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The incentives for exporters to target emerging markets are clear. What is not clear is where to access the resources and the funding required to do so. Emma Clark, Head of Business Development, UK and Europe, Falcon Group, discusses how the solution for exporters lies in ECAs, banks and specialist financiers collaborating across the ‘new’ financial landscape.
With steady growth rates, an abundance of natural resources, and a potential customer base comprising most of the world’s population, emerging markets offer huge growth opportunities for those companies thinking of expanding operations overseas.
But exporting is not without its obstacles. In fact, business growth and access to adequate and flexible funding in the current global economic climate are some of the key challenges faced by companies all over the world.
Fortunately, in a time of restricted lending, a variety of players – including specialist financiers – are stepping in to fill the gap.
Emerging market expansion
Global economic power is shifting from West to East as emerging markets across Asia, Latin America and the Middle East continue to perform robustly. Despite cyclical fluctuations – prompted, in large part, by falling commodity prices and slower growth in China – emerging market growth over the past 20 years has been twice that of developed countries.
It is a trend unlikely to abate anytime soon. Estimations from HSBC, for instance, project emerging market growth to rise to 4.6% in 2017 in comparison to just 1.8% for developed markets. While many developed economies found themselves in freefall during the global recession – and are still struggling to adjust – emerging markets functioned remarkably well throughout the crisis, escaping recession and driving global economic growth.
Things are slowing down but the growth figures remain positive. By 2020, five of the world’s largest 10 economies will be emerging markets. China, India, Russia, Brazil and Mexico will account for a combined $47 trillion in GDP (in PPP terms).
Meanwhile, the Association of Southeast Asian Nations (ASEAN), comprised of states such as Indonesia, Malaysia and Vietnam, has grown to become the world’s sixth largest economy (if considered as a single entity) and as is today considered a major global hub of manufacturing and trade.
The rise of the middle class
Perhaps one of the most exciting prospects presented by emerging market expansion is a growing middle class population. According to Ernst Young estimates, in Asia alone, 525 million people can already count themselves “middle class”. For comparison, the entire population of the European Union is 508 million.
But the growth does not stop there. Over the next two decades, it is estimated that the middle class will expand by another three billion, due almost exclusively to the contribution of emerging markets.
And these consumer markets are extremely prosperous. McKinsey & Company research predicts emerging market consumer expenditure to rise annually from $6.9 trillion to $20 trillion in the next decade.
So, companies are being handed a new generation of consumers with higher purchasing power, a strong demand for infrastructure improvement, and an increased appetite for a variety of consumer goods and services. It is a rare, golden opportunity, and one that will offer companies lasting advantages – allowing them to mark their territory as the leading brand for a particular product or service.
Multilateral regionalism and free trade
Meanwhile, the world of international trade is also changing, with an increasing number of regional free trade agreements (FTAs) and economies splitting up into fewer, larger – and more powerful – economic trading blocs.
Emerging market economies, in particular, continue to be strong advocates of free trade. In many cases, FTAs have facilitated greater volumes of trade between parties as well as strengthening political and economic ties.
One such example is the Gulf Cooperation Council (GCC) – a regional intergovernmental economic union committed to promoting the integration of various fields including finance, infrastructure, trade and cooperation across the Middle East.
As these regions seek to deepen ties – lowering tariffs and non-tariff barriers to trade, through bilateral trade agreements – businesses looking to expand abroad may find fewer barriers to entry with looser trade restrictions and more incentives to encourage doing business in the global marketplace.
Other trade agreements – such as the Trans-Pacific Partnership (TPP) and the WTO’s Trade Facilitation Agreement – are expected to reduce trade costs and open doors to new markets.
Finding credit to finance trade
The only problem, of course, is that exporting is not cheap. International sales, distribution, shipping, order fulfillment and trade compliance all often involve much greater investments of time and money than domestic trade.
One of the major obstacles to the pursuit of trade activity, therefore, particularly for those based in emerging markets, is the inability to access adequate levels of trade finance. In fact, recent Asian Development Bank (ADB) figures estimate a $1.6 trillion gap in the supply of trade finance.
This is due, largely, to ongoing global bank retrenchment and stricter global capital requirements driven by a number of financial, regulatory, economic and political considerations.
Basel III, in particular, has prompted significant changes to the banking framework – aimed at preventing a recurrence of the global financial crisis. More specifically, it has created new liquidity requirements – asking banks to hold more capital on their balance sheets. While such rules are designed to boost bank resilience, Basel III reforms have hit trade finance in several ways. Rules for leverage and liquidity and new risk-weighting requirements have had the unfortunate impact of making trade finance more expensive.
