A CASE FOR ALTERNATIVE TRADE FINANCING FOR IMPORTERS
The practise of law – particularly in the field of shipping and transport – does not operate in isolation but is inextricably linked to international commerce. For this reason, it remains important for lawyers to keep abreast of developments in their field. I recently sat down with Dr Paddy McDowell to learn more about his trading finance offering for medium sized importers.
Paddy has a M.Comm in economics and a PhD in international trade finance and heads up International and South African Trade Finance Advisory Services. He painted a picture of the gap in the market for alternative finance (AF), which he believes has come to the fore following the 2008 crash in the banking and finance sector and the continued depressed market conditions.
Trade finance is often an indispensable part of standard international sale transactions. In the absence of some assurance of payment, sellers will often be hard-pressed to incur any transportation costs prior to delivery of the goods.
Paddy explained that the Basel III Accord was born out of the 2008/2009 financial crisis and is a voluntary international framework, designed for banks by banks, setting a road map for risk management and good governance in the banking sector worldwide. Some of the principal reforms advocated by Basel III are to increase share capital and minimise risk. This may effect lending and may possibly have a restrictive effect on market growth, as small to medium sized companies may find it difficult to obtain credit from banks.
Paddy was surprised to read in the Basel III publication that the risk of financing corporates is described “as toxic”, compared to “safer” risks such as financing Government and real estate sectors.
Following from Basel III, in order to minimise risk, banks are emphasising the need for loan facilities to be covered by security. Security can take the form of personal suretyships, the cession of key man policies and the registration of mortgage bonds over properties, for example. Increased security tends to increase the cost of a facility, increase risk for business owners and possibly delay the granting of credit. Furthermore, commitment fees normally apply to bank financing.
In Paddy’s opinion, obtaining finance from Alternative Finance Houses (AFH) can be beneficial for the following reasons:
- AFHs rarely require a commitment fee or security;
- A deposit based on the facility is required, on which clients earn interest;
- AFHs do not normally charge an administration fee;
- AFHs offer a bespoke facility and personal service, whereas larger institutions will have a range of standardised products;
- AFHs can process an application for a facility in about a month, whereas decision-making by banks is committee driven.
The ideal beneficiary of AF is a company in a growth phase, which has been established for a few years, is profitable (with a turnover of at least R 1.5 million per month) and which sells quality products. An import facility can commence from USD 250,000 for 90 days credit, covered by a bill of exchange.
One of the main purposes of AF is to extend credit to South African manufactures and distributors. When manufacturers increase production or launch a new product, it takes, on average, between six to eight months from the time that orders are placed with overseas suppliers for raw materials before payment is received from customers. This period includes transit and manufacturing time, as well as credit terms to customers. AFHs provide the working capital (cash flow) to assist importers to cover this period.
This kind of investment in smaller businesses should be seen in wider socio-economic terms: more businesses means more jobs, which means a better standard of living for more families. It’s a winning formula for all concerned.
Paddy is convinced that the current economic climate is creating a demand for AF, which will increasingly fund the growth of South Africa’s profitable medium size enterprises and grow the economy.
Of course, the legal sector has its part to play in facilitating AF transactions. As shipping lawyers, we are often required to consider trade finance arrangements when drafting international sale of goods agreements and when advising on risk management implications of transactions as a whole. Armed with the experience of recognising and resolving trade finance problems which arise in practice, we are often best placed to assist with the negotiation of trade finance deals and the drafting of key security instruments.