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For many banks their oldest division is trade finance, a department that offers documentary letters of credit – a financial product that has

played an important role in international trade for more than 100 years. Some scholars even believe that its origins go back to ancient Egypt and Babylon. During this time, the letter of credit has emerged as an extremely successful and popular product to finance and lower the risk of trade transactions. Today, about 10% of all international trade is still supported by letters of credit.

Over the last two decades, however,

trade finance has experienced what is sometimes referred to as a paradigm shift. Thanks to the liberalisation of emerging markets, the “borders and boundaries” for open account payments are now substantially lower. Proving more flexible and, in particular, less costly than letters of credit, open account payments have become the settlement method of choice for trading partners, accounting for approximately 40% of global trade settlements. Following this trend, banks, credit insurers and other financial institutions have launched supply chain finance products. This “modern” method of trade finance fills the financing gap

Elke Doser, Associate Director, Supply Chain and Trade Finance at UniCredit, Asia Pacific, discusses the development of trade finance products through the ages.

China’s trade evolution

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programmes and their local presence and/or close correspondent relationships with local banks can help to develop the concept of supply chain finance and to capture the existing business potential in Asia and particularly in China.

Bank Payment Obligation (BPO) – the next step While open account or supply chain finance has spiked in China over the past few years and continues to increase, another development or paradigm shift in trade finance might bring further relief to corporates in China hungry for liquidity: Bank Payment Obligations (BPO).

A BPO is an irrevocable undertaking given by the buyer’s bank to the seller’s bank guaranteeing that payment will be made on a specified date, provided that electronic data matches the “base line” that has been previously established by the buyer and the seller. Thus, it is a combination of a letter of credit, in terms of risk mitigation by the irrevocable payment undertaking, and an open account payment, as it does not require the bank to check the documents.

The BPO market is still in its infancy and requires further investments, particularly on the banking side. What is particularly interesting for emerging markets like China, however, are the unified BPO rules, issued by the International Chamber of Commerce (ICC), which should avoid potential discussions and disputes between different legal jurisdictions.

While modern trade finance solutions are developing in China, it is still a country mainly based on traditional trade finance, relying on letters of credit for trade financing. This is understandable, as traditional trade finance products have proven to be reliable financing vehicles over the last century. However, international banks have started offering supply chain finance services to Chinese companies, closely followed by their Chinese counterparties. Meanwhile, the latter are making significant progress developing and offering supply chain finance products and BPO. With local and multinational banks on the move, it surely won’t take too long for the “modern” trade finance products to become standardised, reliable products in China and all over the world.

previously covered by the letter of credit and offers extended financing solutions from order placement through payment for both buyers and suppliers.

Regardless of whether the “traditional” or “modern” method is employed, trade finance’s general importance is undisputed. It is estimated that 80 to 90% of all trade transactions worldwide are supported by some kind of trade finance product. Looking to the future, the World Bank expects global trade to grow by 6 to 7% per year during the upcoming years. Needless to say, this level of growth represents significant business potential for all market participants

in terms of financing, payments, risk mitigation and information flow – the major characteristics of trade finance.

Supply chain finance development in ChinaAsia is now the key focus for corporates and financial institutions looking to expand their businesses. Particularly since the global financial crisis, companies from developed countries have increasingly turned towards emerging markets for production and sourcing. This is especially the case for China, despite that fact that its GDP growth rate slowed to 7.8% in 2012, which has been interpreted by many as an early sign that its economy is slowing. The first quarter of 2013 showed signs of recovery, however, and 2013 growth is conservatively forecast at 7.5% by the Chinese government and 8.2% by UniCredit Research. While it remains to be seen how China’s annual growth rate develops, the country will indisputably continue to grow in importance as a major trading partner for the rest of the world.

Although approximately 70% of all trade payments in China are already done on an open account basis, the main source of trade financing is still the letter of credit. While larger and multinational companies generally have access to liquidity, it remains limited and/or costly for small and medium-sized companies. These facts represent ideal conditions for providers of supply chain finance, which enables smaller companies to access additional liquidity based on their open account payments.

Although supply chain finance is an ideal tool for unleashing trapped liquidity, some aspects require special attention. First and foremost, proper legal documentation is the foundation for the successful implementation of supply chain finance programmes. Although China has a national legal system, legal decisions are primarily taken on a regional basis, which requires in-depth local legal know-how.

Some supply chain finance solutions try to mitigate the so-called servicer risk of the supplier (usually the financially weaker party) by asking the buyer to assume credit responsibility and allow regress on that party. Such servicer risks refer, for example, to dilution risks or payment delays due to disputes on the underlying supply contract. Major trade finance banks can add value in this respect. Their know-how and experience in setting up supply chain finance

“IT IS STILL A COUNTRY MAINLY BASED ON TRADITIONAL TRADE FINANCE.” Elke Doser, UniCredit