The Asian Crisis - A catalyst for change

The Asian crisis has forced many Asian companies to shift their focus beyond their traditional domestic and intra-Asian markets to global markets with which they are less familiar.

In particular, booming US and European markets represent an opportunity for Asian exporters to trade themselves out of recession.

The Asian crisis has forced many Asian companies to shift their focus beyond their traditional domestic and intra-Asian markets to global markets with which they are less familiar. In particular, booming US and European markets represent an opportunity for Asian exporters to trade themselves out of recession.

However, dealing with unfamiliar markets and often larger importers used to dictating the terms of trade, represent major challenges for Asian exporters. The same issues also present challenges and opportunities to exporters' banks as they endeavour to support their customers' recovery efforts.

Large importers have for a long time preferred to trade on open-account terms rather than use the more traditional documentary credit process, which can involve higher costs for the importer, and be more cumbersome. With the basic business model of trade likely to be fundamentally reshaped by the increasing application of e-commerce in supply-chain management, many expect the trend towards open account trading to accelerate.

It is no longer enough for Asian exporters to be competitive in terms of price and quality; they need to deal with the increasing demand for open account terms. Exporters need to consider the risk that their buyers may not be able to pay. They may need to think about country risk issues if the buyer is located in a weak economy. They also need to consider the practicalities of receivables collection. Lastly, they need to consider the impact on their own financing arrangement if they are no longer beneficiaries of a Letter of Credit that they can then use to underpin their own funding requirements.

Letters of Credit vs Open Account

Exporters like letters of credit as they afford greater assurance that they will get paid. They derive comfort from the knowledge that a body of rules exists to regulate every step of the LC process, and that these have been designed to minimise ambiguity, promote uniformity and reduce the potential for dispute.

Open-account trading, on the other hand, is a higher-risk undertaking for the exporter who does not retain control or title to the goods pending receipt of payment from the importer. As a rule, exporters would prefer to trade on open-account only with importers that they know and trust.

However, exporters do not always get to dictate the terms of trade. More than ever, importers in the OECD markets insist on trading on open-account terms. Particular industries, where there is strong concentration of bargaining power in the hands of buyers, are leading this trend.

Importers much prefer to have physical possession of the goods (and perhaps even to have sold them on) before making payment to the exporter. The traditional LC process does not hold as much appeal for the importers as for the exporters.

The necessity for strict compliance with the body of rules that govern documentary trade means that any deviation from the terms stated on the LC can delay the negotiation process at the banks, and sometimes delay the underlying shipment of goods. In contrast, open-account trading is more flexible and is often more cost-effective for the importer, as banks are bypassed for everything except payments.

The reason why LCs are still the dominant form of trade-financing in Asia is due primarily to the financing arrangements of exporters and the attitude of their banks. Typically, exporters will continue to require working capital financing. Banks are familiar and comfortable with providing this within the relatively safe framework provided by self-liquidating documentary trade. However, risks to the bank can be higher if they provide poorly structured working capital support for customers' trading on open account.

Receivables Financing & Factoring: An Alternative to Traditional Trade Finance

There are many different types of receivables financing. For the asset-based lender, lending against a pre-determined borrowing base is a type of receivables financing. Factoring is another popular type of receivables financing. From the financier's perspective, it is more structured and secure than lending against a pool of receivables.

Under a factoring arrangement, a business sells its short-term accounts receivables to a factor (usually a bank, a finance company or a specialist factoring company) on a with or without recourse basis, and typically with notice given to the buyers. The factor is then responsible for collection of the receivables.

There are many advantages to factoring for a business, the primary one being better ability to manage cash flow. In addition, since factoring typically provides financing up to a relatively high percentage of approved receivables, the amount of financing available tends to move in line with, and hence support, business growth.

By contrast, more traditional borrowing arrangements with many banks may be constrained by the amount of collateral provided to the bank by the borrower (in spite of protestations by bankers that they are always more interested in cashflow than collateral values).

When additional collateral, such as property, is available, this can be used to support other borrowing requirements if needed. Finally, as factoring is a purchase of receivables rather than a loan, it attracts different balance sheet treatment.

Factoring is often confused with forfaiting. Factoring deals with short-term credits, normally 30 to 180 days, whereas forfaiting finances mid- to long-term debts, with payment terms stretching from six months to many years. In forfaiting, the goods tend to be big-ticket items such as capital goods, as opposed to mainly consumer goods under factoring.

