Wholesale Financial Markets
Day-to-day operations: laying foundations for sustaining growth What do businesses need in the short term from wholesale financial markets? A range of financial offerings exist to help businesses in their daily operations Short-term financing of the business
and to allow them to grow sustainably. This paper looks at ways to help businesses meet their daily financing needs (in particular working capital finance and trade finance). This paper also considers risk
Short-term financial needs Day-to-day risk management
management tools which can remove unwanted risks to short-term business performance.
Figure 1 Short-term financial needs
KEY MESSAGES > To sustain business growth, short-term finance is crucial to the day-to-day business of European corporates. > Companies use wholesale financial markets in the short term to: > Manage their cash flow. Working capital finance is often arranged through major wholesale banks; > Grow through trade. Trade finance allows firms to grow through exporting, with world exports of goods returning to pre-crisis levels at $17tn; > Reduce risk. Wholesale financial markets connect corporates seeking to reduce risk with financial firms specialising in risk management: allowing corporates to specialise in their own core activities and work more efficiently.
1. Working capital finance 2. Trade finance
3. Use of derivatives, swaps, futures, and other instruments to transfer risk
Wholesale Financial Markets: Day-to-day operations: laying foundations for sustaining growth
How do businesses finance their working capital?
UK have signed up to a supply-chain
there can be a long delay between the
finance government initiative, expected
purchase of raw materials and final
The current account of a firm:
to generate £20bn of cheaper financing.
payment of the goods.
A business needs money available for
Firms can also use ‘commercial paper’,
day-to-day trading operations from which
which is a type of short-term bond1.
Banks can help reduce risk: Banks assist by providing short-term bridging loans to
it can fund activity. This is its working capital, calculated as the current assets
“ We need to have a buffer of very flexible
cover the gap, and reduce risk for the
minus the current liabilities. For many
credit through banks.”
companies. For example, the importer’s
companies, this is largely composed of
Vice-President Group Financing
bank may provide a letter of credit to the
trade debtors (i.e. customers who have
major European components
exporter (or the exporter’s bank)
not yet paid for goods and services) and
manufacturer
providing upfront payment upon proof
trade creditors (i.e. suppliers the company has not yet paid).
that the items have been sent. Around “ The impact of the crisis has particularly
80% of total trade transactions, estimated
affected our supply chain and
at $16tn, are aided by financial institutions
Typically financed by banks: Firms often
customer base.”
providing credit, insurance or guarantees
have access to flexible bank credit (similar
Senior Vice-President of Treasury
to the companies involved.
to an overdraft on a current account),
global oil and gas company Trade finance can be flexible to each
which can cover working capital needs in the short term. When there is less liquidity
What is trade finance?
firm: Trade finance can also help
in the wholesale financial markets, banks
International trade can be risky:
companies export by providing
reduce the supply or increase the price of
Companies often grow through trading
guarantees that they’ll get paid,
credit to non-financial corporates.
internationally. However, there are
advance payments of export contracts
significant risks to doing so. For example,
(‘letters of credit’), or provide
Europe’s non-financial corporates
when a good is purchased, whichever
protection against debtor non-payment
depend heavily on banks for short-term
party pays upfront for the product takes a
(‘debt factoring’).
finance; of total non-financial corporate
risk that the transaction will not complete
debt outstanding in 2011, bank loans and
successfully. If the importer pays on order,
European banks are major providers of
other advances accounted for 85% in the
he takes the risk that the goods may not
trade finance: According to a recent
euro-area and the UK. This contrasts with
arrive. If the exporter accepts payment
World Bank study, large euro-area banks
53% in the USA. This suggests regulation
on delivery, then he takes the risk that the
accounted for 36% of global trade
that reduces liquidity to banks will have a
importer will not pay in full. Either way
disproportionate effect on European companies. The EU has tried to mitigate
1 F or more details see paper Growing a business organically through long-term finance.
this through initiatives like the European Investment Fund (EIF). In November 2012 the EIF signed its first guarantee
When payment is at the time of ordering: Trade finance covers the importer’s cash flow
agreement with Spain, which released
Cash
€120m of additional loans to small businesses. Importer
Trade finance facility
Exporter
Financed through the supply chain, and via the financial markets: Supply chain finance gives the suppliers to companies
Goods
access to immediate credit sometimes at reduced rates. Once the firm has
When payment is on receipt of goods: Trade finance covers the exporter’s cash flow upon proof of shipping
approved payment of an invoice, the supplier’s bank will supply immediate
Figure 2
credit. 38 of the largest companies in the
Trade finance facility
Wholesale Financial Markets: Day-to-day operations: laying foundations for sustaining growth
Engineering risk management
trade finance operations in response to
How do businesses use financial services to manage market volatility?
pressure to consolidate activities in
Corporates can use financial services
major industrial projects. It is a large firm
domestic markets. One reason for
products to reduce risk: Every business
employing over 10,000 people in countries
this is that short-term trade finance is
purchases goods and services to use as
across Europe.
easy to trim in order to meet regulatory
inputs. The price of these inputs can rise
capital requirements.
and fall in relation to the demand and
The business challenge: The company’s
supply for these goods. These goods
major concerns were that some of
could be tangible such as steel or
the recent regulatory developments
and it can cover many different risks;
copper (raw materials for production),
could mean that funds they might be
for example currency risk, political
or intangible such as a loan with a
spending in their primary business for
risk, and trade risk, but liquidity
flexible exchange rate. For corporate
product development, research and
requirements will directly decrease
treasurers responsible for risk and cash
development and job creation, could
the amount of trade finance available
management, avoiding volatility in
instead be either spent on credit charges
to a business.”
input prices is worth paying for.
or tied up in clearing houses as collateral.
