As growth in other major economic zones has halted or slowed, Latin America is poised to be the next big trade frontier. Fueled by continued global demand for commodities, a growing population of middle-class consumers, and ongoing infrastructure development, perhaps best exemplified by Brazil’s preparations for the 2014 World Cup and 2016 Summer Olympic Games, growth drivers are strong. However, the region’s success is not guaranteed. In order to deliver on its potential and attract more long-term investment, the various governments of Latin America must work towards modernizing their approach to trade finance.
Since the financial crisis, Latin America has been a bright spot in a somewhat gloomy global economic picture, but the sustainability of the region’s growth will depend on making major changes to its legal and financial infrastructure. Asset-based lending, for example, is a key tenet of global trade finance. Though common in the United States, it is little known in Latin America. Most financial institutions in the region do not accept “moveable” assets such as inventory, accounts receivable, intellectual property, and warehouse receipts, as collateral. As a result, small and medium businesses can substantially pay more for financing than their counterparts elsewhere.
Steps to secured transaction reform
The appetite for advancing financial reforms is building. A recent International Finance Corporation (IFC) meeting focused on driving secured transaction reforms across Latin America. During the event, Charles Shapiro, President of the Institute of the Americas, called for a coordinated strategy across the region to drive legal reform to register and prioritize interests in non-real estate assets, develop an electronic registry for those assets, and enact laws that simplify the process for a creditor to take possession of the asset should the borrower default.
Establishing and maintaining a registry that captures not only the security interest in a company’s fixed assets as registries in several countries do today, and also – and just as importantly – includes such “intangible” assets as accounts receivable, cash, and investments, is critical to this effort. Without the ability to access such information, banks will be challenged to serve global customers seeking financing for their Latin American suppliers. Lenders must be able to secure an interest in the underlying accounts receivable — a necessity for multiple types of financing, including supply chain finance.
Individual countries in the region have made some strides in developing more supportive financial infrastructures. For example, in 2010, Honduras enacted a modern “Secured Transactions Law” (Ley de Garantias Mobiliaras) that enables trade financing with loans that have been secured by inventories, accounts receivable, and other kinds of non-real estate assets. Working with the National Law Center for Inter-American Free Trade (NLFCIT), J.P. Morgan helped Honduran bankers and public officials to understand and prepare for the significant impact the new law would have on business.
The Honduran secured financing legislation was harmonized with the more progressive legislation of the United States and Canada — an initiative that was proposed throughout the region after the Honduran law went into effect. With full support of the U.S. State Department, the National Law Center developed the Organization of American States’ (OAS) “Model Law” to help bring modern trade finance techniques to Latin America.
Another example is the IFC’s partnership with Mexico’s Ministry of Economy to develop a moveable asset registry, Registro Unico de Garantias. Operational since 2010, the registry has collected more than 70,000 collateral assets with a total secured amount estimated at more than $190 billion.
Despite these positive developments, the pace of adoption and ratification of secured financing legislation across the region continues to be slow, in the eyes of some observers. Dr. Boris Kozolchyk, Executive Director of the National Law Center for Inter American Trade reports that, “At the present time, Guatemala and Honduras have enacted laws inspired by the OAS Model Law on secured transactions that are now fully operative. In addition, Honduras has a world class, fully functional registry. Mexico has a similar world class registry in operation but still needs to enact a law presently before its Congress, as do Colombia, El Salvador and Peru. Meanwhile Chile and Costa Rica are contemplating similar enactments and registry improvements.”
Reform needed to support supply chain finance
Latin American businesses have not historically depended on documentary trade instruments as much as those in regions such as Asia, and instead have relied on open account for trade transactions. This process brings efficiency, but limits options for supporting the financing needs of suppliers throughout their supply chains. In order to realize the region’s growth potential, a legislative framework for banks is needed to support the extension of trade finance within an open account environment. Supply chain finance lacks the traditional characteristics of trade finance, which provides security and risk mitigation at a reasonable cost.
In the new world of trade, the challenge is to provide companies — particularly small-to-medium size enterprises — with trade financing that is relatively inexpensive and safe – as well as scalable. To accomplish this, supply chain finance providers must know and understand their rights to the trade receivable. When securing interest in a receivable, there needs to be clarity as to what constitutes that receivable. Providers must have an understanding of the laws of the country that apply to the transaction, and must be able to enforce their rights in a cost-effective and timely manner.
Across Latin America, identifying local law requirements for payment obligations remains problematic. Formal requirements, such as notification to a governing body or a local registry in order to make the transaction effective vary from country to country. Without universally acknowledged debt instruments, trade finance bankers are limited in their ability to help provide the supply chain liquidity that will help their customers maintain an uninterrupted flow of goods and services. Additionally, banks often rely on the securitization of receivables to raise low-cost funds. But in order to use the securitization market successfully, they must aggregate receivables across multiple obligors to create the bundles of risk that are acceptable to investors. Only when legal requirements are understood is this kind of bundling practically and legally achievable. When these issues are not addressed and harmonized, financing for open account transactions cannot be an effective way to facilitate trade in Latin America.
The prospects for modernized trade finance throughout Latin America are bright. There is now a lively debate among businesses, legal experts, and government agencies about the current challenges to trade and economic growth, and general agreement on the urgent need for advocacy and action regarding secured transactions laws that will enable asset-based lending.
In the trade finance arena, global banks like J.P. Morgan stand ready to play a role in sustaining Latin America’s growth. Besides financing, they can provide efficient and secure settlement processes, risk mitigation and sufficient liquidity to supply chain participants. Perhaps even more importantly, J.P. Morgan can act as a leader within industry groups, and as a partner and advisor to leaders of government and business to move Trade Finance in Latin America on its path to the future. The fragility of the global economic recovery, and Latin America’s significant role in sustaining it, has added new urgency to our shared mission.
About the Author
Michael Quinn is a Managing Director of J.P. Morgan responsible for Product Management of the Traditional Trade products in the Global Trade business. Mike has more than 30 years experience in banking with more than half of that time specializing in Trade Finance. Mike has a diverse background in global businesses having managed sales, operations and technology in addition to his product management experiences. He is involved in numerous industry-wide initiatives and associations including his current role as the Chair of the U.S. Council on International Business (USCIB) Banking Committee representing the United States at the ICC Banking Commission and serving on the USCIB’s Executive Committee. He has also served as a director of BAFT-IFSA and as a member of its Executive Committee, and has served as a Director and Chair of the International Financial Services Association. He has also authored numerous articles in various trade and supply chain publications. Mike is a graduate of DePaul University in Chicago.