Flexible Factoring

Many view factoring as complicated because, unlike most traditional financial tools, factoring is relatively flexible. The variable features in a factoring facility can be broadly classified into the following categories:

i) Payment

a) "Pay as paid" - The client is paid as and when his buyers settle the invoices.

b) "Upon Maturity" - The client is paid at the end of a pre-determined date or maturity date regardless of whether the buyers have settled their invoices.

ii) With or Without Recourse

a) With Recourse - The client still assumes the buyer's credit and performance risk. If the factor is unable to collect the debt from the buyer for any reason, it can seek recourse from the client.

b) Without Recourse - The factor assumes the buyer's credit risk but not the performance risk. If the buyer is unable to pay due to financial reasons, the factor has no recourse to the client. However, if the buyer refuses to pay due to some dispute with the client, the factor still has recourse to the client.

iii) Advance Facility

a) Under Advance - The client can ask for advance or prepayment against the invoices factored before maturity or collection.

b) Under Non-advance - No advance will be given to client.

iv) With Or Without Notification

a) With Notification

The client is required to notify the buyers of the factoring arrangement and the buyers are required to make payment directly to the factor.

b) Without Notification

The buyer is not notified of the factoring arrangement and payments are made to the client directly.
Facilities can be tailored, incorporating combinations of the above features to suit individual company's needs.

Factoring Then & Now

The modern form of factoring originated in the US in the 1890s, when factors or agents in the textile and clothing industry started offering European (mainly UK) exporters debt collection services as well as advance payments against goods sold. Factoring remained very much a small-scale business until the 1960s when banks and other financial institutions started entering the industry. From then, the industry grew by leaps and bounds and it is today a US$500 billion a year business.

According to industry estimates, the UK has overtaken the US as the world's largest market, recording business volumes of approximately US$100 billion in 1998. Now, almost all UK clearing banks have factoring subsidiaries or divisions, and this has facilitated the growth of the industry.

Factoring In Asia

Although factoring was introduced in Asia in the1970s, its popularity only took off in the late-1980s. This coincided with the rise of the Asian economies. Since then, the value of business handled has risen steadily. Over the five years prior to 1997, annual domestic and export business factored volumes grew by 25% and 50% respectively.

The recession in Asia over the past two years has had far reaching effects on all sectors of the economy. Financial institutions across the region suffered record bad debts, resulting in several banks scaling down operations or withdrawing altogether from the region. Many companies had their credit lines severely reduced or withdrawn and the assets that companies pledged as security for their banking arrangements suffered severe declines in value.

As a result, there has been rising demand for factoring, which does not require tangible security such as property. On the other hand, in markets such as Indonesia, Thailand and Malaysia, mounting losses from non-performing loans forced many banks and finance companies to scale back on their factoring businesses.

The largest Asian factoring markets comprise Japan, South Korea, Hong Kong, Singapore and Taiwan. Of these, factoring in Hong Kong and Taiwan is a relatively recent development.

Japan, by virtue of the size and sophistication of its economy, is Asia's largest factoring market. However, many factoring operations have been affected by the protracted economic slowdown and industry growth has been impeded by write-offs of unrelated business or problems faced by their parent companies.

Factoring growth in Taiwan has been based on its position as a premier semi-conductor and electronics manufacturer, whose largest trading partner is the US. Hong Kong, on the other hand, has leveraged its position as a financial and transportation hub, handling much of the trade and business flows originating from China.

The Singapore market has seen relatively slow but consistent growth. Like Taiwan, electronics manufacturing and trading were the cornerstones of the industry's initial development. The government also played a part in promoting the facility by setting up financing schemes for qualifying small and medium manufacturers.

Prior to 1997, South Korea was the second largest factoring market in Asia. Most of the business was generated from bilateral trade with Japan. This virtually disappeared as recession hit both markets but, recently, with recovery in its economy, trade volumes are climbing again and with them the factoring business.

Exporters and importers are often in conflict over the way they prefer to trade. The buying power of importers has increased over recent years, and the adoption of e-commerce to streamline supply-chain management is likely to further strengthen the move to open-account terms.

Exporters, however, continue to require financing and hence factoring and other forms of receivables financing appear poised for significant growth in Asia. The ability to provide solutions to exporters and importers trading in the electronic environment will be a critical success factor for financial institutions in the new millennium.

Alexis Wong isásenior product manager, receivables financing, international trade management, Standard Chartered.