NAVIGATING THE CHANGING INTERNATIONAL … · For example, some European ... always easy and can come with risk. ... be able to obtain a discount in exchange for the foreign currency

NAVIGATING THE CHANGING INTERNATIONAL TRADE LANDSCAPE

Gaining a competitive edge abroad requires companies to manage the risks

By Craig Travelstead

Debbie Rechter Tim Shroyer

Published 2.20.2013

IN THIS WHITE PAPER:• Successful risk-mitigation strategies

• Supply chain financing insights • Case study: Letters of credit

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resourcecenter.bmoharris.com/whitepapers

Executive Summary

In an increasingly global economy, companies face a difficult balancing act regarding international trade. Import-ing and exporting are often essential for continued growth and success, but come with evolving risks that firms must identify and manage.

Companies vary in their experience with international trade, but those that effectively manage the associated risks can benefit from:

•reducedpaymentrisk

•optimalworkingcapitalmanagement

•andlimitedexposuretoforeigncurrencyfluctuations.

Both foreign exchange and trade finance solutions contribute to a comprehensive risk-management strategy.

In this white paper, Craig Travelstead, Managing Director of North American Trade Finance Sales for BMO Capital Markets; Debbie Rechter, Managing Director and U.S. Foreign Exchange Sales Manager for BMO Capital Markets; and Tim Shroyer, Managing Director and Regional Foreign Exchange Sales Manager for BMO Capital Markets, explore emerging risks related to international trade, including the instability of overseas economies, trading partners not complying with shipping or payment terms, and the increased prevalence of trading in currencies other than the U.S. dollar. They also discuss the impact of optimizing working capital for importers.

$231 billion $183 billionU.S. Imports and Exports Goods and Services

November 2012 *

Top 5 U.S. Trading Partners of Goods in November 2012

2 3 4 5

Canada China Mexico Japan Germany

INTERNATIONAL TRADE OPPORTUNITIES

Source: U.S. Census Bureau, November 2012 International Trade Statistics (released 1/11/13)

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Potential Instability of Overseas EconomiesCompanies involved in international trade have recently faced a more difficult task as the state of the global economy changes. Recent events, such as the European debt crisis, have presented firms with new sources of risk to mitigate. For example, some European countries mired in the debt crisis were not considered significant risks until recently. Conversely, some emerging market countries, such as Brazil, are now considered lower-risk markets.

Despite changing world economic conditions, foreign exchange markets remain efficient. The financial crisis of 2008 highlighted this efficiency as foreign exchange markets continued to function despite extreme volatility.

Firms engaging in foreign trade can prepare for volatility by implementing risk-management poli-cies that define specific tolerances, and having an experienced financial partner.

Non-Compliant Trading PartnersDealing with non-compliant partners is a risk firms need to manage. The use of letters of credit (LCs) is effective at protecting exporting companies (particularly those new to international trade or those dealing with highly regulated or emerging economies) and helping them operate more competitively abroad without undertak-ing too much risk too soon.

Beyond LCs, firms should make a concerted effort to familiarize themselves with their potential trading partners. As the physical distance between your busi-ness and your partners grows, managing payment and delivery compliance becomes more difficult. Trading partners—whether customers or suppliers—might not always ship or pay on time or in the correct amounts. These partners could lack access to the financing they need because of their size, their financial condition, or the condition of their local financial markets.

A strong knowledge of trading partners not only helps mitigate non-payment or delivery risks but also helps increase your comfort level in dealing with partners. Becoming familiar with a potential partner requires the same due diligence for international trade part-ners as it does for those in the United States.

Companies can become more familiar with their trad-ing partners by reviewing available financial data, or summaries of that data, and gathering references and other information on potential trading partners and the markets in which they operate.

Some European countries mired in the debt crisis were not considered significant risks until recently. Conversely, some emerging market countries, such as Brazil, are now considered lower-risk markets.

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The following profile shows how one BMO Harris client took advantage of a significant opportunity in India by successfully managing international trade risk.

Letters of Credit Open Doors in Challenging Economies

Datacard Group, based in Minnetonka, MN, manufac-

tures the hardware and software used to produce identification and payment cards. For the last several years, the company has been working to increase its presence in the Indian market, where it sells devices that make gift, debit, and credit cards. Datacard is also working on a pilot program for identification cards to help the Indian government keep better track of its growing population and improve domestic security. However, trading with Indian partners is not always easy and can come with risk.

Challenges in the Indian Market

The challenges of conducting business in India were recently detailed in the World Bank’s Doing Business 2012 report.1 India’s overall ranking, which indicates how easy it is to do business in a given country, is 132 out of 183 global economies. In terms of the time, costs, and documentation involved in importing and exporting goods, India’s rank is 109. Regarding the time and costs necessary to enforce contracts, India’s rank is 182—second-to-last on the list.

