How finance is changing in the international trade market
When looking at the development of finance, one must look at the pressures moving behind it. We have moved a lot in terms of the financing of international trade in England, but it does have a rich history.
It started with a barter system being replaced by Mercantilism in the 16th to 17th Centuries. Around 1913, economic freedoms were fostered as customs duties were reduced across countries. As all currencies were freely convertible into Gold, this meant global trade was a lot easier. The First World War changed this and lead to many protectionist attitudes. Post the war and when barriers that countries had built up started to come down, there was an economic recession in 1920. This changed the balance again as there was fluctuation of currencies and depreciation creating economic pressures on various governments to adopt protective mechanisms by adopting to raise customs duties and tariffs.
The World Economic Conference in May 1927 organized by the League of Nations had an aim of liberalizing trade and the creation of a Multilateral Trade Agreement. This was later followed with the General Agreement of Tariffs and Trade (GATT) in 1947. Depression in the 1930s meant a rise in import duties which had the aim of producing a favorable balance of payments and import quotas and restrictions on certain imports. Outside of World War Two and similar blips in our trade history, we are moving closer to a free trading international economy. This is complimentary to both the international finance and shipping market.
Trade finance is the bedrock of international trade and has been throughout history. From the early days people used to borrow money to fund international growth and trade overseas. Money would be borrowed in local markets, finance would be taken overseas and goods purchased in international markets. These goods were then brought back and sold to domestic consumers. Trade finance has grown from historically supporting trade, to actually reducing payment risk. New structures have grown from this initial advancing of funds, to allowing discounting of receivables, the availability of financing that does not hinge on one specific transaction and insurance being able to back up many more of the ‘risky’ transactions. This has all promoted shipping and cross jurisdictional trade.
Historically, the most common products were Letters of Credit (LCs) which reduce payment risk by providing a framework under which the bank makes payments to the exporter on behalf of an importer once delivery of goods is confirmed through the presentation of the appropriate documents. Other forms of trade finance can include Bank Guarantees, Factoring, Trade Credit Insurance and Documentary Collection. Some forms are specifically designed to supplement traditional financing. With new information and communication technologies allows the development of risk mitigation models, which have developed into advanced finance models.
Due to this international element and security needing to be taken in various jurisdictions, especially when goods are sold – Bills of Lading are used and information on shipping are especially storage are sometimes integral pieces of information that a lender needs to get conformable with. Taking security and storage procedures upon vessels is increasingly important when set against the backdrop of a volatile economy as in the last ten years, in some markets the financial crises saw a severe drop in trade and some market participants reported up to a 90% drop in shipping prices due to the oversupply of vessels on the market and lack of credit worthy participants or willing lenders.
In overseas financing, interestingly LCs still account for around 10% of trade and there have been many attempts to bring more advanced technology into this process and reduce the paper trail, but this has not yet happened. It is also reported widely that around 80-90% of goods transported internationally use some type of trade finance facility. When we look at where the market will go, although it has a less risky profile when compared to consumer finance, we have seen trade finance be under more scrutiny as capital controls are further looked at. However, this is tempered with an ambition by governments to increase trade.
Shipping companies also see clients deal on trade credit terms, which differ from typical trade finance. It is used between importers and exporters; they may deal on open account terms, where goods are shipped before payment is received and cash-in-advance transactions, where payment is made before shipment. This leaves payment risk and possibly a greater need for working capital. Advancing finance where a long lasting trusting relationship needs to be in place is more likely to be in jurisdictions that have a solid legal framework for the collection of receivables and if not, they are secured and documented accordingly.
There has been a decline in the use of L/Cs over the last ten years but the world is further opening up to transact with those in China and EME and products are being developed to complement these new relationships. This is especially true within supply chain finance, where banks manage the collection and funding of receivables amongst a number of companies.
With the trans pacific partnership moving forward and having a core aim of liberalizing trade and covering over 40% of the word economy for trade by having a 12-nation Pacific Rim trade pact, we see the future looking bright for both trade finance development and their shipping partners.
Guest blog – written by James Sinclair at Trade Finance Global (www.tradefinanceglobal.com)