Business Day | Insights | Trade Finance | February 2021

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BusinessDay www.businessday.co.za Thursday 25 February 2021

INSIGHTS

TRADE FINANCE Sponsored content

SMMEs help to lessen reliance on imports

Pandemic highlights ways to do business differently, •including digital documentation, writes Lynette Dicey

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nternational trade was significantly impacted as a result of the Covid-19 pandemic in 2020 with trading activity for much of the year muted.

In SA, import activity essentially came to a halt after the country went into lockdown at the end of March 2020 although exports, particularly in the mining and consumer sector, continued, says Thandiwe Legwaila, head of Trade South Africa at Standard Bank.

SA is traditionally a net importer. Essentially, what this means is the country imports more than it exports. The reason for this trade imbalance is in many instances the cost of producing items locally is perceived to be more expensive than importing them from countries such as China.

SA’s level five lockdown

Thandiwe Legwaila … visibility. restrictions meant that only certain goods — primarily pharmaceutical supplies and personal protective equipment — were allowed to enter the country. This provided an opportunity for local manufacturers as businesses

were forced to procure locally.

“A number of clothing retailers who have traditionally imported the bulk of their stock from China were forced to procure locally,” says Legwaila.

“A positive trend post the lockdown is that some of these businesses have subsequently lessened their reliance on China and plan to continue to procure more stock locally. It also illustrates SA is capable of producing more goods locally.”

The result of these restrictions is that for much of 2020 SA showed a net export position, buoyed by good citrus harvests which resulted in local farmers looking for new international markets. While SA is never likely to become a closed economy, Legwaila says this illustrates the fact local service providers are able to meet increased demand.

Given that SMEs are deemed

critical to SA’s economic recovery, she believes technologies such as blockchain have the potential to create a marketplace for small businesses. “What we need in SA is a catalogue of small and medium-sized businesses to lessen our reliance on imports.”

A priority for banks offering trade finance during 2020 was to support clients’ domestic trade finance requirements and working capital needs during what was for many businesses a difficult period.

A PRIORITY FOR BANKS WAS TO SUPPORT CLIENTS’ DOMESTIC TRADE FINANCE REQUIREMENTS

“Different sectors have required different responses but, ultimately, what Covid-19 did was create better visibility of products we can manufacture locally and export to the rest of Africa,” says Legwaila.

The pandemic also accelerated the need for the bank to move from physical documents to digital or electronic documents.

“During lockdown we discovered trade documents could no longer be physical. We frequently discovered that goods were stuck at ports for a long time because of our inability to get the physical documents there,” she says.

Kevin Holmes, head of Trade Product Management at Standard Bank, agrees that digital solutions need to be leveraged to allow for a more frictionless transaction.

“Border control protocols continue to rely on manual processes including a host of physical documentation.

Between 10% and 15% of the costs associated to trade are attributed to paperwork

Kevin Holmes … digital solutions.

required by certain border posts and custom authorities,” he points out.

The challenge, however, is many countries don’t recognise digital documents, reveals Legwaila. In 2017 the United Nations adopted the Model Law on Electronic Transferable Records (MLETR) which enables the legal use of electronic transferable records both domestically and across borders. The MLETR applies to electronic transferable records that are functionally equivalent to transferable documents or instruments, also known as paper-based documents. The latter typically includes bills of lading, bills of exchange, promissory notes and warehouse receipts. The availability of transferable documents in digital or electronic form aims to facilitate

electronic commerce by improving the speed and security of transmission.

“There are readily available technologies to enable electronic documents and as more countries adopt this standard both goods and documents will be able to move much more quickly through borders rather than being stuck for clearance,” says Legwaila.

“The challenge currently, however, is that Bahrain is to date the only country that has enacted this model law into national law.”

African countries have yet to adopt digital documentation.

The Covid-19 pandemic, says Holmes, amplified the need for authorities across the continent and globally to move quickly.

Standard Bank, he reveals, has adopted a number of digital solutions in the past year including intelligent automation and optical character recognition, and has joined blockchain trade finance project Contour. The Singapore-based company uses blockchain for its digital letter of credit network and is planning to expand its offering to standby letters of credit and guarantees.

Contour was founded by seven banks, including Bangkok Bank, BNP Paribas, CTBC Holdings, HSBC, ING, SEB and Standard Chartered.

