Citi's Renato Faria and Sanjeev Ganjoo find that digitising trade instruments and improving working capital management will help Latin America's corporates weather challenging conditions
The macroeconomic and business environment in Latin America has come under pressure in the past year as commodity prices and demand have fallen dramatically, partly in response to changes in China's economy, and trade flows have declined. Some countries such as Brazil and Argentina, will take some time to recover. But even those countries that have fared better such as Peru and Colombia, face greater challenges than they did just 12 months ago.
Companies in the commodities sector now have thinner margins, while the knock-on effects of slower economic growth have rebounded across multiple sectors, including industrials and consumer goods. Faced with challenges in growing revenue, both regional corporates and multinationals are seeking to restore profitability by improving the operational efficiency of their trade flows and the effectiveness of their working capital management.
In the past decade, Latin America has lagged behind other regions - most notably Asia Pacific - in adopting solutions to address these challenges. Latin America's rapid growth as a result of the commodities boom meant that the operational efficiency of trade flows and effective working capital management were simply not a priority for investment. Instead, companies were focused on expanding their businesses.
Now, Latin America needs to catch up with other emerging market regions. Not only are margins tighter and revenues lower, but liquidity is being squeezed. For instance, some banks in Latin America are reducing the amount they lend and borrowing costs have risen almost everywhere. In response, corporates want to use their internal cash flow more effectively, reduce their reliance on external sources of liquidity, lower the risks associated with their exposure to the region and strengthen their relationships with customers and suppliers.
Improving the Operational Efficiency of Trade Flows
Large corporates active in Latin America typically have complex trade flows that often require a large number of manual tasks and paper-based documentation. Managing these processes is labor-intensive, costly and potentially prone to error. In recent years, corporates in other regions, including emerging markets, have begun to adopt new techniques and tools that significantly improve efficiency relating to timeliness of execution and costs. The current uncertain economic environment offers a perfect opportunity for corporates in Latin America to make similar changes.
Traditionally, as part of letter of credit (LC) negotiations, an exporter must collate various documents required for presentation before couriering them to the bank. If some of these documents are not compliant, the documents are returned and the process must begin again, increasing costs. Technology can enable this process to be refined and accelerated.
Some banks offer tools that automatically populate LCs or export collections from their enterprise resource planning (ERP) system. These instruments are then sent in a single batch to their bank via a host-to-host solution at the end of the business day for advance examination and feedback. Physical documents are still required in some countries for legal compliance and regulatory purposes, but sending the documents electronically for review can significantly reduce the potential for errors and accelerate turnaround time.
For companies that are not ready to fully embrace digital platforms, there are solutions available to enable them to take advantage of some of the benefits of digitation without altering their existing processes. For example, using Optical Character Recognition (OCR), paper documents can be scanned and automatically uploaded into a bank's system for advance examination and feedback. Again, physical documents could still be forwarded to the bank if required, but turnaround time is dramatically reduced.
Whether LCs or other documentation are sent directly from a company's ERP system to a bank or OCR is used to transmit scanned documents, faster negotiation of trade documents means that exporters get paid sooner, improving their cash flow and working capital.
For importers, accelerating document processing also offers advantages. They may be able to negotiate a discount from sellers because electronic processes are quicker and easier. Moreover, for both importers and exporters, the digitization and automation of processes associated with trade instruments significantly reduces the number of people required for administration. This means that resources can instead be reassigned to higher value tasks.
Technology also enables large corporations to manage multijurisdictional flows through a centralized shared service center (SSC) tasked with performing procurement and sales functions for all subsidiaries within a specific region. For example, an SSC in Costa Rica could issue LCs for all Caribbean, Central American and Andean subsidiaries.
Enhancing Working Capital Management
For companies operating in countries experiencing macroeconomic instability, such as Brazil, there is a pressing need to reduce exposure and manage risks. One way to achieve this goal is to require subsidiaries to pay the parent company more rapidly for goods and services. However, this strategy has implications for working capital, and therefore, requires local subsidiaries to lengthen their payment terms to suppliers, which can threaten the stability of the supply chain.
Supply chain finance (SCF) allows corporates to achieve these goals without impacting the stability of their suppliers. It enables buyers to extend terms, which can then improve days payables outstanding, enhance their cash conversion cycle and improve balance sheet efficiency. The status of balance sheet payables remains the same under SCF and there is no impact on the corporate's credit rating or ability to borrow. SCF can give corporates a strong negotiation position with suppliers, potentially enabling them to reduce their cost of goods sold and improve gross profit. Also, the corporation can better coordinate its treasury and procurement teams.
SCF uses the superior credit quality of the buyer - and close scrutiny of payment documentation - to enable a bank to advance funds to the supplier earlier (if required), and at a much lower cost than if the supplier borrowed the funds directly. It allows the supplier's receivables to be transformed into cash more quickly, positively impacting suppliers' days sales outstanding and enhancing their balance sheet. SCF gives suppliers additional flexibility: borrowing is available as they require it; they do not have to give up existing banking relationships; and finance is on a non-resource basis.
To date, uptake of SCF in Latin America has been greatest in Brazil and Mexico - the region's largest economies - although other countries are rapidly catching up. Companies across a wide range of sectors have implemented SCF, including oil and gas and consumer products. Many governments in Latin America are promoting the use of SCF as a way to increase access to affordable credit for small and medium-sized enterprises.
Working With the Right Partner
Latin America presents numerous challenges for corporates at the current time. But the digitization of trade services can dramatically improve operational efficiency. Furthermore, SCF offers significant opportunities to enhance working capital and stabilize the supply chain. While a number of banks offer solutions that address some of these challenges, it is important to work with a bank that has a track record of innovation and market leadership across trade services.
Citi has one of the largest trade services networks in the world, spanning over 3,000 correspondent banks in 124 cities across 71 countries. Clients are served by 200 Citi trade specialists and four regional hubs serve Latin America, Asia, Europe and the Middle East, and Africa.
Citi invests heavily in new trade services technology, both for its proprietary trade capabilities within CitiDirect BE®, CitiDirect BE® Mobile and CitiDirect BE® Tablet, and also to facilitate client access to bank independent platforms. It CitiDirect offers advanced digitization options - with new import LC capabilities being added later this year - and uses its OCR technology to help clients gain the benefits of digital without having to change their processes. Citi also invests time and resources to explore new technologies and solutions in trade services, such as Bank Payment Obligations and Blockchain technology.
Citi's globality also drives its robust SCF technology platform, which is integrated into its other cash management, payments and collections, and trade solutions.
To make SCF work effectively, a bank must also have strong local knowledge (and language capabilities). Citi has an on-the-ground presence across Latin America, giving the bank a deep understanding of local risks, opportunities, regulations and complexities that enables it to support clients' SCF programs and advance their objectives.
Renato Faria is head of trade, Latin America, and Sanjeev Ganjoo is head of working capital finance, Latin America, treasury and trade solutions at Citi