Although it now seems hard to believe, conventional wisdom regarded trade finance as something that would continue to be transacted as it had always been-largely by way of Letters of Credit. How totally wrong that was!

No longer a sleepy backwater, trade finance is now a fountain of innovation that is flooding into the global supply chain in ways once unimaginable. The short explanation for this is that big-time shippers, retailers like the Wal-Marts and Home Depots and manufacturers like Dell, demand maximum leverage from their balance sheets-meaning there's no way they'll let capital go dormant in LCs anymore. Instead, they're pushing out expenses and asset holding to their vendors (and their vendors' vendors) and looking to their lead commercial banks to find a way to provide enough operating capital to those vendors to keep the inventory flowing.

Global supply chains, dominated by fewer (but bigger) players on the buy-side, are evolving similarly on the sell-side as the trading giants are looking to capture benefits of scale from their vendors. That's good for such things as just in time sourcing and return on investment. It's risky though, because it introduces new potential risks into the equation-when you're getting vital parts from a limited number of vendors, you can't afford to have any of them encounter liquidity or delivery problems that jeopardize your supply.

This equation of 'mutual dependency' is changing how trade finance is conducted as buyers are shifting from LCs to open accounts. Global trade banks have taken on a second dimension of utility, now in addition to funding the supply chain they are also providing de facto risk management in protecting its resiliency.

A leader in this new realm of trade finance is Citigroup's Trade Services and Finance Unit.

"Intense competitive pressures are forcing participants throughout the supply chain to improve their efficiency and drive down costs," explains John Ahearn, Managing Director of Trade Services and Finance within the Global TransactionServices' business at Citigroup Corporate and Investment Banking. "The largest importers no longer want to rely on time-consuming credit facility utilizing labor intensive commercial letters of credit."

"Without question, the global trade business is experiencing remarkable growth, with increased activity from new entrants as well as veterans in the marketplace," notes Claudia Slacik, Citigroup's Global Head of Trade Services and Finance. "This expansion is being supported in great part by the growing popularity of open account trading around the world.

"We have seen a marked increase in the number of open account trading transactions among our clients and the number of product inquiries we're receiving from our major corporate accounts."

"What we're seeing," concludes Ahearn, "is a fundamental change right now in trade finance." The measure of conventional trade finance, SWIFT data, has been relatively flat the past few years while the volume of global trade has dramatically gone up. "What this tells you," concludes Ahearn, "is that more and more companies are no longer using traditional LCs. They're moving into open accounts like they purchase domestically where the supplier bills them and they pay."

The rub comes on the vendor side. Vendors are being required to have access to greater levels of working capital while at the same time increasingly deprived of what has traditionally been one of the principal collaterals used to secure that capital-commercial Letters of Credit. In Asia particularly, where market banks would typically provide upwards of 85% of working capital as advances against commercial LCs, this can prove increasingly vexing. The necessity for vendor financing is also growing in South America.

"The feedback we're getting in the market," says Dave Conroy, Managing Director, Global Trade Sales, "is that the manufacturers and retailers on the buy side of the sourcing equation don't want to utilize existing credit facilities and an inefficient LC process for purposes of procurement anymore."

The emerging model for world traders is a 'pull model.' They're following the lead of the high tech sector in becoming "manufacturers in name only," outsourcing as much of the supply chain as possible and requiring vendors to holds goods on their own balance sheets longer and longer. While the retail sector is less developed in this respect because of greater fragmentation, it too is trying to do the same thing.

With its large worldwide presence (108 trade-capable branches in 72 countries), Citigroup Global Trade Services is unusually well positioned to respond to changing trade finance. It is aggressively bringing new products and approaches to market to finance end-to-end import and export trade solutions.

"In many emerging markets the financial markets are pretty liquid right now. Vendors can go locally to get short term credit and financing," explains Dave Conroy. But that can quickly change. Interest rates are tightening up, companies are managing liquidity against inflation as well as targeted economic growth. At some point supply chains can get thwarted by a liquidity shortfall on the sell side. As Conroy puts it, "somebody gets caught in the middle in 'just in time.'"

"Our major retail and manufacturing clients want to link up their supply chains not only operationally but also financially," says Conroy. "They need to know that suppliers can respond quickly and resiliently through changing liquidity cycles. Their biggest trade finance concern, apart from the need to improve working capital metrics and cost reduction, is that their supply chain vendors have viable alternative financing resources beyond local credit."

