Mitigating Risk and Creating Competitive Advantage through Trade Finance
by Jeremy Shaw, Managing Director, Global Trade Executive, J. P. Morgan Treasury Services, EMEA
Managing financial risk has always been a core responsibility of the treasury function, but during a prolonged period of economic uncertainty and changing trade patterns, treasurers have also had a growing role in managing trade risks. The years up until 2008-9 witnessed a relative increase in open account transactions due to greater convenience and lower costs. However, the global financial crisis illustrated the importance of trade finance to increase predictability of cash flow, release working capital from the supply chain, and perhaps most importantly, to manage supply chain risk.
Renewed interest in trade finance instruments
Trade finance instruments have traditionally been used to add security to trade transactions with suppliers and customers in less familiar markets – for instance, a European buyer using a Letter of Credit in a transaction with a supplier in Asia. Such transactions were often small, but carried with them some degree of uncertainty. Now, however, in a prolonged period of fragility for the Eurozone, treasurers and CFOs are recognising the benefits that trade finance brings to every region, for both domestic and cross-border transactions. The absence of an appropriate trade finance infrastructure could be perceived as a barrier that, by damaging the flow of trade, hinders the trade and export potential of an economy and region.
The large, multinational corporations that comprise J.P. Morgan’s client base continue to perform strongly (with the exception of some consumer goods companies) and increase their cash balances. Notwithstanding that, treasurers and CFOs are far from complacent about the need to manage risk proactively. Supply chains are often finely balanced, and the loss of key suppliers could have a rapid impact on the company’s ability to deliver on its obligations. Similarly, customers cancelling orders or being unable to pay could result in excess inventory or a loss of cash flow.
Balancing risk and efficiency
Buyers and sellers alike are therefore challenged to manage their supply chain risk without compromising efficiency or relationships. For example, even though a company may have been selling to a customer for many years, their risk profile could have changed substantially (perhaps given current market conditions), so transactions may need additional collateral, such as a Letter of Credit or Guarantee. In industries with a high exposure to commodity prices, this issue is exacerbated further, as when commodity prices rise, larger transactions use up credit limits more quickly. Consequently, we are seeing companies such as those in the oil, gas, and energy sectors requiring further credit support on transactions using trade finance instruments.
For buyers, managing supplier risk effectively is key to a robust supply chain. Companies are therefore strongly motivated to support key suppliers that may find it more difficult to source market liquidity, without adding substantially to their own risk.