Trade flows have recovered and the region is experimenting with new financing instruments and digitalisation. Barbara Pianese reports.
Latin American and Caribbean trade has recovered substantially following the Covid-19 pandemic, on the back of higher commodity prices and stronger economic activity in the region.
As a result, demand for trade financing solutions has also bounced back. “We are seeing significant growth in trade finance across the region. A lot of it is tied to the current elevated interest rate environment and the downturn in the bond markets, which has reduced the access to capital markets for companies to raise liquidity,” says Steve Donovan, head of treasury and trade solutions for Latin America at Citi.
The war in Ukraine has mostly had dire effects on global trade, but also unexpected benefits such an increase in demand for soft commodities exporters, including some countries in Latin America. “Russia and Ukraine account for about 30% of global wheat exports. In the first quarter of 2022 alone, Brazil produced more wheat than in the whole of 2021,” Mr Donovan explains.
Closing the gap
Small companies and large corporations require different solutions when it comes to trade financing. The latter are constantly looking to improve their working capital and build a healthy balance sheet, while small companies are more focused on accessing liquidity.
Small and medium-sized enterprises (SMEs) in developing regions such as Latin America face greater challenges in accessing trade finance. This is an issue, given that SMEs have long played a vital role in job creation.
Globally, more than half of trade finance requests by SMEs are rejected, compared with just 7% for multinational companies, according to a report by the World Trade Organization. Since the financial crisis of 2008, and the resulting regulatory burden banks had to bear, there has been more retrenchment in mid-market trade financing.
Trade finance is operationally heavy compared with traditional bank products such as asset-backed loans
“Trade finance is operationally heavy compared with traditional bank products such as asset-backed loans, where the underwriting is done once and the line of credit is reviewed annually. With trade finance, companies are often shipping to customers on a weekly basis and they require constant underwriting,” says Peter Spradling, chief operating officer at Marco Financial, a tech-enabled trade financing platform. The result is a trade finance gap worth about $350bn within Latin America, he adds.
“Banks lend based on how a company has performed in the past two years. We analyse what the company is doing now and what is its growth potential. About 80% of our clients start increasing their sales once we start funding them,” explains Mr Spradling.
New players, new solutions
New entrants are moving into this space, which could have a positive impact on SME trade finance. “We are seeing that there are not only banks in the space. The sector is attracting a lot of different parties including insurance companies, multilateral development banks and institutional investors, such as private equity firms,” says Ms Bobo. “So, the idea is that instead of a single bank engaged in a direct lending activity to a firm, there is the possibility to build a portfolio of loans that can attract a number of investors. Such a solution would make it easier to lend to smaller firms.”
The International Finance Corporation (IFC) does not lend directly to SMEs but has developed a programme, Working Capital Solutions, that provides funding to banks specifically for work with SMEs. “The programme has been especially successful during the pandemic when banks were looking for liquidity,” says Karla Lopez, IFC sub-regional lead for trade finance in Central America.
“It’s not that banks don’t have an appetite to work with SMEs, rather that regulations require a lot of paperwork and collateral assets, which SMEs do not have. So, SMEs in Latin America end up getting alternative funding from family members and local co-operatives, or they use their credit cards to fund their own imports, which is more expensive.”
HSBC, for example, is developing new solutions across multiple markets in the region. Diego Spannaus, head of global trade and receivable finance for Mexico and Latin America at HSBC, says: “We have been introducing some digital products to support SMEs in countries such as Argentina or Uruguay. In Mexico, we offer digital loans for importers. All they need to do is send us the invoice of the imports and we transfer payment to the supplier.”
Factoring is a growing source of working capital financing for SMEs, according to Oswaldo Sandoval, chief executive of Latam Trade Capital, a specialty finance company. “We mainly work with SMEs, and factoring is our main product,” he says. “The instrument accounts for between 12% and 16% of gross domestic product in developed markets, while in Peru it is 3.7% and in Colombia 2.2%. In Chile, the only one close to developed markets, is around 10.5%. So, there is really an opportunity to support SMEs in the South American markets where we operate.”
Trade finance instruments
Letters of credit (LCs) are widely used, particularly in international trade. “Most of the companies we assist will typically have had longer-term relationships with their clients, which means they will already have in place commercial terms with them. They will maybe do payment against the delivery of the documents and then use credit insurance,” says Mr Sandoval.
Ms Bobo adds: “Depending who they trade with, documentary credit is one of the most used instruments in Latin America, together with any structured trade finance solution that helps mitigate cross-border risk, such as pre-export finance loans. Such structures help especially when trading with countries with a lower [credit] rating.” For banks, this means being able to rely on repayments of loans granted to Latin American counterparties directly from buyers outside those countries in offshore accounts, she says.