Joining Contour, says Holmes, has allowed the bank to expand its offering in collaboration with international finance institutions to corporates across the region.

Contour claims that through digitisation it can improve processing times by up to 90%.

Diversity in intra-Africa trade Africa has traditionally had a trade finance gap. The estimated gap reached its lowest level in 2016 but has since increased.

A conservative estimate put unmet demand for trade finance at $81.8bn in 2019, according to a report published by the African Development Bank and the African Export-Import Bank titled Trade Finance in Africa: Trends over the past decade and opportunities ahead.

Trade finance rejection rates are increasing globally.

According to BNY Mellon, a third of banks say inadequate compliance and know-yourcustomer constraints are the main reason for being rejected for trade finance.

The Trade Finance in Africa report says stringent compliance measures have resulted in two mutually

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reinforcing risks to the African trade finance market that potentially accelerate the gap upward. It says “new compliance measures have resulted in higher costs of due diligence and also lower margins that have contributed to reducing the number of banks that engage in trade finance activities”. It adds that the share of banks engaged in trade finance fell from 92% in 2014 to a low of 71% in 2019.

The main constraints to the trade finance industry, say banks, are competition, correspondent banking, inadequate foreign exchange liquidity and regulatory challenges. One of the biggest challenges, says Shaahien Mottiar, head of Trade Asset Management at Standard Bank, is the gap between perceived

risk and real risk, largely as a result of a lack of understanding of the African landscape.

“The trade finance gap is a multivariate problem. The dominant issues include banks having sufficient lines of credit, sufficient hard currency and country risk appetite. The commercials or economics for banks which are obliged to hold capital also make pricing competitively a challenge.”

The future will be about stepping beyond traditional bank-on-bank risk when working to grow credit appetite for clients, with nontraditional trade financiers coming into play. This includes increased participation from insurance companies and the emergence of other nonbank financial intuitions playing a greater role, such as specialist trade funds.

The Covid-19 pandemic, explains Mottiar, exposed and highlighted some systemic issues in trade value chains.

“Africa primarily exports commodities, raw materials and agricultural goods. The lockdowns put into place to manage the pandemic impacted supply chains and cross-border trade, with many countries then facing a shortage of hard currency due to declining export demand.”

The challenge for Africa is moving downstream on trade value chains beyond the extraction and supply of raw materials. “Intra-Africa trade together with a drive for building capacity for processing and manufacturing offers an opportunity for the countries on the continent to create diversity in their trade,” says Mottiar.

Lessons learnt from Covid-19 While Covid-19 impacted trade flows towards the end of the first quarter and the third quarter of 2020, as economies around the world gradually started opening up banks offering trade finance facilities saw increased demand for letters of credit and short-term working capital.

“Credit support was the lifeblood which enabled supply chain recovery and for businesses to resume operations,” says Esther Chibesa, head of Treasury and Trade Solutions at Citi for Sub Saharan Africa.

However, while trade flow levels will recover as vaccines are rolled out globally and as economies start to recover, the pandemic is likely to have a long-term impact on how trade is conducted, she says.

“Our clients are rethinking how their value chains are organised, where they source products and what contingency plans they have in place. There have been learnings in terms of how customs and port authorities operate, including improved certification processes. Clients also see a

Esther Chibesa … free flow. huge opportunity to improve overall visibility of long, global supply chains via digital platforms, and really address emerging cyber risks in digitised ecosystems. The learnings derived from the past year will be making their way into company contingency planning,” she says.

With regards to Citi, the pandemic accelerated its digital onboarding programme which the bank has invested in to reduce its reliance on paper documentation. The challenge now is for customs authorities

globally to upgrade their customs and port systems to enable digital documentation and for regulation around things like digital signatures.

The bank offers a digital platform for customers to upload invoices in seven of the 11 sub-Saharan Africa countries in which it operates. Last year, reports Chibesa, invoices worth nearly $300m were uploaded on the Citi Supply Chain Finance digital platform in subSahara Africa.

“Not only is the platform easy to use but is cost-effective and meets the demands for digital solutions, and we are excited to ramp up that effort into all our Africa presence markets,” she says. “This solution targets not just our clients’ working capital needs but releases essential liquidity to their suppliers, many of which are SMMEs which were widely impacted in the pandemic.”

