Article

by Mary Detuerk and David Hennah, SWIFT

Cassandras of the consulting world have predicted the downfall of traditional trade finance techniques for years. Their charts bear testament to the ongoing growth of world trade plotted against the dramatic demise of letters of credit. Some time ago now, when invited to comment at an event in London, an industry guru delivered his own Darwinian- style prophesy: "L/Cs are rigid. The rules keep them from changing and adapting. Things that can't adapt, die."

Certainly, the winds of change have been whistling through the world's wharfs and warehouses for over fifty years, bringing with them a shift in negotiating power, not only between importers and exporters but also between corporates and banks. Most notably, the more efficient management of the supply chain has resulted just-in-time production schedules and reduced inventory. The big consignments have been replaced by smaller, more frequent shipments. Trading counterparties trade more often and know each other better. The bonds between buyers and suppliers have been tightened and the perception of risk diminished.

The dramatic graphs and chilling pronouncements notwithstanding, trade bankers still lay claim to the ongoing growth in the value of L/Cs. Occasionally, they may even remark on the continuing growth in volume, defending these claims with such familiarly bullish statements as "We think we're gaining market share", thus apparently avoiding any direct contradiction of conventional industry wisdom.

Reminiscent of Mark Twain's famous remark, "The reports of my death have been greatly exaggerated", the instruments of traditional trade finance are also far from dead. More accurately, the business can be said to be evolving through a process of natural selection into something better suited to the ever-changing needs of today's world.

Force for change

Global trade has become the rule rather than the exception, with more and more middle-market companies entering the competitive fray in search of low-cost sourcing. Client needs have become more sophisticated. Competition has intensified, and the full bundle of services previously offered by banks has progressively been proven less attractive to the market.

Corporate customers have demanded change, and bankers have adapted accordingly, radically realigning their pricing and packaging with the revised perception and profiling of risk. Many have come to realize that their traditional trade products and services, commonly grouped together for marketing purposes, can be broken down into a number of constituent parts including document management, compliance checking, dispute resolution, risk mitigation, working capital finance, etc.

And so it is that whilst banks continue to offer their traditional product bundles, they have also started to sell these same services separately and more creatively. Often they supplement them with alternative forms of financing (both pre-shipment and post-shipment) and also with other value-added services, for example workflow and event management, and data processing for increased transactional control.

In essence, the previous generation of rigidly managed credit facilities has been overtaken by a more flexible approach to working capital management.

Innovative solutions

Innovative supply chain finance programmes are being crafted to meet the simultaneous needs of both buyers and sellers, much as the traditional service offerings did. These new solutions are designed to leverage the financial strength of one trading partner in order to provide services at improved terms to the other. Expressions such as "arbitraged interest rates" don't even raise an eyebrow, it seems. Well structured, these services represent a real win/win/win situation for buyer, seller and bank.

The value of the solutions on offer often hinges upon the ability of the bank to access and analyze key information about the underlying commercial business transaction. Typically, such programmes rely upon the relevant data being obtained from both buyer and seller. This may also demand cooperation between participating banks working in partnership.

The TSU

The degree to which the data can be captured and validated, mined and matched, influences the level of comfort the bank will have in extending facilities and taking on the risk. The aggregation and analysis of data allows financial service providers to develop a portfolio perspective that can result in significant benefits to buyers and sellers alike.

Recognizing the prevailing trend of migration to open account, SWIFT took the decision to consult with a group of senior bankers, the Trade Services Advisory Group, to identify ways in which SWIFT itself might better assist the banking industry as a whole to rise to the challenge of changing market conditions. It was here that the initial idea of the SWIFTNet Trade Services Utility (TSU) first came into existence.

Having launched the TSU in April 2007, SWIFT has concentrated on building its community of users. Today, there are more than 60 banks in over 70 locations worldwide that have subscribed to the TSU. Four leading software vendors have successfully undergone an accreditation process for the SWIFTReady TSU label. The accredited applications can be deployed by banks to integrate TSU functionality into their existing front- and back-office processes with increased efficiency. Additionally, several banks offer TSU-enabled software for other banks to white label.

So the foundations have successfully been laid. But what exactly is the TSU and how does it help the banks?

First of all, it is important to note that the TSU is a bank-to-bank solution. It does not encroach on the corporate/bank relationship. The TSU acts a vehicle for banks to have data matched via the SWIFTNet messaging infrastructure, using common standards and abiding by a common Rulebook. By electronically matching the data extracted from a purchase order to that contained in other related documents such as a commercial invoice or a variety of transport documents, the TSU provides banks with a continuous flow of timely and reliable information to support the delivery of competitive supply chain services. Trigger points are flagged; decision-making processes can be enhanced, duplicated effort eliminated and operating cost reduced.

In reality, the TSU is a very simple concept that nevertheless has the potential to impact radically on the range and quality of services that banks can offer all the way through the transaction lifecycle from purchase order to payment. SWIFT has brought to the table a collaborative channel to help banks take a more holistic approach to the delivery of innovative, supply chain business solutions.

Simplicity is conscious. The simpler the solution, the more likely it is to succeed in what can be, after all, a highly complex business.

From a corporate perspective, the TSU remains invisible. But it is the corporate customers of the bank who will ultimately benefit as the TSU progressively helps banks overcome the barriers and broaden their product offerings. Getting to grips with the metrics of the supply chain is of vital importance. For most, this translates directly to controlling working capital: the reduction of Days Sales Outstanding (DSO) and Days Inventory Outstanding (DIO), and the extension of Days Payables Outstanding (DPO). Technologies like the TSU help to increase visibility, providing for straight through processing in an open environment. Banks can apply the information received to improve and tailor their corporate services.

Enhancements

Moving forward, the value of the TSU will be further enhanced through additional business functionality. The second release, due in the early part of 2009, will not only support transactions involving more than two banks, but also provide support for data elements taken from other documents, including insurance and certificates.

The inclusion of a TSU reference in the MT202 is expected to benefit the payment reconciliation process. Banks will be able use TSU-provided data to link the payment to the underlying commercial transaction without integrating their back office systems.

Release 2 will also incorporate two important new concepts. The first of these is known as the Notice of Intent to Pay. This confirms the intention of the buyer to pay the seller, very similar to an approved purchase order or approved invoice. The second is the Bank Payment Obligation, which commits a bank to settle with another bank and is therefore stronger in terms of its contractual significance.

Many banks have already had the opportunity to get used to working with Release 1 of the TSU and are now beginning to appreciate the business benefits. With Release 2, those benefits will multiply.

Recent events in the credit markets have, of course, brought about a certain amount of turmoil (see the lead story in this issue). It remains to be seen what impact this will have on trading patterns in the short to medium term. Many companies have been driven to reexamine ways of releasing capital that may otherwise be tied up in their supply chains. Others continue to rely on the traditional forms of trade finance.

As noted at the outset, these traditional instruments are far from dead, but banks are certainly approaching the business needs of their corporate customers in far more creative and imaginative ways than before.

It is unlikely to happen, but should one day the ultimate demise of the letter of credit finally come to pass, then once again Mark Twain may speak on behalf of many: "I did not attend the funeral, but I wrote a nice letter saying I approved of it."

Mary Detuerk is Senior Product Manager, Trade Services Utility and David Hennah is Senior Product Manager, Global Transaction Banks at SWIFT. Their e-mails are mary.detuerk@swift.com and david. hennah@swift.com