Effects of Brexit on UK SME trade finance
Even in a world of daily news cycles, Brexit at 1 ½ years old is still very much in the headlines these days. In this short article we outline some effects that Brexit may have on UK SME trade finance.
First to define some terms:
• TRADE FINANCE—an area of commercial finance that can include factoring, purchase order funding, credit insurance, and inventory and supply chain finance
Trade finance is used to increase a firm’s liquidity, support its growth, and minimize trading risks (especially those risks presented by cross-border trade). Used by small and large firms, trade finance is especially utilized by SMEs.
• SME—a small- or medium-sized enterprise; for our purposes, this means firms with between £5 million and £500 million in annual revenues
• BREXIT—a big thing that happened a year and a half ago which will result in…?
A weak attempt at humor…but the fact is that there is still a lot of uncertainty about the effects of Brexit on the UK, EU, and global economies. Direct and knock-on effects in financial services are of particular concern to many. And while there are sure to be implications for large banks and large corporates, as usual it will be the SME sector that will be most at risk for disruption.
While our firm is not active in the UK market yet, as we have business on both sides of the Atlantic and plan to enter the UK market in 2018, we are studying this situation closely. Below are four key trends that we are observing, and which we expect to strengthen and accelerate over the coming one to three years.
1. Liquidity will likely be tight and turbulent
Brexit will almost certainly reduce and constrain systemic financial liquidity in the short term. UK (and EU) banks will be forced to splinter and reallocate equity in inefficient ways due to the implications of “ringfencing” and “passporting” introduced or accelerated by the breakup. A recent study suggests that a “hard-ish” Brexit could collectively cause about £13 billion in restructuring expenses and necessitate £40 billion in additional tier one capital for affected banks. While another study suggests that in the extreme, over £1.3 trillion of bank loans, securities, and derivatives would need to shift from the UK to the EU.
This means that banks will likely reallocate resources away from riskier and/or less profitable lines of business. It is not a stretch to imagine banks reserving their remaining liquidity for their larger corporate client relationships, and consequently decreasing their lending to SMEs.
On a positive note, UK Export Finance, a government body, is creating a scheme whereby they will take on 80% of the risk of approved working capital loans or bonds sought out by UK exporters.
2. Payment terms are long and getting longer
It is a global phenomenon that large corporates are pressuring their smaller vendors to offer longer sales terms, thereby putting immense pressure on their upstream supply chains. But the situation seems especially acute for UK SMEs, with a noticeable bifurcation between smaller and larger companies. And with systemic liquidity tightening, the situation is unlikely to improve in the short term. Consider a few facts:
• Smaller UK manufacturers (<£500m revenues) are forced to wait nearly twice as long as their larger competitors for invoices to be paid—67 vs. 38 days respectively, according to a recent poll.
• A survey two years ago showed that UK SMEs were collectively owed £67.4 billion in past due invoices—and the trend seems to be getting worse.
The UK government is trying to level the playing field via legislation like the Enterprise Bill and its resulting creation of the Small Business Commissioner—a position charged with advocating on behalf of SMEs within the larger business community. However, the reality is that SMEs are reluctant to disrupt their relationship with large and potentially key customers, and are likely to simply accept longer terms when these are demanded.
3. Trading patterns will evolve
While the UK has an open and globalized market, the fact is that UK trade is heavily skewed toward the EU market, with, for instance, 48% of UK exports bound for the continent. If highly favorable trade policies do not follow-on from Brexit negotiations, it’s possible that UK exporters of goods and services may look further afield, rather than just across the channel.
A recent analysis by the Financial Times predicts that UK trade to fast-growth markets in South Asia and Africa may become more important to UK exporters (particularly in the higher-end services industries) as these economies expand and mature.
Meanwhile, 63% of EU businesses who work with UK supplies expect to move some of their sourcing out of the UK as a result of Brexit, according to a poll by the Chartered Institute of Procurement & Supply.
4. Uncertainty will continue
One of the biggest impacts of Brexit has been, and will continue to be, uncertainty—pure and simple. To put a finer point on it—uncertainty with a twist of negativity.
When asked about Brexit’s impact, 42% of SMEs said it would hinder them, 19% said it would help them, and 35% said it would have no effect.
These attitudes are leading SMEs to adopt a defensive posture toward financing options as well. Almost a third have put investment plans on hold and are in “survival mode,” according to one recent poll. Fifty-nine percent predict Brexit will make it harder for them to obtain financing. Fifty-seven percent have not even tried to get external financing in the past 12 months. Meanwhile about a third have put more of their own money into the business.
The statistics show that owners of SMEs are concerned about committing to new debt and putting their balance sheets at risk. At the same time, they recognize a need for flexible and scalable financing such as factoring and trade finance in general that will allow them to compete internationally—selling to old and new customers in traditional and emerging markets. The numbers bear this out, with total turnovers of clients supported by invoice finance and asset-based lending up 4% for UK clients as a whole, at £214 billion through the first 3 quarters of 2017. On the export side invoice discounting has grown by an impressive 33%, and factoring by a healthy 11%.
These trends lead us to believe that UK SME market demand for on-shore and off-shore alternative trade finance options will increase over the next few years, as companies evaluate new global trading opportunities, remain defensive about taking on balance sheet liabilities, continue to be squeezed by down-stream payment demands, and perhaps find it harder to obtain traditional lines of credit from a liquidity-constrained banking sector.