The growth in open account trade in Asia is expected to continue its march forward this year. That’s despite some regulatory concerns, a lack of regional credit insurance cover and a simple failure by some local banks to understand the process. “In 2010 open account exceeded 2008’s peaks by between 15% and 17%; by contrast, letters of credit grew by only a few percent in 2010 over 2008,” said Ashutosh Kumar, Standard Chartered Bank’s global head of local corporate products and receivables management.
Open account already accounts for about 90% of global trade with letters of credit accounting for just 10%. In Asia-Pacific, letters of credit probably account for a slightly higher proportion, but are declining steadily, particularly in China, Taiwan and Hong Kong where open account trade grew at close to 50% in 2010 over 2009.
It is not all plain sailing though. Banks in some of Asia’s largest cities are comfortable with open account trade and know how it works, but this isn’t always the case in smaller cities. What are the rules? What do they need to do under an open account transaction to get paid? When will the insurer pay and when will they not? Despite the best efforts of international banks and some larger local banks, these questions remain unresolved for smaller players.
When explained in simple terms, open account trade makes a lot of sense. To ship a million barrels of oil from Indonesia to Singapore might take 24 hours, but letter of credit documents might take a week to reach the importer, thereby adding time and cost to the whole operation. “The physical supply chain has moved way ahead of the financial supply chain when you talk about letters of credit. Growth will still come from open account trade despite a lack of understanding and credit insurance in certain parts of Asia,” said Kumar.” Slowly but surely more and more players are moving towards supporting open account trade.”
Not all regulators seem convinced though. Take, for example, India. In September last year, the Indian regulator, the Insurance Regulatory and Development Authority (IRDA), banned all forms of credit insurance except for cover provided by the Export Credit Guarantee Corporation. This followed a series of large defaults on credit insurance policies issued by state-owned insurers. Although the IRDA allowed insurance companies to provide limited trade credit protection three months later in December, insurers remain unable to sell insurance policy products to banks or other lenders.
“We are now seeing even more challenges in India where the regulator has said that banks cannot use an open account transaction which has been issued to finance companies, or take assignment of an insurance policy which becomes collateral like a letter of credit and finance against that,” explained Kumar. “Concerns like this are becoming another challenge among many countries, where they are not moving to open account but sticking to letters of credit.”
The good news is that the move by the IRDA is probably a knee-jerk reaction to a series of defaults on state-owned insurers’ policies, and therefore will likely prove temporary, according to Kumar. “I think they will eventually move back to encouraging the participation of global trade, by allowing credit insurers and bankers to work together to support open account trade. In the longer-term, trade can really only move in one direction.”
Finally, and of central importance, is the lack of regional trade credit insurance. The availability of this all-important insurance to suppliers of goods and services against the risk of non-payment by buyers, remains heavily constrained throughout much of the region. “The credit insurance market is very concentrated and is tightly controlled in many countries in Asia, so an international insurance or credit insurance company cannot simply go in and start doing business wherever it wants. They would first need to do a tie-up or get a licence, which, although possible in theory, it is practically quite difficult to get risk mitigation for an open account trade transaction,” said Kumar.