Five Trends Shaping the Future of Trade Finance
20 December 2013
The recent news that Citi and Santander launched a sizeable syndicated securitization of Trade Finance assets got me thinking about the changing nature of trade finance and this time of year is always apt for a little crystal ball gazing.
Increasing toe dipping by major banks in the receivables securitization pool seems like a natural progression for the industry as banks seek to address the challenges commonplace across the banking industry - capital management, liquidity, increased credit constraints and new risk weighted capital requirements in Basel II/III. While banks have certainly been able to take advantage of an increased demand for risk mitigation from corporates and assist more in the open account market in recent years, there are distinct challenges on the horizon as well as opportunities.
In a recent article in Trade Finance magazine, Sameer Sehgal, MD EMEA Trade Head at Citi, noted that in many ways trade has been a counter cyclical business over the years. The crisis actually increased demand for Trade Finance products as liquidity and funding dried up. As the debt capital markets open up again though there are opportunities for the Trade Finance industry to capitalise on the reliable cashflows underlying collateralised trade receivables. Tapping long-term buy and hold investors searching for steady returns could be one sustainable way to raise capital efficient funding and bridge existing gaps to better meet increasing demand for finance, for example in the corporate SME sector. Interesting times ahead.
For the most part however, the world's trade finance banks will continue to be challenged by global economic conditions, capital costs and regulation. I stirred the tea leaves a little more and this is what I saw:
1) Pricing in risk
Half a decade on and the world is still suffering the after effects from the financial crisis. Consequently, there are continued pressures on the cost of financing as banks must account for higher risk. These conditions are likely to continue to stifle the growth of world trade over the next couple of years at least. However, there is increasing evidence that the shift of global trade finance to an Asia hub is a trend that will continue, driven by the growing maturity of intra-Asian trade and the increased growth of trade between emerging markets (often called south-south trade).
2) The thorny neck tie of regulation
Again in the wake of the crisis, there has been a marked tendency towards increased regulation. Over-regulation has also constrained the growth of trade finance. Given that trade is traditionally regarded as low risk (typically short term and self liquidating), the impact of new regulation such as Basel III is likely to have some unintended consequences in terms of reducing the availability of credit and/or forcing higher prices. Management of operational risk and compliance will continue to rank high on every trade banker's agenda.
3) Living in a material world...for now
Traditional trade is largely dominated by manual, paper-based processes. The opportunities for dematerialisation leading to increased efficiencies are immense. We are beginning to see increased traction in Internet banking, particularly for a multi-bank unified portal solution supporting trade, cash and FX solutions. Online working capital solutions are being developed by the industry that go beyond the boundaries of traditional trade finance. Further progress in this area is encouraged by SWIFT initiatives such as MT798 and BPO.
4) If you can't beat 'em, join 'em
The ability to compete in the trade market requires a significant investment in time, money, people and technology. These high investment demands will continue to drive consolidation across the industry. This trend has been and will be accelerated further by the decisions made by tier 1 banks to limit their credit lines and hence limit their correspondent banking relationships with lower tier counterparties, driving some of those banks either to outsource or potentially to exit the trade business altogether.
5) Speaking a common language
The long term trend towards increased trading on open account is irreversible and will continue to fuel demand, in particular from small suppliers in emerging markets, to have access to alternative forms of finance through a range of bank-assisted open account, often bracketed as 'supply chain finance'. This gives rise to endless opportunities for product innovation and different flavours of financial supply chain solutions. The growth of this business has to some extent been inhibited by the lack of a common language or a common set of definitions. Although BAFT-IFSA has taken a lead in this area, we can expect other industry bodies to pay due attention in the months ahead in order to create a common platform to foster growth and consistency of purpose.
About the Author
David Hennah, Head of Trade and Supply Chain Finance, spent eight years driving SWIFT's financial supply chain strategy. He is known for his work in recent years to bring the Bank Payment Obligation to market as an established business practice. David was a member of the ICC BPO Rules Drafting Group and is the author of the ICC Guide to the Uniform Rules for Bank Payment Obligations.
Trade and Supply Chain Finance: Leveraging Cash to Compete