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SME Trade Finance Options Grow but Challenges Persist

By Karen Lynch

Small and midsize enterprises (SMEs) seeking trade finance today encounter an increasing range of options but ongoing challenges in leveraging them, according to recent market research. Trends highlighted by that research include the continued rise of open account trading over traditional trade finance, new financial technology (fintech) alternatives, and the general easing of small business credit conditions.

Open Account Trading Rises

 

"There has been a clear and decisive global shift to trade on open account terms," according to the 2017 ICC Trade Register Report, an annual report released in March 2018 by the International Chamber of Commerce's (ICC's) Banking Commission.1 SMEs have followed the trend established by larger importers that have transitioned from traditional letters of credit to open account trade, in which goods are shipped and delivered before payment is due, usually in 30 to 90 days.2

 

While open account transactions can incur lower costs, require less processing time, and improve the competitiveness of bids (versus, for example, cash in advance), they carry more risk for exporters than importers. "The exporter should be absolutely confident that the importer will accept shipment and pay at the agreed time and that the importing country is commercially and politically secure," according to the U.S. Department of Commerce.3 Another risk involves the recent tendency of larger companies to stretch out payment terms for business-to-business (B2B) payments.

 

Risks to exporters can be mitigated by such trade finance techniques as export credit insurance. And now, SME-targeted insurance is coming to market; for example, one company uses a digital platform to offer SMEs on-demand insurance covering a single invoice or buyer.4

 

SMEs can also bridge cash flow gaps between shipment and payment on open account with export working capital financing,5factoring (selling receivables at a discount to a finance provider), and supply chain financing. Also known as "reverse factoring," supply chain financing involves agreements by importers to approve suppliers' invoices for financing by a bank or other financier, in the interest of maintaining robust supply chains. According to the World Supply Chain Finance Report 2018, global supply chain financing grew by 36 percent worldwide in 2016, to $447.8 billion.6

 

Traditional Trade Finance Challenges

 

At this point, traditional trade finance, including such instruments as letters of credit, loans, and loan guarantees from national export agencies, covers only about 10 percent of merchandise trade, according to the Trade Register Report7.

 

For banks, "trade finance [is] a very attractive real-economy business with enviable default and risk characteristics," according to the report.8 Yet SMEs' access to trade finance remains limited because they often lack collateral, a documented history of past transactions, and an understanding of available finance alternatives, according to the report.9

 

"Efforts to close the gap continue, with big hopes placed on technology," the report said. But significant advances are needed in such areas as digital trade rules, globally harmonized digital identities, and broad cross-industry and government acceptance of digital standards.10 Among other initiatives, an ICC Working Group on Digitalization has been formed to speed this evolution.

 

In the meantime, bank prices and fees for traditional trade finance have been dropping in recent years, according to a separate ICC report titled Rethinking Trade & Finance 201711. However, the report suggested that banks may not be able to sustain these lower trade finance charges due to their own cost pressures.

 

Fintech Innovates Trade Finance

 

Technology tools for SMEs run the gamut from messaging to online payment risk calculators to global platforms based on the blockchain distributed ledger technology, and they are in various stages of rollout and uptake.

 

Examples of currently available digital enhancements include new trade finance tools from SWIFT, the global financial messaging platform. For example, SWIFT's MT 798 messaging service12 links multiple banks used by one company in its trade operations to transfer letters of credit and guarantees. And SWIFT's bank payment obligation (BPO) offering13 enables a bank to supply secure financing from the moment a trade is agreed.14 As SWIFT describes it, "The BPO sits alongside payment terms such as letters of credit, advanced payment, or open account. Unlike traditional instruments, however, the BPO combines legally binding rules with electronic messaging and matching capabilities."15

 

Increasingly, banks and fintechs are also enhancing digital trade finance offerings with value-added services. For example, the insurance platform for SMEs that is mentioned earlier in this article incorporates a database on the credit worthiness of companies around the world, along with a risk calculator.16

 

Looking ahead, a fintech pilot project including several global banks aims to use blockchain for managing, tracking, and protecting trade transactions between SMEs. The Digital Trade Chain, more recently renamed we.trade, is expected to be deployed in 2018.17

 