To that end, Citigroup Global Trade has set as a strategic objective expanding its small and medium sized customer base around the world. Growth in this sector is targeted at 20-25% per annum (measured by assets outstanding). These are the vendors who are supplying global supply chains and also most at risk by financing requirements. Keith Karako, Managing Director, Global Trade Finance Head for Citigroup, acknowledges that SMEs are vulnerable and that Citigroup has made a "core decision" to increase its activity in the sector.

"Our franchise," explains Karako, "is designed to support large corporate customers wherever they want to do business. The shift in our customers interest is moving us in the direction where we're spending more time with SMEs."

This translates into more accessible and flexible financing directly to those vendors in emerging markets who are so critical to large corporate supply chains. "We have an advantage because we know the people who are buying from them, we know the supply chain," says Karako. "We have the ability to bank the guys on the other side (emerging market SMEs) because of Citigroup's global footprint and our ability to offer capital in the local market."

Moreover, Citigroup's capacity to work both sides of a supply chain, its capacity to serve as a kind of financial intermediary between vendors and buyers, provides more detailed knowledge about such things as visibility, procurement processes and credit ratings. "It helps us to know what these buyers are buying and what portions to finance," continues Karako. "We know from a buyer's standpoint who is a good supplier and who isn't."

Citi's aggressive development of vendor financing, important as they are, really constitute only the beginning stages of what is anticipated to be a threshold leap in the processes of trade finance. "With end-to-end linkage, we have a good template to offer vendor financing," says Conroy.

That 'template' has the potential to become refined as integration between buyers and sellers is increasingly supported by Citi's technology backbone. The plan is to establish the ability to see purchase orders flow, measure vendor operational efficiency against those orders, and then track inventory from outward-bound factory shipments to final possession by the buyer. To do this, Citi is exploring establishing strategic relationships with global logistics providers to synchronize bank and logistics technology platforms that can provide complete visibility across the physical and financial supply chain.

"We're looking into partnerships with companies in the supply chain business," says Keith Karako. "That would let us know where the inventory is and see its status at every stage. We have the ability to track purchase order inventory flow out of the factory to its receipt by the buyer and measure how well the vendors operate against orders. What we don't have now is visibility once they ship the goods out of the plant. In Asia, for example, it can take 30 days in ocean transit. Right now we can't track goods in transit so how can we maximize finance of it? When we know where it is, we can continue to finance inventory on the boat when it leaves the plant, on board and in the buyer's country and not squeeze the seller who would normally be squeezed due to lack of in transit financing."

The big buyers are driving the process. They are seeking the Dell model of 'negative working capital,' with limited inventory, expedited receivables and favorable trade payable terms.

"The 'holy grail' around this is the inventory carrying costs which the buyer isn't willing to bear. They only want it on their balance sheet for the minimal amount of time. If we get integrated with logistics supply chains, we can offer finance solutions to the vendors to finance inventory costs," says Karako.

The plan is to line up logistics companies to align with Citi-financed vendors. "If you line up a logistics company to do everything as part of the vendor financing, if you can deliver a package deal, it may save the seller money. We can do this because we can leverage off the buyer's credit worthiness," says John Ahearn.

This next step in the integration of the supply chain with trade finance is expected to help modulate liquidity crises associated with sovereign or financial events in emerging markets. With Citi able to fund vendor sourcing more aggressively in regions affected by liquidity events, the stability of the large company's supply chain is more resilient than would be the case if vendors were reliant on local banks.

A secondary benefit is expected to be the efficient use of capital. Standard business practice in the past has been for offshore vendors in the supply chain to include inflated financing costs into their cost of goods to buyers. In the emerging Citi model, the cost of financing is much more transparent. "There will be less and less ambiguity for suppliers to build a fudge factor into pricing," concludes Ahearn.

Trade finance more fully integrated with logistics transportation processes are also expected to help insulate the supply chain from unexpected shocks. Citi executives cite their global reach-and thus ability to fund vendors in different locales-as a powerful tool to help large corporations geographically diversify their vendor base. "There are risks that didn't exist in the past," points out Ahearn.

Sidebar: Citibank Enhanced Open Account Services

In addition to conventional trade services including letters of credit, import and export collections and Letter of Credit reimbursements, Citi is pushing boundaries forward with its Enhanced Open Account Services. Rightfully promoted as "the next generation in international settlement solutions," it leverages Citi's relationship with large company buyers in the global supply chain to speed the receipt of payment to vendors. This capability positions buyers to negotiate better pricing and effectively reduces dependence on trade credit lines.