Asia’s trade finance gap is no secret. Estimated by the Asian Development Bank in 2017 to be $600 billion, it remains an enduring and testing problem, stifling job creation and economic growth. Two-thirds of the total trade finance gap stems from small and medium-sized enterprises (SMEs) in emerging markets without the collateral or credit rating to make themselves attractive propositions for banks. Banks have their own problems to contend with, including compliance issues, regulatory capital requirements, and tightened margins. All these factors have combined to limit banks’ ability to serve those in need, and have led to a significant drop-off in correspondent banking relationships.
Mind the gap? Trade finance as an asset class
So how are industry players looking to tackle such a complex problem? One approach is by developing trade finance’s profile as an asset class, leveraging demand from institutional investors for assets with different risk-return profiles from traditional bank loans. By selling trade assets, banks can optimise their capital allocation and increase their origination capacity for trade finance lending, ultimately lowering the financing gap. Many banks are therefore looking to adopt an “originate-to-distribute” securitisation model to obtain this capital relief and address concentration risk, and are heavily promoting the merits of trade finance as an asset class to institutional investors. If global liquidity availability contracts, regulators introduce additional capital requirements, and commodity prices continue to increase, then this trend will only gather more momentum.
The allure of trade finance assets
In theory, convincing institutional investors of the appeal of trade assets shouldn’t be a problem. Tightening yields in debt capital markets has made the higher yields of trade assets attractive. They have a stable and consistent return profile, are self-liquidating, and have short-term credit exposures. There’s no shortage of trade finance transactions across a number of structures, mainly using floating rates, which means that institutional investors can enjoy a diversified portfolio, relatively low volatility and low correlations to other mainstream asset classes, and a high resilience to market cycles. Trade finance also has remarkably low default rates.
But there’s a mismatch in perception. Trade receivables are currently viewed by many institutional investors and asset managers in Asia as illiquid, requiring various bilateral agreements, and carrying operational settlement risks. The secondary market for the distribution of trade assets is also currently immature. An efficient, reliable technological infrastructure that allows institutional investors to access trade finance portfolios is currently lacking, and there is a need for standardised reporting to improve credit transparency in what is currently an opaque secondary market.
An elegant technology solution
Fortunately, that is changing, technology being the enabler. For example, in 2017, CCR Manager, a collaborative project supported by the Monetary Authority of Singapore was launched. It is a digital trade finance platform that automates inter-bank distribution and facilitates the distribution and sale of working capital, trade, and supply chain finance assets to a wide range of international investors quickly and efficiently. Almost 40 global financial institutions from 17 countries are now members of the initiative. UniCredit has been involved from the beginning as a pilot member bank, combining its presence in Singapore and other Asian hubs with its European foot print to offer global coverage on the platform.
The creation of a more formal secondary market for trade finance will make trade assets more transparent, and non-bank investors are already showing increased interest. It’s not hard to see why. Banks and non-bank investors can execute more transactions through easier handling, pricing transparency and a repository of historical bid, offer and deal data – making the entire market more liquid. As of today, more than $1.5 billion worth of transactions have been recorded on the platform.
Looking further ahead, central counterparties such as custodians and clearing houses could help minimise the number of partners participants have to deal with, and provide post-trade settlement infrastructure such as derivatives or securities that promises to reduce settlement, counterparty, and legal risks. This kind of approach also opens the door for data analytics, market benchmarking, and pricing indices; and enables investors to carry out portfolio management, reporting, and compliance activities 24 hours a day – with real-time visibility of market conditions.
With the secondary market for trade finance assets currently at approximately $1.7 trilliong – roughly 10% of global cross-border trade, digital platforms such as CCR Manager can help tap this potential. It enables banks such as UniCredit to increase their trade finance lending, particularly for SMEs. As more banks and institutional investors come onboard, the knock-on effects for the real economy could be profound. Nevertheless, a concerted and collective effort bybanks will be needed to ensure trade finance reaches its potential as a tradable asset class.