Optimised SCF: The enabler we’ve all been waiting for

Dominic Broom, SVP Working Capital at Arqit, explains how the UK’s Electronic Trade Documents Act and similar legislation being passed in other G20 countries can transform funding across supply chains.

Accessing working capital funding has long been a challenge for smaller businesses in particular and curtails opportunities for business growth. But the shackles that constrain existing supply chain finance solutions are being removed, thanks to a monumental change to age old laws.

The importance of digitalising global trade finance processes is a familiar topic. But implementing such change within international trade is challenging due to both the industry’s sheer scale, and the fact that many of the rules and regulations upon which it relies remain centred upon pre-digital practices. Indeed, global trade has existed for centuries, and the vitally important laws that oversee and govern the safe exchange of goods across the world, were established to facilitate paper-based trade. For instance, legal concepts such as ‘possession’ and ‘transfer’ continue to govern the exchange of negotiable trade documentation in most jurisdictions. Because of this, digital documents are simply unable to be used to facilitate trade finance transactions. Until now.

A change to the law has marked a pivotal moment for the industry. The UK’s Electronic Trade Documents Act 2023 (ETDA), which came into effect in September, now allows certain documents commonly used in global trade to be legally recognised in digital form in the same way as their paper-based equivalents. Negotiable documents, including bills of exchange and promissory notes, can therefore be used in the financing of trade transactions in digital form – and it is this that is key to unlocking far superior and more flexible methods of supply chain finance (SCF).

Releasing the shackles of supply chain finance

For most businesses, the SCF solutions that exist today are far from ideal. They are typically financed from the ‘weakest link’ in the chain – usually the SME exporter with the tightest balance sheet – with the finance filtering upwards. Banks are often less willing or able to take on the perceived risks and/or the KYC costs they pose, leaving smaller businesses overlooked. Even with the support of ECAs, banks have been forced to focus on large ticket transactions, rather than plugging funding gaps at the tail end of supply chains. Consequently, long supply chains, involving negotiated payment terms and deferred payments between buyers and suppliers, place significant strain on exporters’ working capital.

Enter digital negotiable instruments (DNIs). DNIs include digital versions of promissory notes (DPNs) and bills of exchange, and act as a binding, irrevocable promise of payment by a corporate. Importantly for banks, this acts as a risk transfer mechanism, allowing lending to be based purely on the credit standing of their corporate buyer client. The performance risk of any so-called ‘weaker links’ in the chain therefore does not need to come into the equation, enabling banks to provide funding that can start with the strongest link and seamlessly cascade down the chain. This ‘inversion’ of the current SCF funding structure means funding can effectively and efficiently reach the ‘long tail’ – for instance, the smaller exporters. And, due to the DNI being used as the basis of the lending rather than non-negotiable instruments, such as invoices and receivables, this dispenses with the need for separate assignment agreements and irrevocable payment undertakings (IPUs) regarding transfer of ownership. Subsequently, suppliers can receive a same-day payment, with 100% of an invoice’s value financed by the bank.

This approach opens up far more opportunities for smaller exporters to access finance – more quickly and with fewer costs – and ensures a more resilient chain for all parties. Meanwhile, corporates are able to negotiate a discount from suppliers for the faster payment, while also securing extended payment terms from their banks as part of their SCF programme. Moreover, free from the constraints of siloed SCF solutions, corporates have control over how and when they utilise their DNI-based SCF programme, choosing when to employ their own or third party cash, according to their business needs at any given time.

The ease of digital

DNIs are not just transforming the way in which end-to-end supply chains can be funded. Their digital nature allows corporates to have far greater control of how and when they use SCF, enabling treasurers to effortlessly switch between internal and external sources of funding depending on which is the most effective for them at any given point in their business cycle.

Digital solutions can be seamlessly integrated into existing global trade platforms and corporate enterprise resource planning (ERP) systems, minimising onboarding disruption, enabling easy interoperability and making implementation straightforward and efficient.

From a security perspective, DNIs generated by certain platforms¹ are almost impossible to tamper with because they are digitally sealed. This, coupled with a record of the instrument, including proof of ownership, being stored on a digital ledger, provides the holder of an instrument with complete assurance that it is genuine, digitally secure and auditable from source.

In terms of costs, DNIs can cut end-to-end transaction costs by up to 80%. For financial institutions, as well as removing any supplier onboarding costs (typically $60,000 per business), they also reduce the considerable investment in third-party software that is associated with operating large SCF programmes, such as reverse factoring. With costs minimised, this can allow local and regional banks to enter the market and engage in SCF programmes, often supported by ECAs, thereby generating wider investment and liquidity opportunities for both buyers and sellers.

What’s more, documenting a single shipment can require up to 50 sheets of paper, making non-digital processes far from ESG friendly. As the emphasis on sustainability continues to take centre stage across the world, switching to digital trade instruments is also an effective way of contributing to a business’ ESG efforts.

Looking ahead

The ability to optimise SCF through DNIs will inject and safeguard liquidity throughout the chain.

The widespread adoption of DNIs will result in new finance becoming available to a wider range of businesses, as well as new financing tools becoming available to corporate clients. This has significant implications for smaller exporters in emerging markets in particular – and the ETDA development has arrived at an opportune time.

Geopolitical headwinds are making supply chain stability and access to working capital of paramount importance, and with the trade finance gap rapidly escalating (increasing by US$1trillion in the last four years to $2.5trillion), steps need to be taken to facilitate access to available pools of liquidity. Businesses can now rely on SCF that
facilitates access to working capital, lowers funding and admin costs, provides security of payment, enhances speed of execution, and higher advance rates. This is an invaluable development, and a lifeline for many, as a far
broader range of suppliers can now be accepted onto SCF programmes, with up to 100% of the supply chain being financed, rather than the average 20% previously.

Berne Union members can use DNIs to provide credit risk and/or liquidity support to businesses though their short term programmes, as more robust supply chains will help to drive increased revenues and opportunities for business growth, helping to benefit global trade and the economy as a whole.

Note
1 such as Arqit’s TradeSecure^TM