With NAFTA storm clouds on the immediate horizon, many shippers are considering how best to expand their sales. Logistics fluidity and financial liquidity are both required to provide the oxygen necessary to keep goods pulsating through international supply chains. Global trends, challenges and market opportunities are shaping and impacting a shipper’s need for working capital, trade credit or marine insurance. This article is intended to help shed some light on the vital topic of supply chain finance solutions that will no doubt increase in importance over the coming years.
International and Canadian trends shaping trade finance
The Asian Development Bank (ADB) and the International Chamber of Commerce (ICC) reported a US$1.6 trillion shortage in trade finance in May 2017. According to the ICC, the “chronic” shortfall has come about largely on the back of the unintended effects of global financial crime regulation. The ICC points to various studies which show that many global banks have begun to exit correspondent relationships in perceived high-risk regions. Mr. John Danilovich, the ICC’s Secretary General, said: “This is a complex global problem requiring a concerted global response.”
In November 2017, the United Nations Inter-Agency Task Force on Financing for Development acknowledged the scope of the international shortfall of trade finance and explicitly recognized that it was an essential tool to enable the flow of commerce through global supply chains.
In their report, Supply Chain Finance: A New Means to Support the Competitiveness and Resilience of Global Value Chains, Export Development Canada researchers Jean-Francois Lamoureux and Todd Evans found cause for sober reflection. They determined that within Canada progress has been slower to occur in connections with improvements to the financial supply chain (that is the flow of financial information and money that takes place) compared to the progress made in supporting the physical movement of goods.
Canadians are not alone in needing to adapt to changing structural conditions of international trade and the requirements of global supply chains. Financial markets in different countries around the globe have various degrees of sophistication, credit availability and capacity to support this type of activity.
Chris Duggan, Vice-President, Trade Strategic Initiatives – National Specialized Solutions, Royal Bank of Canada, suggests that the simple fact that suppliers and buyers are operating overseas lengthens the physical supply chain significantly which, in turn, creates a longer financial cycle for all parties involved. Consequently, both the working capital requirements to finance trade transactions are impacted and the need to mitigate market risks for both importers and exporters in those markets rises in importance.
Companies that deal internationally have to be able to differentiate between the regulatory requirements for each of the countries in which they operate as well as the differing financial strength of those countries and the commercial companies with whom they deal. The attendant risk and working capital requirements of their partners often lead them to seek risk mitigation, in various forms, as well as differentiated transaction structuring to minimize their working capital usage.
Supply chain financing tools available in Canada
The range of instruments available to support companies internationally is continuing to evolve to meet changing market conditions and the potential for increased disruption due to the cancellation of trade treaties, logistics, liquidity events, regulatory requirements and challenging foreign exchange markets, to name just a few.
Companies looking to improve their performance often start with a desire to create enhanced supply chain liquidity according to Liquid Capital’s Stephen Ison. As such, the process begins with measuring their cash conversion cycle (CCC). For example, an importer purchases inventory, stores it and/or uses some of the stock to create additional value (i.e., manufacturing), then markets and sells the goods required to pay their suppliers and cover the cost of having the products shipped. While retailers are responding to the demands for ever faster physical shipping cycles (due to electronic commerce and other factors), it is still common practice for importers to wait and wait to collect on their invoices. The importer has used its cash at the beginning, is still waiting for money at the end and the time between is called the Cash Conversion Cycle.
If improvements in supply chain financing don’t keep pace with developments in the physical speed of logistics, problems soon arise. The CCC, in the example above, can be many months long. Shortening the CCC means a company has more cash at any given time for expansion, unforeseen challenges, purchasing opportunities and more. Ison, stresses the fact that “cash is not only king” but “cash is, quite literally, the lifeblood of business.”
Logistics, shipping and the esoteric world of maritime law might not initially lead one to think about the topic of supply chain finance solutions. However, there is some beneficial supply chain finance solutions explicitly designed for this world. At least one is almost as old as shipping itself! Accounts receivable factoring, or “factoring,” was invented by the Romans sometime before the first century. It is common in Europe and is expected to become more popular as a result of the Canadian-European Comprehensive Economic & Trade Agreement (CETA).
