Until recently, trade finance has been more or less off-limits for institutional investors. The market was almost exclusively the business of bankers able to decode difficult trade finance deals.
But low and even negative yields in traditional investments coupled together with new digital platforms that encourage standardization across the trade finance industry have shifted opinion around the asset class.
Christoph Gugelmann, Tradeteq
Institutional investors are now looking at how they can access trade finance assets to enhance returns. And if they can get more involved, this could create a deeper, more liquid trade finance market that will facilitate access to trade finance for corporates that have struggled to access cash in the past.
According to the International Chamber of Commerce (ICC), the trade finance gap – the gap between the amount of capital required for businesses to run as efficiently as they can and the amount of finance provided – stands at $1.5 trillion a year. So programmes that support broader access to trade finance are very welcome.
“We are still in the early stages but we see a new and dynamic market emerging, which will have benefits for corporates at many different levels,” says Christoph Gugelmann, CEO and co-founder of Tradeteq, an online platform which allows investors and originators to transact trade finance investments.
“The development of a scalable trade finance distribution market will create liquidity and a new space for the underbanked,” he says. “It’s a win-win situation for all.”
But is it really this straightforward?
High returns, low default rate
Growth in supply-chain finance – providing short-term credit to improve working capital for buyers and sellers – over the last decade has been a game changer.
“Today, we estimate global volumes of [supply-chain finance] have grown in excess of $100 billion, which has created higher values and a more liquid market,” says Geoffrey Brady, head of global trade and supply chain finance at BAML.
“This means that the trade finance market on the whole has become much less volatile and naturally more attractive. This is what many investors seek when they look at trade finance as an asset class,” he says.
It is also far easier to securitize.
Commodity trade finance products offer yields of between 3.5% and 5% according to Greenwich Associates. And they are safe. Very safe. According to the International Chamber of Commerce (ICC) in a report published back in 2017, default rates on trade finance assets were between 0.03% and 0.24%. Industry experts believe little has changed since then – in terms of returns and default rates, in any case.
Banks have remained integral to the development of the market as they provide the lending – around $10 trillionof trade finance to companies annually – but institutional investors have found it difficult to enter the secondary market. As such, the market remains relatively small, estimated at about $300 billion according to HSBC, and is dominated by the banks.
“Traditionally, a lot of this is to do with a lack of opportunity and a lack of understanding or awareness of the asset class itself,” says Natasha Condon, head of trade sales, Europe, for Citibank.
“Most of the time, these types of assets are not rated so immediately they are off the cards for some investors. On top of this, many investors aren’t familiar with the assets and the way they are packaged so only sophisticated trade finance bankers end up taking part,” she says.
That’s not all. “Trade finance remains a largely paper-based, often legally complex and operationally intensive activity which exacerbates these challenges,” says Damian Kwok, head of trade and supply chain Australia, New Zealand, Pacific and head of trade portfolio management at ANZ Institutional.
“This antiquated way of distributing assets has limited the investor pool,” he says.
A recent report published by BNY Mellon with the ICC found that one third of respondents to their global survey said that the rejection rate for trade finance transactions from their institution had accelerated in the last 12 months.
“Heightened regulation around capital requirements over the last ten years or so has made it harder for banks to fulfil their corporate customers’ demands because they can’t always make enough funds available,” says Gugelmann.
“Moreover, they are cautious – especially the larger international banks. They have strong, long-standing relationships with some of the bigger international corporates and don’t necessarily have the risk appetite or capacity to build relationships with smaller corporates or those further down the supply chain,” he says.
According to the ICC, this disproportionately affects micro, small, and medium-sized enterprises (MSMEs) in low-income and emerging economies. Starved of finance, this could seriously limit global economic development: MSMEs represent around 95% of the world’s companies and 60% of private sector jobs, according to the ICC, but without access to trade finance they may find their abilities limited.
If nothing changes, the trade finance gap may widen and the market for trade finance assets may shrink.