Datacard has experienced many of these shortcom-ings first-hand, finding the market fragmented, highly regulated, and not very transparent. These difficulties make it nearly impossible for Datacard to engage in certain practices (such as offering custom-ers lease-financing arrangements) that are common in more developed countries.

Yet, because of its size and great potential for further growth, India is an important market for Datacard, motivating the company to find solutions to overcome some of these challenges—particularly the risk of unfulfilled financial or commercial contracts.

Datacard’s Solution?

To sell its products to companies in India and those in other risky, highly regulated, or emerging economies, such as Pakistan and Bangladesh, Datacard has relied on letters of credit (LCs). Chris Hammerstrand, Assistant Treasurer with Datacard, has found that trading partners in such economies are very receptive to LCs, and that LCs can facilitate otherwise difficult transactions, such as lease-financing agreements.

BMO Harris Bank through BMO Financial Group has an extensive network of more than 20 correspondent banks in India, which illustrates its commitment to clients interested in trading in India, as well as the bank’s knowledge of conducting business there.

Hammerstrand points out that not every potential partner has the experience necessary to offer compa-nies the right solutions within a given country, so it is important to be selective. He suggests seeking out partners that operate in the same markets in which the company would like to operate and grow. Using partners without common interests and goals can make companies like Datacard less competitive in the marketplace.

“You need to work with a banking partner that sees the Indian market, for example, as a place that they want to grow, too, so that their risk appetite is in line with yours,” Hammerstrand says.

He adds that the ability to customize LCs on a case-by-case basis to address the unique challenges associated with a particular project or country also highlights the importance of having a strong relation-ship with a banking partner. Companies want to be able to pick up the phone, discuss an opportunity with a partner, and come up with a solution quickly.

“The slightest discrepancy can delay payment or prevent products getting to the customer on time, so I’m going to work with a partner who knows me well,” Hammerstrand says.

1. http://www.doingbusiness.org/data/exploreeconomies/india

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Increased Prevalence of Dealing in Foreign CurrenciesWhen a company generates revenue in multiple cur-rencies, significant shifts in exchange rates can affect revenue expectations. For example, as the U.S. dollar appreciated against other major currencies amid the European debt crisis, companies that had not antici-pated the change suffered. In fact, one well-known company, which generates approximately 60% of its revenue outside North America, had projected that foreign exchange rate changes would negatively affect its fiscal year 2012 results by as much as $3 billion in revenue and $400 million in profit.

Risk increases as overseas markets account for a larger share of a company’s revenues. To mitigate this risk, firms should first evaluate their opportunities for growth abroad and decide whether to price their products in the local currency or in U.S. dollars.

Although the U.S. dollar is still the dominant trade currency, companies can benefit if they are prepared to conduct business in other currencies. Firms paying overseas vendors in U.S. dollars may incur higher prices in exchange for forcing vendors to take on foreign exchange risk. However, if U.S. businesses are willing to conduct transactions in other currencies, they may be able to obtain a discount in exchange for the foreign currency exposure.

Companies with foreign currency exposure have a variety of instruments available to help mitigate the risk, including forwards, non-deliverable forwards and foreign exchange options. In fact, the average daily transaction volume of foreign exchange instruments (forwards, spots, swaps, options) in North America for April 2012 was $860 billion, according to the Foreign Exchange Committee’s semi-annual Survey of North American Foreign Exchange Volume.2 Companies can also take advantage of accounts denominated in foreign currencies, which eliminate conversion risk by enabling settlement in one currency, if they antici-pate ongoing needs in that currency.

2. http://www.newyorkfed.org/FXC/volumesurvey/

Firms paying overseas vendors in U.S. dollars may incur higher prices in exchange for forcing vendors to take on foreign exchange risk. However, if U.S. businesses are willing to conduct transactions in other currencies, they may be able to obtain a discount in exchange for the foreign currency exposure.

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Less Favorable Payment Terms for ImportersFor importers and buyers of domestic goods looking to optimize their working capital, supply chain financing can be an effective solution. Supply chain financing—also known as payables financing—offers increased flexibility in working capital financing, real-time moni-toring and tracking of payables and receivables, and streamlined purchase-order processing.

Supply chain financing shifts the financing aspect of foreign trade from the buyer-supplier relationship to the buyer’s bank, as suppliers no longer incorporate financing charges into the cost of goods sold. Once a company has approved invoices, its suppliers have the option to sell their receivables to the company’s bank for early cash, while the company continues to have a trade payable on its books. In exchange, the buyer will request longer payment terms from its supplier. For example, a manufacturer with rapidly growing international sales could use supply chain financing to shift its payment terms from 50% sight (50% at 45 days) to a more favorable 100% at 45 days. Suppliers will actually be paid at sight instead of having to borrow from local banks at a relatively higher cost

of funds, and the company’s more optimal working capital management will allow it to free up cash for other initiatives.

