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Trade finance, where backers agree to buy up a commodity while it is in transit, is getting a new lease of life – as finance directors look for alternatives to traditional forms of lending, says Alex Hawkes

Britain’s disillusion with banking grows by the day. As crisis follows crisis, and the banks pull in their horns to deal with piles of bad debt, beaten-up SMEs complain bitterly of a lack of lending and mis-selling of complex financing arrangements.

But, in the midst of the gloom, an opportunity could be emerging. The old-fashioned art of trade financing, along with other forms of alternative finance for businesses, is beginning to flourish again.

Banks are being spurred by regulation towards more tightly-drawn types of finance, including trade finance. New entrants, meanwhile, are hoping to fill the broader gaps left by the banks in financing SMEs that cannot get overdrafts on the terms that they used to.

And the broader need to rein in working capital as the downturn bites is opening up further opportunities for innovative financing.

Finance partners
Trade finance is by no means a new concept. William Tebbit, commercial director of Trade Finance Partners (TFP), describes it simply as “old-fashioned merchant banking”.

The principle is simple – a customer has an agreed order from a big company, but for whatever reason cannot pay a deposit for the raw materials required.

This is where the trade financier steps in, taking on the financial risk of buying the raw materials with the agreed order as its security.

It is, in one sense, merely greasing the wheels of world trade. But it is also proving to be increasingly popular.

“There’s a real squeeze on SMEs. Banks simply aren’t lending to small businesses,” says Tebbit.

Without overdrafts and bank loans provided in the usual way, trade finance can step into the breach. TFP started providing finance in earnest last year and made a profit in its first year of trading. It turned over £12.3m in the year ending March 2012, recording a pre-tax profit of £103,825.

It is aiming at the SME market. Backed by alternative fund management company The City of London Group and by Australian bank Macquarie, Tebbit and his colleagues aim to finance deals where the solvency of the end customer is not in any doubt.

“One of our clients is a clothing manufacturer. He had a large order to fulfil from Argos [a catalogue and online retailer] for a new range of baby clothes, but was unable to pay deposits or to open letters of credit.

“So we placed the orders with the factories, issuing a letter of credit to guarantee that they will get paid,” Tebbit says, describing a typical deal.

TFP has put up cash for trades involving pizza boxes for Pizza Hut, car batteries and recycling equipment. It makes its money on a mark-up – buying the goods from the supplier for £100, say, and selling them to its customer for £106.

Tebbit also says that while TFP recorded sales of £12m last year, “it is running a lot hotter this year”.

Others agree that they are seeing a resurgence of interest in trade finance, but not always for the same reasons.

Maurice Craft, ex-chair of the Asset Backed Financing Association and managing director of Regency Factors, another trade finance prov- ider, pinpoints new regulation as a key driver: “The banks, since the imposition of the Basel capital rules, have found that provision of overdraft facilities, traditionally the lifeblood for business, has become ‘expensive’ in capital adequacy terms, and have thus tried to steer their facilities offered to less ‘expensive’ products, such as invoice finance and leasing for capital equipment.”

John Bevan, Barclays head of trade and working capital for the UK and Ireland, agrees that the regulatory changes have driven banks towards trade finance: “From a bank’s perspective, trade products are structured. Therefore, they are much more efficient from a capital perspective. We can provide more [of them] and at a better price.”

He also highlights a broader perspective – that international trade trends are driving greater interest in trade finance.

“There has been a consolidation of supply chains over the past 12 to 18 months, particularly among SMEs, but also among larger corporates. Suppliers now come from further afield than previously.”

Because suppliers are often further away, trade finance can provide some kind of security. He adds that it is working the other way too. Barclays will also finance trades in the opposite direction, another market that is growing.

“On the export side, demand for UK products from more traditional markets, in the eurozone for instance, has declined. We are starting to see demand emerging from the BRIC economies,” says Bevan.

As supply chains lengthen, companies reach for trade finance as a way of getting both protection and certainty of payment.

But, on a more basic level it is just another way of managing working capital, limiting the amount of cash being used to run the business at any one time.

Robert Smid, a partner at PwC, tends to advise on bigger deals – helping companies to securitise a whole range of invoices rather than just getting finance for one trade. But many of the principles are the same.