A range of tools are available:
Variety of risks covered: Some of the
Financial tools which are used by
underlying business risks (actual or
corporate treasurers to achieve a stable
forecast) that this firm either currently
cash flow include derivatives (e.g.
hedges, (or has considered hedging), are:
finance in 2011. However euro-area banks have been cutting back their
“ Trade finance is very important,
A multinational engines manufacturer produces large engine components for
Chief Executive Officer French consultancy
forwards and options), and swaps (e.g. for interest rates and currency).
> Foreign exchange risk on cash flows;
These are defined and described in the
> Commodity price exposures;
Wholesale Financial Markets paper,
> Energy price risk;
The engine-room of economic
> Credit risk, for example the purchase of
recovery; helping European companies
a credit default swap (CDS), or other
set up and grow.
similar instrument;
Other
■ Commercial letter of credit 44% ■ Standby letter of credit 9% ■ Guarantee 18% ■ Collections 19% ■ Open account 8% ■ Other 2%
■ Commercial Open account letter of credit 44% ■ Standby letter of credit 10% ■ Guarantee 21% Collections ■ Collections 18% ■ Open account 6% Guarantee ■ Other 1% Standby letter of credit Commercial letter of credit
Other
> Employee share scheme liabilities; > Emissions Open account trading scheme liabilities; > Inflation risk; Collections
> Pensions scheme liabilities. Guarantee
Other non-financial firms will have their Standby letter of credit own set of specific risks that they may wish Commercial letter of credit
to hedge via derivatives, such as the risks of the weather, or property prices.
“ We hedge risk using derivatives, the most Figure 3 Global export transactions volume
Figure 4 Global import transactions volume
% Share
% Share
Commercial letters of credit are by far
Bank guarantees are more
the most popular form of trade finance,
popular when importing compared
their business, and reduce risk.”
with 44% of the volume.
to exporting.
Deputy Chief Financial Officer, materials
Source: ICC Global Survey 2012
Source: ICC Global Survey 2012
manufacturer
common for us being foreign exchange risk; these products are absolutely necessary for companies to manage
Wholesale Financial Markets: Day-to-day operations: laying foundations for sustaining growth
Key question: Why is the derivatives market so large?
Conclusion Businesses require a range of options for short-term finance and to ensure
The size of the market: Various figures are
derivative based on it. There may be
sustainable growth, and European
given to indicate the size of the
multiple derivatives on a single security,
financial and professional services firms
derivatives market, and views have been
some of which may expect the value of
provide them. Corporate banks with
expressed that it might be out of
the underlying asset to rise, and some of
deep pools of liquidity help manage
proportion with the bond and equities
which expect the value of the underlying
working capital and trade. Tools are
markets. For example, the European
asset to fall.
available in the financial markets for financial risk specialists to purchase
Parliamentary Commission estimated the OTC derivatives market volume at
The ‘Gross market value’ nets out all of
business risks from corporates.
$605tn in 2010, which is equivalent to
these to produce an aggregated net risk
This allows the risks to be managed
approximately ten times the size of
position, which is significantly lower. The
effectively. Firms can then focus on
world GDP.
estimated gross market value of all
their own core activities, to help them
derivatives outstanding is €19.5tn, which is
grow in the long term.
Terminology is important: Any lack of
a fairer direct comparison with the equity
clarity is often a result of the terms used.
and bond markets, which have market
‘Notional amount outstanding’ adds up all
capitalisations of €55tn and €95tn
the value of every security that has a
respectively.
Authors The Wholesale Financial Markets Papers are compiled by Accenture Research for
About IRSG
About MEDEF
About Paris Europlace
About CBI
The International Regulatory Strategy Group (IRSG) is a practitioner-led body of the financial and professional services industry, dedicated to shaping the international regulatory regime so that it promotes open, competitive and fair capital markets and supports economic growth. It is an advisory body to the City of London Corporation and TheCityUK.
MEDEF is the leading network for entrepreneurs in France, with over 780,000 member firms, 90% of whom are small or medium businesses with less than 50 employees.
Paris Europlace represents the major players in the financial markets of France. Its role is to promote Paris as a financial market.
The CBI is the UK’s leading business organisation, speaking for some 240,000 businesses that together employ around a third of the private sector workforce.
Other papers in this series www.cityoflondon.gov.uk/business www.TheCityUK.com
Starting a business Growing a business organically through long-term finance Combining forces for growth: acquisitions, mergers, buy-outs Growing a business through alternative finance