However, even before the pandemic there was a decline in the more traditional trade instruments such as LCs and open account transactions. “We see a lot of trade finance in different guises. A lot of it is around distribution finance, all forms of supplier finance, receivables, discounting, trade payables and general trade working capital solutions. That’s where we’ve seen an important upswing in volume and in value,” says Citi’s Mr Donovan.
Zeynep Ersel, IFC regional lead in trade finance for Latin America and the Caribbean, says: “If you look at smaller countries like Haiti, or even countries like Bolivia, where traditionally there is not a lot of funded trade finance, you still see LC-type transactions. Otherwise in countries such as Ecuador, Brazil, Guatemala, Colombia, Peru, Honduras, El Salvador or Costa Rica, you see funded trade finance.”
Brazil is reforming its foreign exchange regulation and this is a really important milestone
Access to domestic currency is a further constraint for foreign banks providing trade finance in Latin America. A lot of import-export transactions are dollarised, while domestic transactions are carried out in local currency. In countries like Brazil or Chile, which do not have a convertible currency, it can be very difficult to get access to financing unless there is a bank already established in the country, says Ms Bobo. “That is why, for a bank, it is important to have a local presence to access the currency and be able to finance domestic transactions.”
Mr Donovan adds: “Brazil is reforming its foreign exchange regulation and this is a really important milestone because it will enhance legal aspects and result in less bureaucracy.” The law, which comes into effect towards the end of the year, will allow businesses to hold foreign currency in Brazilian bank accounts.
Digitalisation efforts
Over the past few years, personal finance has been revolutionised by technology. At the domestic level, companies are using many more automatic payment methods to settle their bills. However, when it comes to the settlement of exports and imports, there is still room for improvement in terms of digitalisation.
“If you are talking about an application programming interface or a uniform protocol, or moving towards blockchain settlement of trade finance transactions, we are still not there yet because each bank still has its own platform. In my opinion, it is going to take about five years. In Latin America, the bigger companies are all testing and trying different solutions,” says Ms Ersel.
HSBC has made an agreement with platform Contour and conducted a pilot trade finance transaction using blockchain in Mexico. “We were the first bank to do so in Latin America. But of course, one of the aspects that is stopping us is regulatory approvals despite the fact that we are in the process of getting it in Mexico,” says Mr Spannaus.
LCs are instruments that could benefit from the deployment of blockchain. “The information goes back and forth between importer, exporter and bank. With blockchain, the same information can be exchanged in a closed platform with the time of transaction reduced from eight to 10 days to up to 18 hours. So, that’s the benefit that we see in the future from companies using blockchain,” Mr Spannaus adds.
Innovation is also coming from the fintech sector. There are a number of mature and maturing fintechs in the trade space offering discounted payables or receivables. Banks are establishing partnerships with some of them.
Earlier in June, fintech Omni announced a strategic alliance with JPMorgan. The former will offer supply chain finance and working capital loans to the bank’s clients.
“In the past, many people thought that fintech would be taking the business away from banks. But as time has passed everyone realises that it is more of a partnership than a winner-takes-all approach,” explains Mr Spannaus.
Latam Trade Capital’s Mr Sandoval adds: “One of our affiliates has developed a device called Flare that did not really exist in the market. It is a small box that allows for real-time tracking of shipped products and provides a lot of information including temperature or position. It is a small and relatively cheap device that we can provide to our clients.”
Digital adoption is high on everyone’s agenda, especially in countries like Brazil, which is rolling out regulations to boost the use of electronic invoicing (e-invoicing), according to Mr Donovan.
Original paperwork is still often needed for record keeping, however. “Containers need the original bill of lading when they arrive at ports. But also freight carriers are now beginning to digitise and are doing electronic bills of lading. We are seeing a push in a lot of countries, most recently Colombia, which a few years ago received a loan from the World Bank to invest in e-invoices, with the aim of avoiding tax evasion.”
Marco Financial is developing a digitised version of documentary collections where the buyer sends funds in a digital escrow that the fintech holds and releases to the seller once all the requirements are met. “It is pretty much the same use case as a LC or a documentary collection, but done in a digitised way,’’ Mr Spradling explains.
The company is also developing something it calls Marco Scan, an optical character recognition technology which reads invoices or any documents and digitises them. The fintech uses technology to pull all the historical information and judicial records from databases to give clients an immediate answer about their request for financing.
Looking ahead
The current high interest rate environment and potential stagflation could make it more difficult for companies to obtain trade financing in future.
However, Latin America is likely to attract an influx of investment in the coming years, if financial institutions and providers are able to get their head around operational risk and a sometimes an exaggerated country risk associated with the region.
Recently, Chile and Colombia elected left-wing presidents, who are typically less business-friendly. However, as Mr Spradling says: “We haven’t seen this affect any of the factoring or trade finance because all parties understand how important trade is for the economy.”