For all the current efforts, however, the Euromoney Trade Finance Survey 2018 found that very few corporate finance executives have begun using them. Swift's MT 798 was most used by survey respondents (28 percent), followed by BPO (23 percent), electronic bills of lading (20 percent), and blockchain (6 percent). The holdup is attributed, in large part, to the fact that trade transactions often include many parties with different levels of technological capabilities.18

 

SME Credit Conditions

 

Generally speaking, credit conditions for SMEs have improved, according to Financing SMEs and Entrepreneurs 2018, from the Organization for Economic Co-operation and Development (OECD).19 The average interest rate charged to SMEs declined in 2016 in 30 out of 36 countries, the OECD said. And while interest rates are slowly trending upward in the United States, the good news is that small business loans are becoming more readily available as they become more profitable for banks, according to Fundera, a small business lending marketplace.20

 

Despite positive developments, "structural problems to access external sources of finance persist, especially for young firms and start-ups, micro-enterprises, and innovative ventures with an unproven business model," the OECD report said. These businesses, whose primary assets may consist of intellectual property and other intangibles, often lack assets that can be easily used as collateral.21

 

The

Takeaway:

SMEs face both opportunity and challenge as the trade finance market undergoes significant change. Options for financing import-export trade are proliferating, but usage trends are mixed. Ultimately, the digital transformation of trade finance is expected to lead to lower costs, faster processing, and greater access to funds. However, it is proceeding only gradually.

Karen Lynch - The Author

The Author

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.

Sources

1. 2017 ICC Trade Register Report, International Chamber of Commerce; https://cdn.iccwbo.org/content/uploads/sites/3/2018/02/icc-trade-register-report-2017.pdf
2. Trade Finance Guide, U.S. Department of Commerce; https://www.trade.gov/publications/pdfs/tfg2008.pdf
3. Ibid.
4. “Euler Hermes Launches Insurtech Brand to Bring Trade Credit Insurance to SMEs,” Global Trade Review;https://www.gtreview.com/news/fintech/euler-hermes-launches-insurtech-brand-to-bring-trade-credit-insurance-to-smes/
5. Trade Finance Guide, U.S. Department of Commerce; https://www.trade.gov/publications/pdfs/tfg2008.pdf
6. World Supply Chain Finance Report 2018, BCR; https://bcrpub.com/publications/world-supply-chain-finance-report-2018
7. 2017 ICC Trade Register Report, International Chamber of Commerce; https://cdn.iccwbo.org/content/uploads/sites/3/2018/02/icc-trade-register-report-2017.pdf
8. Ibid.
9. Ibid.
10. Ibid.
11. 2017 Rethinking Trade & Finance, ICC Banking Commission; https://cdn.iccwbo.org/content/uploads/sites/3/2017/06/2017-rethinking-trade-finance.pdf
12. “MT 798,” SWIFT; https://www.swift.com/our-solutions/corporates/drive-trade-digitisation/mt-798
13. “The Bank Payment Obligation,” SWIFT; https://www.swift.com/our-solutions/corporates/drive-trade-digitisation/bank-payment-obligation
14. “Trade Finance Survey 2018,” Euromoney; https://www.euromoney.com/article/b16bp3d2cf3ccs/trade-finance-survey-2018-results-index
15. “The Bank Payment Obligation,” SWIFT; https://www.swift.com/our-solutions/corporates/drive-trade-digitisation/bank-payment-obligation
16. “Euler Hermes Launches Insurtech Brand to Bring Trade Credit Insurance to SMEs,” Global Trade Review; https://www.gtreview.com/news/fintech/euler-hermes-launches-insurtech-brand-to-bring-trade-credit-insurance-to-smes/
17. “Banks Unveil Roadmap for we.trade Blockchain Platform,” Global Trade Review; https://www.gtreview.com/news/fintech/banks-unveil-roadmap-for-we-trade-blockchain-platform/
18. “Trade Finance Survey 2018,” Euromoney; https://www.euromoney.com/article/b16bp3d2cf3ccs/trade-finance-survey-2018-results-index
19. Financing SMEs and Entrepreneurs 2018, Organization for Economic Co-operation and Development; http://www.oecd.org/cfe/smes/Highlights-Financing-SMEs-and-Entrepreneurs-2018.pdf
20. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/
21. Financing SMEs and Entrepreneurs 2018, Organization for Economic Co-operation and Development; http://www.oecd.org/cfe/smes/Highlights-Financing-SMEs-and-Entrepreneurs-2018.pdf

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