates the trade finance activity of banks. The primary role of the H.K.M.A. is to ensure the stability of the Hong Kong currency and banking system.
Velotrade holds all the necessary licenses to provide trade finance solutions to the Asia market. Velotrade is a digital trade finance platform with headquarter in Hong Kong.
Generally speaking, the trade finance operation department performs due diligence on all the parties involved. The trade finance assistants and trade finance officers are responsible for the onboarding. The onboarding process must be conducted to on-board new entities and allow them to use the platform. By doing so, the funding company makes sure the parties satisfy the legal requirements.
In trade finance, lending corporates can provide funds in two ways:
They grant funds directly using their capital. Hence, loading the balance sheet with debts and liabilities. Generally speaking banks and other traditional institutions do so. For example, HSBC global trade and receivable finance department or Standard Chartered Hong Kong trade finance unit.
Financing companies use investor’s money to provide funds. Hence, acting as intermediaries. Thus, sourcing a pool of investors with different risk appetite, to make sure the financing needs are always satisfied. FinTech trade finance companies are exploring opportunities in this area.
The debtor A.K.A. the buyer
The buyer is the entity purchasing goods from the supplier. Thus, by definition, he is the debtor owing to the supplier. Hence, he is legally obliged to pay the debt to the counterpart. The counterparty is called the creditor.
In trade finance the debtor is responsible for paying back the funds to the lending company.
The seller, or the supplier, is the company producing goods. It can be a manufacturing company or factory who exchanges goods in return for money. Most of the times, the seller is engaged in international trade activities selling his products abroad.
The seller owns rights on the invoice payments, and the debtor will repay him at due time. In trade finance, the seller is the pillar of the origination stage. Origination is where the invoices, the receivables and the other credit rights are “originated.”
Investors are companies or entities with excess liquidity. They can be hedge funds, high net-worth individuals or indeed banks looking for alternative sources of yield. Although they could already be trading traditional assets like FX, Bonds or Equity, they may not be involved in trade finance yet. In fact, in recent years, more and more trade finance funds are being created.
How can investors invest in trade finance assets?
Trade finance asset investors enhance returns with short-dated and low correlation assets. For example, a family office intends to strike a deal on a real estate transaction. They know there is a period of six months to one year before the completion of the project. Hence, they are comfortable with tying funds in long-term investments.
What can Investors do alternatively?
Asset investors could use trade finance instruments with expiry at 30/60/90 days instead. By rolling the position a few times, they would pick-up a better yield than if the funds were sitting in the current account.
There are many agents (brokers) and parties (debtors/buyers and sellers) involved in trade finance. Their role is to work with financial corporates. Through helping the parties to communicate and negotiate brokers earn commissions. The commission (brokerage fee) can be either a percentage on the notional or a fixed rate.
These are the most popular category of brokers seen in global trade and receivables finance.
Insurance brokers help clients to find insurance providers. Also, they assist the underwriting of the contract between the parties. For example, expensive microchips need insurance coverage for unforeseen events during transportation. Thus, the buyer and the seller would like to underwrite insurance.
Introducers for corporates connect Small and Medium-sized corporates with financing institutions. Agents help companies (factories and manufacturers) to access funding options. Thus, their strength relies on their networking abilities.
Introducers for investors are part of alternative investment solutions. Their role is to connect clients with excess liquidity to financial institutes. They do not have the licenses and capabilities to operate as lending agents. Thus, they rely on their broad portfolio of wealthy individuals, hedge funds and family offices to generate revenues.
Shipbrokers and freight brokers play an essential role in the early tiers of the supply chain. They move raw materials and goods across continents. Hence, facilitating international commerce and import & export trade finance activities. For example, commodity traders (iron ore, coal, soybeans, sugar) work with shipbrokers to find cargos for their load. Likewise, containership brokers match containers (goods) with vessels (forwarders) to deliver goods globally.