With competition intensifying in the region and business confidence steadily increasing, businesses looking for growth are feeling the need to trade more on open account terms rather than the traditional methods of secured terms such as cash in advance, letters of credit and bank guarantees. With the increasing demand to drive sales growth, be competitive, mitigate credit risk and to avail of adequate bank funding, has led to stimulating the need and demand for trade credit insurance in the region due to the multiple benefits that it offers sellers, buyers and banks.
A wide majority of the companies based in the Gulf Corporation Countries comprise of SME’s that account for an estimated 80% of the business houses in the region. These businesses need funding to support their cash flows and fuel business expansion. Due to a lack of a well developed and robust capital markets environment in the region, and difficulty to obtain private funding; has led to a high dependence for businesses to raise finance from the banking system.
On the other hand, with banks tightening up their governance, post the global financial crisis and the occurrence of the Arab Spring, local banks are looking to have better quality of assets and collaterals across their lending books. In addition, the Basel II & III guidelines have put more pressure on local banks to gear up to comply with this framework.
The Basel II & III framework stresses on the need for banks to have better collaterals and prudential requirements with a view to achieving a safer financial system. The guidelines on capital, liquidity, maturity and leverage aim at reducing the incentives for building-up high-risk, highly leveraged banks assets that lead to a systemic impact during the global financial meltdown during the years 2009 -2012.
Given the above, the banks in the region are today more willing to share their spreads with investment grade credit insurers as this forms as an excellent collateral to minimize their non- performing assets and reduce their regulatory capital under Basel II & III.
This has given rise to an increasing trend of credit insurance backed trade finance, where the insured can leverage their credit insurance policy to obtain funding facilities from their financing banks.
The simplest form is where the bank is made a loss payee, which means if the insurer accepts liability of the loss, the claim will be agreed with the insured, but the claim will be paid to the nominated bank (loss payee). The bank in turn structures an invoice discounting facility, where funds are advanced on the invoices raised to insured buyers. Typically, advances of 80-90% of invoice values are provided.
Another financing tool backed by credit insurance that is gaining popularity in the region is factoring. Factoring is not one product, but rather, it is a composite product offering a mix of finance, trade credit insurance and credit management services. Factoring is an alternative route by which businesses can increase their cash flow to fund business growth. The main recognizable forms of factoring are Recourse and Non-Recourse. Recourse factoring involves a factor (bank or financier) discounting the receivables of its clients, but retains the right to seek full recourse from its client for any bad debts. On the other hand, non-recourse factoring offers the client a full credit management service on selected approved receivables, without recourse back to its client in the event of a bad debt.
Another method that is slowly gaining significance in the region is “Securitisation”, which is an alternative financing method. Through this method companies can transfer certain assets, such as trade related debts or receivables, to a special purpose vehicle which converts the debts into securities and sells them to investors. This is used particularly by companies intending to transfer their receivables off their balance sheet. Here too credit insurance can play a vital role to tailor a solution to cover the special purpose vehicle via an excess of loss approach to reduce the credit risk of pooled receivables.
Bespoke and structured trade credit insurance solutions can now be offered to funders, which could backup vendor financing programs, mitigate counterparty risk, and back structured trade finance transactions of higher value. This allows banks to have the necessary backup to support the working capital requirements of its clients. Furthermore, these structured trade credit insurance programs allow banks to reduce the capital under risk weighted asset classes under the Basel II & III framework.
Therefore, a Trade Credit insurance policy can be leveraged to gain adequate and cheaper funding and additionally provide a wide range of inherent benefits. However, one should always be mindful of its prime benefit as a financial tool to protect against a buyer’s failure or inability to pay its trade debts due to commercial reasons such as protracted default or insolvency or due to political risks that are beyond a seller’s control. By having trade credit insurance, it helps to protect a seller from the severity caused by a catastrophic loss, balance sheet strength is ensured, cash flows are protected, and loan servicing costs are reduced. A trade credit policy also allows companies to feel secure in extending more credit to their existing buyers, or to pursue new buyers that would have otherwise seemed too risky. It significantly reduces the risk of entering into new markets.
We at Markel can provide a wide range of bespoke products designed to meet the needs of both corporates and funders through our reinsurance programs. Our policy structures comprise of trade credit reinsurance programs such as multi-buyer (excess of loss or ground up cover), named buyers, single buyer with non- cancellable country and buyer limits.
The products offered are commercial risk cover, export comprehensive covering political risks, policies designed for supply chain financing such as receivable and payables discounting, advance payment protection, trade receivable securitization program, pre-credit risk or work-in-progress cover and syndicated co-insurance solutions.
The team has extensive experience of providing global solutions but can also tailor policies for specific credit risks, markets and contingencies. The emphasis is on specialist, bespoke, flexible solutions with a strong focus on risk management and good corporate governance. Reinsurance policy structures provide for realistic levels of risk sharing and can be written on a multi-buyer or specific account basis; for credit risks, policy tenors and payment terms of up to 60 months can be accommodated. Indemnity levels of up to 100% are possible when combined with other forms of risk share.