Why some CFOs are turning to traditional trade finance instruments

To succeed in today’s global trade environment, many companies have adopted innovative supply chain solutions. This has included a return to traditional commission-led trade finance structures, which are an attractive solution in the current higher credit cost environment. Such solutions can bolster cash flow and create clear, mutually beneficial terms with suppliers.

Businesses trading across borders have also adjusted to the challenges of supply chain pressures and the subsequent squeeze on margins, demonstrating an ability to innovate and respond effectively in a more unpredictable geopolitical and macro landscape.

“Companies have experienced significant supply chain disruption in recent years; immediately followed by a wave of inflationary pressures and increased borrowing costs, which recent events in the Red Sea have further exacerbated,” says Simon Smith, Regional Director of Global Trade at HSBC UK. “It’s been a tough environment for UK businesses, but they have proactively sought out innovative solutions in response to these challenges,” he adds.

One challenge for companies has been accurately forecasting sales and estimating required stock holding. Fluctuating demand and stock levels have at times squeezed cash flow and companies have turned to alternative ways to maintain and generate cash.

The question of how companies manage their supply chains has been high on the agenda for many businesses, particularly those operating across multiple territories. Firms have diversified and created new avenues within their networks to help them respond to challenges. Some companies have experimented with near-shoring and reshoring, while others have added suppliers in new countries to support contingency management. Often, new suppliers are outside of traditional locations as companies diversify country risk, particularly where political and sector tensions exist.

Companies have also built relationships with sustainability and digitalisation at the heart, driving a shift to more strategic, long-term partnerships. Stock management has also been a priority, with tighter, more considered control systems introduced to ensure key lines are always available.

A key component of adaptation has been the implementation of more traditional funding solutions that help companies stay flexible and nimble. Smith has seen customers revisiting financing methods such as Letters of Credit (LCs) and Guarantees.

“Despite the end of sharp global rate rises in sight, it remains more expensive to borrow money and companies are looking at every option to preserve cash and save cost,” he says. “The balance sheets of many suppliers have also been eroded, so they are seeking secure and guaranteed payment methods. This is where traditional trade instruments can help,” he adds.

“By using Individual LCs, Guarantees and Standby LCs, companies can retain cash in the short-term that can be used for other purposes,” explains Smith. “They can get an LC or Guarantee which could be at a cost saving compared with a base-rate led solution in the current environment.”

There’s also been an increase in demand for bespoke corporate solutions, such as Asset-Based Lending (ABL). ABL is a corporate solution suited for businesses that are working-capital-intensive and asset-heavy. Companies like the bespoke and all-encompassing nature of these agreements, the dynamic funding they provide, and the fact the entire debt requirement of a business can often be accommodated via a single facility agreement.

Whilst some companies are in a strong cash position, a number of businesses have approached HSBC to generate additional liquidity. The bank has been able to support many businesses across a variety of sectors including agrifoods and manufacturing through ABL, leveraging unencumbered assets and advancing against inventory to generate the funding they require. In many cases, it has also enabled them to accelerate their strategic plans and pursue corporate opportunities.

Trade instruments can prevent companies from having to draw on base-rate-led solutions, such as conventional borrowing facilities, i.e. overdraft or Revolving Credit Facility, where they are subject to interest margins in addition to base rate. Businesses are able to pay a lower quarterly commission charge in return for issuance of a trade instrument that provides a guarantee of payment to a beneficiary, subject to the fulfilment of terms.

Companies are seeking to revert from paying suppliers at the point orders are placed, or at the point of shipment, to issuing contingent liabilities to suppliers in exchange for more favourable terms. “Recently, a well-known corporate in the retail space advised all its suppliers it would be issuing LCs in support of future orders and revised payment terms. This has had a very positive impact on their cashflow,” says Smith.

Traditional tools like LCs also offer wider benefits to suppliers. The receipt of an LC enables a beneficiary to confirm and discount in-country, generating working capital if required locally in support of production. This is commonplace across many sectors, such as the apparel industry and commodity markets. Changes in credit ratings to the buyer or supplier, sometimes both, have also driven a request for such instruments as entities seek to protect against payment default risk.

The 2023 launch of the UK’s Electronic Documents Trade Act, which provides for certain electronic trade documents, including electronic bills of lading, to be accorded the same legal status as their paper equivalents if they meet the relevant criteria, has been seen as a catalyst for digitisation of the industry.

HSBC Global Trade has a broad range of funding products that can unlock and provide working capital, and a range of risk mitigation solutions that help protect both buyers and sellers.

“We are investing heavily in digitalising trade, and solutions like TradePay enable companies to pay suppliers instantly without the need to provide trade documents, with appropriate funding tenors attached,” explains Smith.

“The profile and needs of every business are different; spending time to truly understand the supply chain, supplier and customer base of every company is what we do well. We can bring different perspectives for companies on their challenges – as well as the right funding solution.”