Quite apart from security and other reasons, getting finance for a deal can work out cheaper than other more long-term forms of financing in some circumstances, he says.

“The overall indicator of what is cheaper is who has the better credit rating, you or the customer?” Smid says.

If you are selling to a big retailer that is good at paying its bills, then the finance company will be comfortable financing the trade and offering decent terms.

Smid says that was the reason why companies used to securitise their invoices – because their client was BT, or rather the state.

Suppliers could get money up front from the bank because it knew that the invoices were underpinned by the state’s credit rating.

One thing that is very popular at the moment, Smid says, is “reverse factoring”. This is the practice of arranging for a bank to pay your suppliers for you quicker than you would pay them.

“If I have a better credit rating than my supplier I can use that to help them get paid earlier. Some small suppliers can’t afford to wait 60 days to get paid. If I give a promise that I will pay the invoice in 60 days, an intermediary will pay them in 10 days. The supplier gets 99.5 per cent, but gets it 50 days earlier. And they would never be able to get that kind of financing.”

Bigger companies can gain an advantage by using those techniques too – offering them while at the same time pushing out their own payment terms and helping their own working capital.

With companies having 20 to 30 per cent of their sales at any one time tied up in working capital, there are plenty who are looking at ways to reduce those figures, and to make them ultimately less reliant on any forms of financing.

Bevan agrees that ultimately the use of trade finance comes down to a working capital requirement. “There’s a lot of myths around trade finance. It’s effectively just part of the working capital cycle of many businesses. Many people are not looking for a specific product, but want an end-to-end working capital strategy.”

Tebbit warns that the hotter market is bringing in some new and inexperienced players. The oil and commodities trade finance tends to be done by the big banks, while Bibby is another big player, he says.

“We are seeing there are a few private individuals who think there’s an opportunity to provide finance to SMEs – a lot of people who don’t quite know how to do it.” Hedge funds have been coming in too, he says.

“For some of the smaller businesses it’s quite dangerous.”

Craft agrees that it is a complicated area.

“Funding the purchase of goods or raw materials on behalf of an importing client needs to be structured in a way that will satisfy all parties to the transaction. The supplier has to be assured of being paid for the goods they supply, the client needs to be confident that the arrangement doesn’t spoil the relationship with the supplier, while we as financiers have to satisfy ourselves that we are secure at all stages of the transaction.

“The facilities are not the usual vanilla offering and they require tailoring to the individual needs of the client. The degree of skill required has limited the providers of the product thus far and its use is not as prevalent as it could be. Given time, it may well become as mainstream as factoring or invoice discounting.”

Alex Hawkes is a leading financial journalist who writes for several UK newspapers.


TFP in practice

Eric Bain is finance and operations director at Atlantic Enterprises,a UK packaging group, and has been using Trade Finance Partners (TFP) since December last year.

TFP helps Atlantic to finance its purchase of food packagingfor a major UK restaurant chain. The whole process takes a month,and Atlantic would normally get paid six weeks later.

“On that basis we would be waiting ten weeks for our money,”Bain says.

As well as avoiding the upfront costs of doing business, his Turkish supplier is “even more happy”, he says, because it gets cash up front.

“TFP pay cash on day one of receipt of goods. As a result I was able to negotiate a significant discount that covers any costs charged by TFP.”

Bain thinks trade finance has a significant advantage over invoice discounting and factoring, because Atlantic only ever sees its profits, and has no cash in its bank accounts that needs to be used to buy more raw materials.

Factoring and invoice discounting “gets you money quicker. But it doesn’t help manage cash flow. In tough times all companies use their cash flow, whether or not it’s their profit. They are teetering on the edge of insolvency. If you can trade on your margins rather than your cash flow, you won’t get into trouble”.

Bain used to work in property during the boom, when banks were lining up to lend: “This service wouldn’t have been relevant then.”

He adds that it is not for everyone – if you are selling to small companies or to consumers it won’t be much use, since TFP prefers to lend against secured orders from companies with excellent credit ratings.

Bain says that using trade finance will also enable Atlantic to bid for a much bigger contract coming up, which would otherwise have required £300,000 worth of working capital.

Illustration: Robert Nicol


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