I sat down with Federico Travella, founder and executive chairman of Novicap. In Part Two of the interview we talked about the importance of digitalization, ESG, the opportunities and risks presented by AI, invoice finance pricing and inflation.
Sticking on the topic of digitalization, you seem to be quite a strong advocate of this movement to bring digitalization to this space. Is blockchain technology the best way to do this? Or are you more technology neutral?
I think blockchain is a technology that can certainly be leveraged to digitize trade and trade finance, but I would not discard non-blockchain systems.
And maybe as a side note here, John, why is it important that invoicing and then trade finance, and receivables finance is digitized? Why do we care so much? I think it’s twofold, right? One is that the opportunity and market becomes much bigger for working capital finance providers. Think about the typical path an invoice goes through. If you think about a B2B transaction: we exchange goods or services and then I send you an invoice. To take an extreme example, I send you a paper-based invoice by snail mail. The time that it takes for you to receive that invoice, scan it, put it into your ERP, and then potentially finance it – that’s weeks.
Consequently, the window over which you can finance that invoice is a lot shorter because it takes a lot of time to digitize that paper, to put it into the ERP and then potentially a bank or a FinTech lender can finance against that. And so that supplier obviously is waiting for its payment, but it also doesn’t have the ability to finance that receivable.
This is why, for instance, in the US, just electronic bill payments – think digitizing checks – is a massive market and a lot of players are chasing this opportunity. In Europe, we pay by wire transfer luckily. So, for once we have that advantage. But still the lead time from the moment the invoice is sent to the time that has been recognized as goods for payment on the debtor side can be very long. So, e-invoicing makes all of this not only quicker, but also easier for a third-party – like a bank or a FinTech – to provide capital against that invoice and expand the opportunity, injecting much needed working capital into the real economy.
Then secondly, the excitement around e-invoicing is also related to reduction of risk – fraud and performance or dilution risk being the main ones in this industry. You see in markets like, for instance Mexico, the dilution on invoices is almost negligible. This is because all invoices are recorded digitally and centrally, and once the opportunity window during which a debtor can, for instance, apply a credit note closes, the invoice is final and due for payment. There’s a single process for all B2B trade.
Lastly, I also expect governments to develop public registries that allow financiers to see whether a company has pledged its receivables to a third party, for instance as security or because it has sold the credit rights to a financier.
This new funding that Novicap has secured – a 200 million Euro facility with Fasanara Capital – is connected to ESG, is that right?
While not strictly connected to ESG, we are naturally keen to provide companies that are ESG-compliant with more working capital financing. Besides maximizing the impact we drive in society, we also believe that the ESG criterion lowers the risk. If a company’s management team pays attention to ESG, then in our view, that lowers the risk for financing that company.
Could you tell me a little bit about why that is?
If a business has the right measures in place when it comes to sustainability on those three levels [of environment, society and governance], we believe that lowers the risk of the organization because it future-proofs the entire company. And as such, we are keen to provide financing against that company. I think by the way, in a few years’ time, everything will have to be ESG-compliant. We’re now in this period where there’s different standards. People are trying to figure out how this world [of ESG compliance] works. But generally speaking, I think in three years’ time, everything will link back to ESG and those companies that don’t prepare for it will lose access to financing, or pay more for it.
Can you tell me a few things that Novicap are doing in terms of ESG?
So, a good example is how we – going back to risk – are also implementing ESG criteria in our risk model, which will again provide, in our view, a positive selection of both risk but also of companies that are taking ESG seriously and are also eventually contributing to a better world. I think the biggest impact we are having every day is that we finance the real economy, we support SMEs making their payroll and paying their expenses. Because our network of suppliers and debtors on the platform is so large today, we are talking about thousands of jobs.
This impact is something which excites me as an entrepreneur, but also, I think, it’s something our team and company very much values. We’re not trading, or financing the speculative part of our economy – we indeed support the real economy.
How do you see AI being leveraged in trade finance in the near future? It’s moving so quickly.
Yeah, we’re really witnessing a Cambrian explosion of AI applications right now. And there’s also such a difference between generative AI and AI which, I guess, goes beyond this conversation. I think that the interesting applications in the short-term are related to user experience and customer service.
Many banks are really excited about AI because they see this as a massive cost reduction opportunity. They can really churn probably like 80% of their support staff and at the same time provide better customer support. I hear a lot of incumbent banks are paying attention to this initial opportunity.