The launch of the African Continental Free Trade Area (AfCFTA) is both important and opportune for the continent, she says, adding that this is Africa’s opportunity to be a player on the world stage. “The pandemic

reiterated the need for a free flow of services and goods across the continent and for African nations to diversify their reliance on economies beyond our continental borders.”

Conceding there will be challenges to implementing AfCFTA from a policy perspective and that “the devil is likely to be in the details”, Chibesa says AfCFTA will create more opportunities for trade between member states.

To take advantage of the opportunities offered by AfCFTA will require that member states successfully position themselves for increased trade.

Citi’s priority, she says, will be to support those clients who are doing business on the continent with trade finance services. Citi offers a range of solutions from simple trade loans to structured trade finance solutions.

The bank, which supports 2,500 corporate and institutional clients in subSaharan Africa, was responsible for 50% of all clearing dollar denominated trade flows in the region and intermediated more than $2bn worth of trade flows in 2020.

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BusinessDay www.businessday.co.za Thursday 25 February 2021

INSIGHTS: TRADE FINANCE

AfCFTA aims to remove trade hurdles

eement •mayAgrgrow intraAfrican trade by more than 50%

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ntra-African trade has traditionally been very low at less than 18% compared to intra-regional trade of more than 50% in Europe and Asia. Many of Africa’s businesses are faced with higher tariffs when they export continentally versus when they export beyond the continent.

The African Continental Free Trade Area (AfCFTA) agreement aims to address this by creating the largest free trade area in the world based on the number of participating countries. The agreement plans to connect 1.3billion people in 55 countries with a combined gross domestic product of about $4trillion and remove some of the main obstacles to intra-African trade including weak productive capacities and limited economic diversification as well as remove — or significantly reduce — tariffs related to intra-African trade.

Estimations are that AfCFTA could grow intra-African trade by more than 50% once it is properly operational. The agreement, which came into

Lodewyk Meyer … impetus. effect in 2019 after being ratified by 22 African countries, was due to commence operations in July but was delayed to January 2021 as a result of Covid-19.

The primary aim of AfCFTA is the creation of a liberalised market for goods and services to boost intra-continental trade, address the continent’s industrial deficit and reduce its reliance on primary goods exports. However, for AfCFTA to reach its full potential depends on each participating member country’s political will to implement significant policy reforms and trade facilitation measures. There is no question that implementation will be a challenge. Lowering or removing tariffs is likely to be the easy part while

‘Improve SMME access’ — report Accessing trade finance is becoming a growing challenge for small and medium-sized enterprises (SMEs).

According to the report Trade Finance in Africa: Trends Over the Past Decade and Opportunities Ahead, the rejection rate for SME trade finance applications is at an alltime high of 40%, partly due to new regulatory restrictions that have increased compliance costs and decreased margins and is making small transactions from SMEs unattractive to banks.

The report says that while the data shows the risk profile of SME trade finance assets has improved, the rejection rates on these applications has doubled, despite increased support facilities for SMEs from institutions such as the African Development Bank, Afrexibank and the IFC’s global liquidity programme. It adds that a more flexible approach towards supporting SMEs is still needed if approval rates are to increase.

“For trade finance to flourish requires improved access to trade finance for SMMEs and for regulatory frameworks to be aligned,” says the report.

The report also showed that banks intermediate in only 40% of Africa’s trade with a significant trade finance gap for which it blames regulatory

bottlenecks. As a result it recommends policy responses with regard to the pandemic and the need to boost financing in the region. Although development finance institutions are playing a key role in supporting trade finance in Africa, the report recommends that awareness be raised regarding strict regulatory requirements for intermediaries.

GLOBAL RECOGNITION

Another factor to consider, says Lodewyk Meyer, a partner in the banking and finance practice at Baker McKenzie, is the growing global recognition of the importance of environmental, social and governance considerations in financial markets. Sustainable financing is becoming increasingly imperative to investment decisions, he says.

“With both lenders and corporations acknowledging the critical role finance plays in achieving a greener economy, the role of private finance, regulation and measurement is moving sustainable finance from niche into mainstream and this is an area to watch in the trade finance space in Africa, in particular the development of agriculture value chains and funding for sustainable development of this sector.”