A second tool, called Purchase Order Financing (POF), can dramatically shorten the CCC by impacting both ends of the supply chain. It’s not uncommon for suppliers to require a substantial deposit, full payment before shipping and/or a letter of credit to perform the work. This creates a considerable cash flow burden for a company that doesn’t expect to collect on the ultimate sale for at least several months and sometimes a year or more. With POF, a finance company steps into the picture, uses a Letter of Credit or Collection Against Documents to induce the manufacturer to perform and then (usually) factors the receivables, upon delivery, to clear the Letter of Credit. Ison observes that “shippers who have pre-sold their goods will find POF an effective tool.”
Many companies use a broader spectrum of products, depending on the nations in which they operate to be able to diversify their risk exposure between countries, buyers and industries. “One solution doesn’t work equally well in all markets. For example, Asia is a large market that often requires traditional trade instruments such as ”Letters of Credit” or “Guarantees” whereas trade within North America is predominantly oriented to Open Account transactions,” according to RBC’s Duggan.
Shippers capturing the full spectrum of international trade opportunities are increasingly using a variety of instruments such as Open Account, Guarantees, Letters of Credit, Documentary Collections and Cash in Advance, as well as various forms of insurance, depending upon their transactional requirements, according to Duggan. He also cited growth in “Approved Payable Financing” for the suppliers to large international corporations that want to make their payable structures more uniform in all of their markets as another supply chain financing trend worth watching.
The supply chain role of marine insurance
Mariella Dauphinee, Marine Claims Manager, Western Division, Intact Insurance Company, emphasized the point that “discussions about supply chain finance solutions would not be complete without mention of insurance as a risk management tool.”
Marine cargo insurance is designed to provide comprehensive coverage for goods in transit (with incidental storage), not only by water (sea/river) but also during transportation by air, road, rail for manufacturers, importers and exporters, commodity traders, logistics companies and the like.
According to the Marine Insurance Act, a person has insurable interest wherein they may benefit by the safety or due arrival of insured property or may be prejudiced by its loss damage. Dauphinee noted: “The assured, or the person to whom the claim is payable, does not need insurable interest when the insurance is taken but does need to have an insurable interest at the time of the loss.”
The International Commercial Terms (Incoterms) are often used as the basis to determine which party has an insurable interest for a particular leg of transport. The Incoterms specify the “critical point” during transit which defines the passing of risk (of loss or damage to the goods) from the seller to the buyer.
Traditionally, traders relied on negotiating commercial transactions on the most favourable terms of sale so that the risk of cargo loss and damage was transferred to the other party as early as possible (if you are the seller), or as late (if you are the buyer). Ison observed that “now savvy shippers also have more tools where they can better align their choice of supply chain financing tool to not only reduce risk but improve their company’s cash flow and thereby become a more agile competitor.”
Canadian International Freight Forwarders data indicates that freight forwarders play a vital role in expediting the movement of an estimated 70 per cent of Canada’s containerized cargo. Consequently, due diligence in marine carrier selection may be a financial risk management step that even some container shippers may be tempted to skip.
The demise of the international carrier, Hanjin Shipping, in 2016 demonstrated the adverse impact shippers could face from carrier failure. For example, the cash conversion cycle resulting from long delays, or possibly non-delivery of goods to customers was negatively impacted. Carrier failure can also result in additional costs related to finding alternative means of transporting goods and reputational damage if products are not available for delivery to end users.
Shippers who regularly review the insurance coverage will have systems in place to ensure that their coverage has kept pace with changes in their logistics practices. For example, an insurance review will determine whether there is coverage in place for things such as forwarding charges should the voyage be interrupted short of the destination.
RBC’s Chris Duggan commented, “companies should perform a regular risk analysis on each of the markets they are involved in to determine if they need to change their risk mitigation and working capital requirements.” But shippers don’t have to wait before exploring new tools that will help make their business more competitive in international markets.
Given the menu of financing tools available, making the best choice involves proactively identifying specific business needs and requirements since the devil is, indeed, in the details. When thinking holistically, shippers will realize that basic information such as the nature of the product, the origin, the destination, and nuances in the contracts and credit history are all required by various financial underwriters.
Since underwriting requirements respond to changing market conditions and the details of the individual transaction, it can be time-consuming for shippers who don’t plan. Planning allows firms to see how the various tools could be utilized to implement their international business strategy. At the very least, by planning a better understanding of how to optimize both the availability and cost of capital to manage growth and supply chain insurance risks will strengthen a firm’s existing position in domestic markets.
Darryl Anderson is a strategy, trade development, logistics and transportation consultant. His blog Shipping matters focuses exclusively on maritime transportation and policy issues: http://wavepointconsulting.ca/shipping-matters.