Deferred payment terms are increasingly common in international trade. The time it takes for invoices to be paid is often between 30 and 90 days but can be longer depending on the terms.
With trade finance, Suppliers (Exporters) can get instant cash advances to keep operations running and cover expenses. Meanwhile, their Buyers (Importers) can still benefit from paying invoices months later, having had time to distribute and sell goods. The main difference is that the Buyers pay a financing company, not the Supplier. In a non-recourse factoring agreement, the Supplier is protected against non-payment, meaning that no money is owed to the finance provider if the Buyer doesn't pay.
If Suppliers have to wait months to receive capital, they can struggle to pay staff and bills and start new production cycles. Suppliers - particularly those in emerging markets - find it difficult to grow if they get stuck in this cycle. These Suppliers often don’t have the bargaining power to request faster payment from their large international Buyers. This has led to an increase in Suppliers seeking trade financing arrangements so they can compete with other Exporters on price and payment terms.
By gaining upfront capital through trade finance, Suppliers can avoid running into cash flow problems. The finance also gives Suppliers reassurance that they will be paid, allowing them to attract more international Buyers by offering longer invoice payment terms.
In recent years, many companies have increased the time they take to pay their global vendors. The average payment time is 56.7 days, according to Hackett Group Inc.
So why is all this of interest to investors looking for good returns on their money? Read on to find out.
Trade finance can either be issued by banks or specialist third-party finance providers.
In recent years, numerous independent financing platforms have emerged. Stricter banking regulations - such as Basel III - have made it more difficult for banks to offer trade finance flexibly. Banks are more reluctant to offer loans to Suppliers in developing markets, primarily because the markets are seen as too risky. This has allowed new non-bank trade finance providers to enter the market. To read more about how these FinTech firms are changing the trade finance landscape, we’d recommend reading this article.
Numerous private equity firms and pension funds have invested in these 'alternative' financiers, which explains their continued success. After advancing cash to Suppliers (usually 90% of the invoice value), the financiers collect payment from Buyers when the invoice falls due. The financiers then send the balance to the Suppliers but deduct a pre-agreed service fee. This business model is appealing to investors looking to make steady returns.
Carlos Mendez, a co-founder of Crayhill Capital Management L.P., a New York-based asset management firm, said: ‘Banks are pulling out, and private capital is moving in.’
According to the International Chamber of Commerce, the global trade finance market is worth $10 trillion (USD). While global trade does present its fair share of risks to investors, these new financiers are driving innovation in the market. These firms are not bound by the same regulatory constraints as banks, allowing them to serve more SMEs more quickly. The use of efficient technology is a large part of the positive reaction these firms receive from clients.
Previously, banks such as HSBC, Citibank and Standard Chartered Bank were heavily involved with trade finance. However, as said above, most banks are reluctant to provide trade finance for businesses these days. Some banks have retreated from trade finance entirely.
Banks have predominantly stepped back and non-banks (with plenty of outside investment) have taken their places.
John Ahearn, Global Head of Trade Finance at Citibank, said: 'Higher capital charges are encouraging Citi to look for ways to distribute more of its receivables business to institutional investors who want to reap higher returns. We’d like to diversify the investor base...’ he said, noting that roughly 5% of its loans now go to such investors.
Stenn is a non-bank trade financier and is getting a $500 million (USD) credit facility from French investment bank Natixis SA. This will be backed up by insurance from American International Group (AIG) Inc. AIG will protect Natixis against non-payment of invoices purchased by Stenn. This reduces the lending risk for Natixis and the capital it must set aside for its credit line to Stenn.
This $500 million (USD) will be used to expand Stenn's service of providing cash to SMEs in developing markets. Crayhill has also provided Stenn with a $300 million (USD) financing facility, which helped secure the credit line.
'Stenn pays an average of 99 cents on the dollar for receipts due within 30 to 60 days, meaning it is charging the Suppliers between 6% to 12% annual percentage rates,' said Crayhill’s Mr Mendez.
'Much of that return ends up going to investors, who earn yields that are higher than other types of short-term debt investments. According to Federal Reserve data, non-financial corporate debt maturing in 60 days carried annualised rates of 2.02% as of July 23.'
It's clear that investors are exposing themselves to a volatile global trade environment. Kerstin Braun (Stenn President) said: 'Increasing protectionism won’t shrink the market even if it changes trade flows... The goods are there [and] the Suppliers are there. [Protectionism] may redirect global trade, but not stop it.’
—Jon Emont contributed to this article.
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