03 November 2014

Managing trade risk

Globalisation has seen a huge increase in the number of small and medium sized businesses starting to trade internationally. While this is a worthwhile step in terms of profitability and diversification, it does involve taking on new risks. However, as Mark Hussain, Global Head of Commercial Insurance & Investments at HSBC explains, it is possible to mitigate these risks economically

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The growth of the web and the rise of globalisation have radically altered the demographic of global trade. Small and mid-sized companies that would previously have only traded domestically have quickly become accustomed to doing business with buyers and suppliers around the globe. A 2014 UK survey by accounting software vendor Exact revealed that some 54 per cent of SMEs now sell products or services abroad, while for the manufacturing sector the figure is even higher, at 68 per cent. Furthermore, exporting is now the biggest growth area for 19 per cent of the UK’s 4.8 million SMEs [1].

Another factor in the growth of SME participation in global trade in developed economies has been the slowdown in many of those economies since 2008. Smaller companies realised that they could not depend upon domestic markets for growth and so started to look overseas instead. In Western Union's most recent International Trade Monitor survey [2] 83 per cent of SMEs expressed confidence about current international trading conditions – the highest level ever recorded. In addition, 71 per cent of SMEs were confident that their business would see increased international activity over the next 6-12 months.

International trade risks and how to manage them

Credit risk

While this optimism and activity is encouraging, trading internationally involves taking on new risks. One of the most fundamental is the credit risk of overseas customers. Domestic credit risks can be handled in the context of a familiar legal framework and business practice. In the case of customers perhaps thousands of miles away, these do not apply. Especially for smaller businesses, the default of just one important overseas customer can have a severe impact, perhaps even resulting in closure. A classic example of how this can arise is where a large seemingly prestigious new overseas customer insists upon open account terms as a condition of doing business. Without the protection of a mechanism such as a letter of credit, this leaves the SME supplier completely exposed to the risk of buyer default and a total loss.

Fortunately a cost-effective way of mitigating this risk is readily available: trade credit insurance. In addition to covering a risk of loss on receivables, suppliers also save on significant resources required to recover bad debts internationally. Furthermore, trade credit insurance can also be used to cover additional risks that prevent payment, even when the customer is willing to pay. Among others, these can potentially include war, the introduction of currency controls and government-imposed import and export restrictions.

The purchase of trade credit insurance can also improve the Interest rate a business can obtain under any receivables finance scheme it has in place with its bank. At the same time, the mitigation of credit risk allows for more strategic expansion of sales to key credit-worthy customers. Finally, trade credit insurance gives businesses access to specialist trade credit analysts who can provide global economic and corporate intelligence analysis. This may be invaluable for businesses looking to expand into new markets and may represent a major saving in resources when conducting credit checks on prospective customers, as well as when analysing broader issues such as country risk.

Cargo risk

Another risk that new exporters face is the loss of shipment in sea transit. Especially if the gross margins on products are small, this can have a particularly deleterious impact on small or mid-sized businesses. The loss does not even need to be total to cause problems: damage or late delivery can cause contractual disputes with customers, to say nothing of longer term reputational damage. Furthermore, as with credit risk, the familiar customs and legal framework of domestic activity do not apply to marine cargo, so a more specific remedy is needed.

Fortunately it is available in the form of marine cargo insurance. This provides comprehensive protection on goods in transit worldwide (including storage) and can be tailored to better suit customers' needs in terms of types of commodity, destination and transportation.

As a result clients can be assured that the impact on their business and its supply chain can be mitigated in the unfortunate event that their shipment is destroyed, damaged, stolen or delayed.

Conclusion: maximise opportunity, minimise risk

While the global trade opportunities available to small and mid-sized businesses have grown substantially, taking full advantage of those opportunities requires mitigating the associated risks. A banking partner that can offer impartial assistance, along with a thorough understanding of both the individual client business and the potential risks, is ideally-placed to suggest the appropriate trade credit and marine cargo insurance remedies.



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