Beyond that, I see opportunities when it comes to risk modelling, for instance. Building, maintaining, and stress-testing risk models can be very complex and time-consuming for humans. An AI may come up with new scenarios which humans haven’t thought about. As a result, you could build better risk models and, consequently, mitigate risks better.
My base case assumption is that an AI-based system will perform better over time than a human system because humans are fundamentally limited. That is a reality. We both needed our cup of coffee this morning to fire up our engine. We have limited bandwidth, attention. So, I think fundamentally, my base case assumption is that those AI based systems will perform better than humans when it comes to dealing with complexity.
Then the core question for me is, if we follow that assumption for a second, is to determine – and I think a lot of the current global conversation in the AI space relates to this – what is the strength of an AI today? How strong will AI become? We don’t want a runaway scenario where indeed AI may make certain decisions that are against humanity or were not part of the plan because its interpretation [of the request] is incorrect.
And then secondly, how do we manage that strength? So, how strong can it become and how do we manage it? These are two very different questions. My basic assumption, again, is that AI will become a lot stronger than humans in many, many areas. How quick, I don’t know. Are we talking about a hundred years? About 20 years? Is there a runaway scenario where it happens within a year? I think, and not being an AI expert but following a little bit of what’s happening, the range is very wide. And so, that’s why you see a lot of experts being concerned because they don’t really know how quickly this can become a reality.
There’s this movie with Joaquin Phoenix which you probably have seen called ‘Her’, which is about someone who falls in love with a robot, with an AI.
Right. It’s a chatbot; it’s on his phone.
Exactly. It’s a very good movie. The movie director Spike Jonze has a great quote about AI “By far, the greatest danger of Artificial Intelligence is that people conclude too early that they understand it.” The scary thing about AI is that we won’t realize when AI has gotten too strong. And that is, I think, what everyone is concerned about: the dystopian scenario in which we wake up and realise AI has taken over or has actually misinterpreted a certain instruction.
There are very interesting possible scenarios which relate to trade finance. If an AI-based trade finance platform has been given instructions to optimize for returns – not an implausible situation – then it may exclude certain companies and could result in the opposite of financial inclusion. Similarly, an AI based system may monopolise or make certain decisions that are really not the intent of the humans.
Food or energy systems are other good and complex use cases. Grain seems a timely example. If a country wants to ensure there’s food security, like enough grain, but the AI based system starts to monopolize the entire industry, and this leads to food insecurity in other countries or in other systems, then this can have dramatic negative effects.
In sum, I think the opportunities of AI are unprecedented because it helps us to deal with complexity that humans can’t solve. It’s the first time that humanity has taken up a new technology that quickly. At the same time, I think we’re still trying to understand how strong it can become and how it should be managed.
I totally agree with you. At the end of the movie when he suddenly realizes that this chatbot has over 8,000 other interlocutors and 641 other lovers. That’s the moment when he realizes: “I’ve been played”.
That is like what they call the Turing test, right? When you are chatting with someone, and the system can pass as a human. So far, my interactions with chat bots have been often disappointing, but that is changing rapidly now.
I don’t think we’re too far from that point. I sometimes find the language a bit clumsy and repetitive but It’s just a matter of machine learning. We’re refining it all the time.
It’s a bit of a rabbit hole that we could get stuck in but, again, as humans, we are fundamentally flawed. We have limited capacity, and that is eventually also why some of the world’s problems haven’t been solved. I’m originally trained as a scientist and the advances in science are slow because the problems are so complex and resources are limited. Say, nuclear fusion – a very complex problem. And so, if AI can become the best scientist in the world, I find that really exciting. If you can have breakthrough discoveries at a much faster pace, that is incredible. It’s great news for humanity if we don’t need to wait 35 years before nuclear fusion. Therefore, I think generally speaking, the pros should outweigh the cons here as long as we manage it carefully.
I totally agree. How does your platform price risk and set interest rates and how is that different from regional banks within the EU? How does it affect Novicap’s value proposition?
It’s a technical question. This is actually something which is very curious to me. Spain is a market where we have a relevant percentage of the market and as such have a good grip on rates and pricing. The Spanish banks price risk in a very narrow band or range. In other words, the financing cost for SMEs is quite homogenous with banks and is, like typically, 1-3% over base rate.