Emerging markets have been hit particularly hard as the new regulations sharply increase the risk- weighting of lending between financial firms – an essential component of trade finance, where the importer’s bank lends money to the exporter’s bank.
Under Basel III, developed economies are assigned a 20% risk-weighting, while – according to the Bank for International Settlements (BIS) – emerging economies are often subjected to risk-weightings of 150%. Such discrepancies mean that even banks that are very keen to provide trade finance in such economies find it difficult to make a profit in emerging markets.
Furthermore, compliance measures such as anti-money laundering (AML) and know your customer requirements (KYC), also play a part in creating a trade finance gap. While essential, these have made the on-boarding of new clients more time-consuming and expensive – further impeding banks’ ability to offer trade finance.
A recent survey by LexisNexis Risk Solutions estimates that the full cost of AML and KYC compliance is costing banks over $1.5 billion annually across six-core markets in Asia: China, Hong Kong, Indonesia, Malaysia, Singapore and Thailand.
The costs are prohibitive, with as many as 90% of respondents from the International Chamber of Commerce (ICC)’s 2016 Global Survey citing compliance costs as a significant barrier to trade finance.
With the benefits of size and reach increasingly being outweighed by the cost and complexity of running businesses across dozens of countries, many banks have adopted a ‘smaller and simpler’ mantra.
Even HSBC, for instance, one of the largest global providers of trade finance, has been forced to shrink and streamline its operations over the past five years – focusing more on core domestic markets.
With bank retrenchment continuing to impact the supply of trade finance, businesses, particularly those in developing regions, often struggle to find the adequate financing necessary to expand and grow – remaining reluctant to enter into less familiar markets.
Beyond the bank
So how might businesses find the financing they need to export more goods and services?
Following the retreat of global banks, a variety of players – including regional banks, export credit agencies (ECAs), multilateral development banks (MDBs) and insurers – have been stepping in to meet the shortfall in trade finance.
Regional banks – although also subject to regulation and compliance – have ramped-up their efforts to provide trade finance. DBS Bank, for instance, a Singapore-based financial institution, has developed a strong presence in South East Asia – strengthening supply chains and helping companies to improve their working capital position.
Meanwhile, ECAs continue to play an important role in the trade finance market – further complementing the support provided by financial institutions and banks. In Europe, for examples, ECAs such as UK Export Finance, Euler Hermes and SACE are stepping into the gap left by banks.
Another important trend to note is that the demand for ECA support is increasingly being driven by exporters, rather than importers. For exporters, ECA financing is not only critical in ensuring payment for their products but also in gaining a competitive advantage in the market – enabling companies to provide a viable financing solution for their exports.
Increasingly, these and other newly established financing vehicles are rapidly becoming mainstream options for corporates looking for more innovative and flexible ways to finance their growth.
Finally, specialist financiers have been expanding geographically and broadening their product range.
In the US, for instance, non-bank financing generated more than US$36 billion in funding in 2015. Certainly, non-bank financing can no longer be considered a fringe activity.
In fact, specialist financiers are particularly suited to meeting companies’ expansion goals. Having operated in emerging markets for a number of years, specialist financiers possess both the in-depth local knowledge and the extensive networks critical to exporting success.
Moreover, by taking a transactional approach, specialist financiers are able to construct innovative and flexible solutions – enabling businesses to pursue their expansion agendas while removing the headache and risk of cash flow complications and restrictions.
Collaboration, not competition
That said, while all these institutions play an increasingly important role in plugging the funding gap, the gap is too great to be filled by one kind of player alone.
The future success of the new global financial landscape, therefore, lies in collaboration. Many specialist financiers have built extensive relationships with a wide variety of players across the financial landscape – including ECAs such as UKEF and insurers such as Aon – meaning that they often collaborate, not compete.
And it is crucial that the new key players of the financial landscape also collaborate with global banks – combining their flexibility with the banks’ vast resources.
Moreover, a new financial landscape built on many, collaborating players means that companies wishing to expand into emerging markets now have access to a more diversified and sophisticated funding base than ever before. Companies can access a wide variety of solutions – preventing them from “putting all their eggs in one basket”.
Expanding business operations abroad can create unlimited opportunities for growth, particularly in emerging markets. And as the landscape of international finance continues to shift, collaboration among industry players will be essential in fuelling the real economy.