Rules of origin to be ‘agreed by July’ Critical to the success of the African Continental Free Trade Area (AfCFTA) is for member states to agree the rules of origin. Only once these rules are agreed can agreements around intra-African tariffs be finalised.

The rules of origin include the criteria needed to determine the nationality of a product and are a necessary step to determine which products are subject to tariffs and duties.

TRADE LIBERALISATION

For the free trade area to succeed in its objectives requires that these rules are appropriately designed and enforced so they support preferential trade liberalisation.

The Economic Development in Africa Report 2019 advises that rules of origin need to be simple, transparent, businessfriendly and predictable. The report adds that if rules of origin

are too costly or complex to comply with businesses will instead choose to trade with partners outside the free trade area.

In a nutshell, rules of origin enable goods which qualify as originating within the free trade area to circulate duty-free within the free trade area.

In January AfCFTA announced that nearly 90% of the rules of origin have been agreed, with the remaining 10% due to be completed by July.

Tariff reduction schedules are also expected to be finalised by July. According to the terms establishing AfCFTA, member states must phase out 90% of tariffs over the next decade.

A committee focused on rules of origin will be set up under AfCFTA and will review the implementation of the rules annually, as well as transparency provisions.

implementing nontariff and trade facilitation measures is likely to be more complicated.

To date 54 out of Africa’s 55 nations are signatories to AfCFTA — Eritrea is the exception — and 34 countries have ratified the agreement, including most of Africa’s major economies such as SA, Kenya, Nigeria, Kenya and Ghana. A number of customs unions, including the East African Community, the Economic Community of West African States, the South African Customs Union and the Central African Economic and Monetary Community, have submitted their tariff offers and were ready to trade at the beginning of 2021.

The African Union has called for

other countries to ratify the agreement and submit their offers by the end of June 2021.

“There has been some concern from poorer countries which have relied on the income received from trading tariffs and are therefore hesitant to lower them,” says Lodewyk Meyer, a partner in the Banking & Finance Practice at Baker McKenzie in Johannesburg.

“However, efforts to protect the most vulnerable countries include tariff protections for domestically sensitive products.”

In January the African Export-Import Bank announced it would fund a $1bn adjustment facility to allow countries which had adjusted their cross-border tariffs to offset their losses.

AfCFTA member countries will be able to draw from the fund by the end of 2021.

“AfCFTA is an ambitious plan that needs continent-wide political buy-in. So far it appears to have provided impetus for African governments to address their infrastructure needs and trade logistics systems as well as overhaul regulation relating to tariffs, bilateral trade, crossborder initiatives and capital flows,” says Meyer.

He says both domestic and foreign trade will benefit from reforms to regulations and trade policies that enhance competitiveness and improve the ease of doing business across the continent.

According to Baker

McKenzie’s recent research conducted in partnership with Oxford Economics, titled AfCFTA’s US$3-trillion Opportunity, there are unprecedented opportunities for Africa and its trading partners to reap economic benefits from possible improvements in transport infrastructure reduction of red tape for crossborder dealings, renewed funding and improved liquidity.

If successful, says Meyer, AfCFTA will provide African countries with the opportunity to diversify their economies, scale production capacity and widen the range of products made in Africa, boosting the production of manufactured goods, including the potential for

multinational companies to set up manufacturing plants on the continent.

“Closer integration of neighbouring economies is a potential avenue for creating scale and competitiveness through domestic market enlargement, promoting, developing and boosting foreign investment through greater efficiency,” says Meyer.

There is widespread consensus that implementation of AfCFTA will be neither quick nor easy. Speaking after his appointment as AfCFTA secretary-general in 2020, Wamkele Mene said the challenges facing Africa include an overreliance on the export of primary commodities to

traditional markets; narrow export bases caused by shallow manufacturing capacity; a lack of export specialisation; underdeveloped industrial regional value chains; and high regulatory and tariff barriers to intra-Africa trade. Exacerbating the challenges facing the continent is poor transport infrastructure including an inadequate road network and inefficient ports. Addressing the transport infrastructure issue will require a significant investment from governments and the private sector.

Ultimately it will be up to each country to position itself to take advantage of the opportunities offered by the free trade area.