Now what is interesting is that, while banks price risk within a narrow band, their decision to finance a company is often binary – they either reject or accept the client for financing based on a balance sheet-centric risk underwriting model. It’s really black or white for banks. At Novicap, we take a more granular, holistic view on risk and pricing which results in a greyscale of credit limits and pricing. We’re able to do so thanks to our technology than can deal with the complexity and granularity in SME finance.
In recent times, central banks have been raising interest rates regularly. How does that impact your business? I guess if you give a client a fixed interest rate for a facility and then your funding costs increase then you end up losing money?
This is the asset liability management side of our company. You want to link your prices, your rates, to base rate so your pricing recalculates with central bank base rates fluctuating. I’ve seen some players who got into trouble because they assumed we would always be in a ZIRP world. ZIRP stands for Zero Interest Rate Policy World.
Increasing interest rates seem to be the only thing banks or governments can do to try and curb inflation. Is there anything else that you think we could do to reduce inflation? Because rising interest rates, for instance in the UK, doesn’t seem to be working. So, I was thinking, you have quantitative easing, but we’ve kind of given up on that idea. The years of austerity…
In a typical recession debt levels are built up. Then there are haircuts; there’s restructuring, and that is what we’ve seen with the GFC (Global Financial Crisis). There was a significant reduction of debt levels. It was painful. And it happened at every level. It happened at the country level, for example Greece. It happened at the corporate level with debt holders either converting to equity or restructuring their debt. And it happened at the individual level: people losing their houses and banks being underwater with mortgages. So, it happened at multiple levels of society and this had a cleansing effect.
The pandemic was very different because debt levels increased dramatically. I think an amount equalling nearly one third of the global GDP was injected into the economy at record pace. So that’s about 30 trillion dollars entering the economy. Really an unprecedented monetary and fiscal response.
And so, in hindsight inflation isn’t really surprising. So much capital entering the economy in such a brief period of time should have cautioned everyone. When it comes to inflation, I think people weren’t used to it anymore. Our reference framework was zero or even negative interest rates. Governments actually had difficulty increasing inflation to meet the European target of 2%.
Now we have this period where we have a lot of zombie companies because debt levels are at a record high. Similarly, governments are being questioned whether they can also pay back their debts. America’s just having to make a deal to raise their debt ceiling. Which is unsurprising because if there wasn’t a deal then the world would be gone. When it comes to the US, I think the question really is will we be in a similar situation in six months’ time? And I think we will.
Will they be increasing the debt ceiling again? How can they build up credibility? There are budget restraints and they’re really going to stick to this new ceiling or they will have to increase the ceiling again in time. I think, all in all, we do have a lot of factors that can trigger a recession. The economy is very vulnerable. There’s a lot of ambiguity, there’s a lot of parallel factors. I would expect that more and more companies will have increasing difficulty servicing their debt.
Someone who’s more interested in this would obviously monitor corporate default rates, especially in that high yield segment, in that riskier segment. I think if we go to 8% or 10% next year or in the coming year – now US levels are at 4% or 5% – so, if we go to 8% or maybe 10%, then we’re really in a more problematic situation.
Alright, then I think we’ll leave it there unless there’s anything else that you want to mention?
We’ve touched on a lot of points. The question around China was an interesting one because we’re arguably in the most complex geopolitical situation since the Cold War. When you read about nearshoring of supply chains and so on, it seems we often get the impression global trade is down. Anecdotally, when I ask my friends over a dinner party whether they think global trade is increasing or decreasing, the answer is almost always the latter – they think global trade is dead. But the opposite is true, global trade is consistently growing year on year; the world is still trading.
Of course, some countries have more interest in trade than others. A country like the US is self-sufficient in food and energy and can thus act differently than countries who are dependent on such imports. And so, if you link that to trade finance, the opportunity there has never been so immense because of the trade finance gap. Which is the difference between the demand and supply in trade finance. It’s standing at, I think, 2 trillion or 3 trillion. I think it’s 3 trillion now – there’s different estimates out there. Anyhow, I mean, there is 3 trillion worth of open account trade in which suppliers wait for payment. With such unlimited demand, it’s an exciting time for entrepreneurs to innovate in this space.
Special thanks to Federico for the interview.