Trade finance races to keep up with services exports
The services industry could help to shore up trade finance, but banks need to think creatively about the products that will facilitate this.
HSBC’s Global Trade Report 2016 finds there has been a strong increase in the export of services. This relates to intangible goods, often IT or technology services. At a time when traditional trade is stagnant, and trade routes are changing, it underlines the importance of a rising export sector.
Vivek Ramachandran, head of propositions, global trade and receivables finance, at HSBC, says the growth is significant.
“The services industry is now worth $5 trillion, treble the sum 15 years ago," he says. "While in some countries services represents 75% of GDP, it is currently less than 25% of trade overall. In the coming years we will see a shift as this begins to align.”
HSBC notes that for traditional trade, 2016 has been a difficult year, impacted by weak commodity prices, the slowdown in Chinese demand, and protectionist measures implemented by a number of World Trade Organization members.
There is little sign yet of the services industries overtaking the traditional trade sector, but growing evidence they could be mutually beneficial.
Ramachandran says: “There is the subtle point that the trade of goods and services is not exclusive. They do not represent two ends of a spectrum. A product can be improved on by the value of the services received alongside it.”
However, for the trade to happen, the sector needs to find the right way to finance it. Changing trade types means the traditional methods of financing do not always work, as there is not an underlying physical product to back the transaction and provide security against the risk.
Alexander Malaket, deputy head of the executive committee, ICC Banking Commission, says the growth of the services sector does not come as a surprise, adding: “There has been an ongoing shift up the value chain in international trade towards the services sector, with particular attention towards advanced economies – and emerging markets – to put more focus on high-value services trade. This progression is nothing new. What we are seeing now is an awareness of these issues.”
There is still demand for trade finance products, but the numbers are not growing. The ICC’s 2016 Global Survey found just 52% of respondents saw an increase in trade finance activity, compared with 63% the previous year.
Malaket says to meet these new requirements, the product suite available will need updating.
“Trade financing has not managed to keep up with the growth of the services sector," he says. "There has been discussion on how to finance trade in intangibles, including services. There is some effort to address this growing requirement, for example by Malaysia Exim, which had financing options aimed at professional services exports.
"The challenge is that there is no underlying asset, which can make it difficult to secure the transaction and provide trade finance.”
HSBC's Ramachandran agrees that some updates need to be made to how financing is secured, adding: “The inflow of goods is different to what banks are used to dealing with. They need to look into ways of monetizing unbilled receivables on contracts. They need to modernize to create multi-year contracts and find how to monetize clicks online.”
Deploying new technology for its own sake is unwise, and doing so to enable small improvements in existing models or processes is clearly not compelling - Alexander Malaket, ICC Banking Commission
Previously, there had been some recognition of the need to shift thinking, but services trades had not been taking place at a significant-enough volume to sustain interest.
ICC's Malaket says: “Historically, banks were looking to provide solutions and services to so-called knowledge-based businesses including financing, so the concept is not entirely new, but there is urgency now to focus on this issue as trade patterns evolve and develop.”
It remains to be seen how much longer trade finance banks can cling to traditional ways of doing business, for example using documentary trade.
Ramachandran says: “We are seeing $17 trillion in trade, broken down to $2 trillion in documentary trade and $15 trillion on open account. The decline of documentary trade is not something we’re seeing.”
Although the services industry does not lend itself directly to the adoption of digital platforms, these might soon provide a catalyst for change.
Ramachandran says moving to digital is a wide-scale effort that is necessary, if nothing else to prevent the gulf between the arrival of product and paperwork from widening any further.
“To digitize trade we need the involvement of the entire community," he says. "There is a real need to standardize and digitize documents. At present we can see goods being shipped and arriving ahead of the documents. Previously the technology has not been sophisticated enough, but this has changed with the arrival of distributed ledgers and smart contracts.”
Although there have been attempts to digitize, such as with Swift’s bank payment bligation (BPO), there has not been a wave of enthusiasm for the platforms from the industry.
Hugo Verschoren, chief expert, centre of excellence, trade finance services at ING Belgium, says: “If you look towards Swift’s operations and others like essDOCS and Bolero, they are supporting the replacement of paper documents.
"However, these systems are not changing the essence of traditional trade products. Although in 2016 paper is still firmly around, the digitization is starting to happen now slowly.”
To speed adoption up, Ramachandran says it needs to have every part of the chain involved.
“For implementation to work, it needs the whole ecosystem to adopt it. This will mean the banks, shipping companies, customs and port authorities will all have to work together. If we are in a situation when even one part of the process remains paper-based, then the view will be to let it all stay paper-based.”
The slow movement of some will end up holding back the whole business.
Says ING's Verschoren: “Developments like BPO showed promise but the market didn’t pick it up. Some banks are trying to lead the way, others are standing on the sidelines or awaiting a clear demand signal from corporate clients.
"To date, this promising proposition has not picked up the degree of traction we were hoping to see, but it is clear now that digitization of trade, and therefore digitization of trade finance, are well under way.”
This could be the time when new technology finds its use. As Ramachandran says, this is the first time technology has been sophisticated enough to revolutionize trade platforms.
Malaket adds that if there is to be a change, it needs to make a considerable difference, explaining: “There is significant buzz around distributed ledgers and blockchain. Some market observers see great potential in the technology; others question its value. At the moment, at least in trade finance, it is unclear what challenges we will aim to solve, and whether we will use distributed ledger technology to transformatively advance our business, or just incrementally move forward.
“Deploying new technology for its own sake is unwise, and doing so to enable small improvements in existing models or processes is clearly not compelling.”