But there are a number of new players now aiming to create access to, and transparency in, this deeply complicated market.
The Trade Finance Distribution (TFD) initiative is one example of the industry working together to build a trade finance market where assets can be bought and sold efficiently. It is made up of a number of banks, institutional investors, trade associations, trade finance service providers and multinational organizations, with the aim of expanding access and distribution of trade finance assets.
In essence, we are democratizing access to trade finance- Christoph Gugelmann, Tradeteq
The consortium uses Tradeteq’s technology and platform to buy and sell trade finance assets.
“We make sure investors meet their compliance, risk management, credit scoring and regulation requirements. We do all of the due diligence, and that process is standardized. This takes the unknown out of the process,” says Gugelmann.
“Streamlining access to these assets has opened the door to institutional investors and specialist funds to participate in trade deals. In essence, we are democratizing access to trade finance,” he says.
Last month, HSBC – which is also a member of the TFD initiative – signed an agreement with Allianz Global Investors to create a platform to allow institutional investors to take part in the trade finance market.
“Our solution will allow the bank to wrap a range of customers’ trade finance assets – from traditional products such as trade loans to structured solutions like supply chain and receivables finance – into notes that the newly-created Allianz Working Capital Fund (ALWOCA) will buy and offer to Allianz Global Investors clients later this year,” says Surath Sengupta, global head of trade portfolio management and distribution at HSBC.
“This will encourage trading on the secondary market that doesn’t solely revolve around the banks,” he says.
Other international trade finance banks are also looking to make similar arrangements, with some close to disclosing full details around these deals.
“As more non-banking investors ‘buy’ and invest in trade assets, banks will be able to increase new trade financing activity, which can help close the trade finance gap,” says Adesh Sarup, head of transaction banking, North Asia at ANZ Institutional.
A dynamic secondary market where institutional investors can take part in trading will shift the funding risk away from banks’ balance sheets, giving them the opportunity to work with corporates that would otherwise not be able to access trade finance.
Michael Vrontamitis, Standard Chartered
Eventually, this could help to reduce the $1.5 trillion trade finance funding gap.
And perhaps riskier companies – such as SMEs – could also benefit. As Sengupta says: “As the market develops, increased liquidity will mean that banks can support a larger number of deals that will directly influence the supply chain – and SMEs are a big part of that.”
For some, however, SMEs may still find that access to trade finance is limited. “Yes, increased liquidity and cleaner balance sheets may allow banks to finance more trade transactions, but that doesn’t mean that they will,” says Olivier Paul, head of banking commission at the ICC.
“It is true that banks could have more capacity to lend if trade finance would be more considered as a viable asset class, allowing an originate-to-distribute model. But whether this will be allocated to SMEs – or even to trade finance – is unknown,” he says.
This is because the credit risk, regulatory costs and compliance issues still remain high on the agenda for banks. As such, banks may not find it economically viable to support SMEs in their trade finance ambitions.
The pie will be bigger, and hopefully this will create benefits to more than just SMEs- Michael Vrontamitis, Standard Chartered
“Today around two thirds of all trade transactions rejected by banks come from SMEs, and this trend is likely to continue if banks continue to de-risk. In fact, the situation may become worse for SMEs in the short term, especially as the trend towards de-risking in places such as emerging markets – where SMEs are seen as the lifeblood of the economy – continues,” he says.
Michael Vrontamitis, head of trade, Europe and Americas at Standard Chartered based in London, agrees. “There is a connection between SMEs’ access to trade finance and the trade finance market, but not in and of itself,” he says.
“The purpose of vehicles such as the TFD initiative is to open up banks' balance sheets, create liquidity and improve profitability but this may not mean that they will lend to SMEs. What it will do, however, by bringing key originators together, is standardize language and make trade finance cheaper on the whole.
“The pie will be bigger, and hopefully this will create benefits to more than just SMEs,” he says.