Supply chain financing offers several benefits to U.S. companies:

•morefavorablepaymentterms(60or90days,ratherthan30)

•morecontrolovertheentiretransaction

•accesstocashfortheU.S.company’ssuppli-ersatalowercostthanthecostofborrowingintheirlocalmarkets.

The Last WordEffectively managing the risks related to interna-tional trade requires companies to make informed, proactive decisions. In this way, firms can clarify trade finance risk-management policies and achieve foreign exchange objectives.

A financial partner that can assist firms with both international trade finance and foreign exchange makes balancing growth with effective risk man-agement easier. Such partners can help businesses evaluate complex situations, as well as broader macroeconomic conditions.

Visit us online at ResourceCenter.bmoharris.com for more industry insights

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About the AuthorsCraigTravelsteadManaging Director of North American Trade Finance Sales BMO Capital [email protected] 312-461-3345

Craig Travelstead joined Harris Bank in 1982 after start-ing his career at Manufacturers Hanover Trust Co., New York, where he worked for two years and completed the management-training program. Over the years, he has held various positions in International Banking and Trade Finance with both Bank of Montreal and Harris Bank.

He currently manages the North American Sales Team with offices in Chicago, Milwaukee, Toronto, Montreal and Vancouver. Craig holds a Bachelor of Arts degree from Illinois Wesleyan University and a Master’s in International Business Studies from the University of South Carolina.

TimShroyerManaging Director & Regional Foreign Exchange Sales Manager BMO Capital [email protected]

Tim Shroyer is Manager of Chicago Corporate and Institutional FX Sales. Tim started his career with BMO in 1996. Prior to BMO Capital Markets, Tim worked at Coopers & Lybrand, General Binding Corporation, Sara Lee, and Citibank. Tim received an undergraduate degree in Computer Information Systems and a MBA from the University of Chicago.

DebbieRechterManaging Director & U.S. National Foreign Exchange Sales Manager BMO Capital [email protected] 312-845-4089

Debbie Rechter joined Bank of Montreal in 1993 and is a Managing Director and the U.S. National Sales Manager for the Foreign Exchange Products Group. Debbie manages sales teams in New York, Chicago, and Milwaukee responsible for the marketing of all FX products.

Debbie serves as the co-chair for the Employee Giving Campaign for BMO Capital Markets and co-chair for the BMO Capital Markets Diversity Council. Debbie received her MBA from the Kellogg School of Management at Northwestern University.

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About BMO Harris Bank

BMO Harris Bank’s commercial banking team provides a combination of sector expertise, local knowledge and mid-market focus throughout the United States. BMO Harris Bank provides a broad range of personal banking products and solutions through more than 600 branches and approximately 1,300 ATMs in Illinois, Wisconsin, Indiana, Kansas, Missouri, Minnesota, Nevada, Arizona and Florida. Deposit and loan products and services provided by BMO Harris Bank N.A. Member FDIC. BMO Harris BankSM is a trade name used by BMO Harris Bank N.A. BMO Harris Bank is part of BMO Financial Group, a North American financial organization with 1,600 branches and approximately $552 billion in assets (as of the fourth quarter, 2012).

Investment banking clients are served by BMO Harris Bank’s affiliate, BMO Capital Markets. Also a part of BMO Financial Group, BMO Capital Markets offers corporate, institutional, and government clients access to a complete range of investment products and services through 17 North American offices and 30 worldwide offices.

Visit us online at bmoharris.com/commercialbank

This white paper is a component of BMO Harris BankSM. Information contained in this publication is based on sources such as statistical services and industry communications that we believe are reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions and are subject to change. Past performance is not indicative of future results. BMO Harris BankSM and its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. BMO Harris BankSM is a trade name used by BMO Harris Bank N.A. Member FDIC.

BMO Capital Markets is a trade name used by the BMO investment banking group, which includes Bank of Montreal globally: BMO Nesbitt Burns Inc. and BMO Nesbitt Burns Ltee/Ltd. (members CIPF) in Canada; BMO Capital Markets Corp. (member SIPC), BMO Capital Markets GKST, Inc. (member SIPC) and BMO Harris Bank in the U.S.; and BMO Capital Markets Limited in the U.K.

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NAVIGATING THE CHANGING INTERNATIONAL … · For example, some European ... always easy and can come with risk. ... be able to obtain a discount in exchange for the foreign currency