Trade finance as an asset class is not new but it is becoming a more interesting proposition for corporate investors. Why, how and when will it meet the needs of treasurers?

Trade finance as a short-term asset class is not traditional territory for corporate investors. But it is becoming more and more interesting as an investment opportunity as the nature of trade and the finance that supports it changes.

It was announced at the start of April that 14 leading global financial institutions had come together to create the Trade Finance Distribution Initiative (TFD), an effort to establish the US$25trn trade finance industry as a more appealing asset class for institutional investors.

The key to success here is TFD’s initial focus on creating common data standards and definitions. This will enhance operational efficiency and improve risk management. Some of the banks involved are HSBC, ING, Lloyds Bank, Deutsche Bank, Credit Agricole CIB and Standard Chartered Bank.

Its goal is based on the understanding that trade is the lifeblood of the world’s economies. It recognises that even with current market protectionism, economic slow downs in geographies such as China and the Eurozone, and industrial sectors such as automotive undergoing a period of reinvention, there are openings for participants the world over and that trade as an asset class has great potential.

Digital driver

The internet is democratising trade, giving SMEs the same level of access to global markets as multinationals. As digitisation and automation are making trade cheaper, safer and faster, McKinsey has calculated that data flows will increase by nine times in the period 2014 to 2021, driving a cross-border data flow value of US$2.8trn.

The shift to digital is also creating a significant re-evaluation of commercial operational and delivery models, and with this comes a new approach to trade finance. E-commerce merchants are being financed against inventory stocked and receivables due from online sales. More intangible goods are being financed, such as software downloads and media content purchases. And there is increasing monetisation of offerings such as annual maintenance contracts and cloud services.

Trade in services generally is expected to more than double by 2030, accounting for 25% of all trade, according to Oxford Economics. Trade geography is on the move too, with a progressive shift in emphasis from West to East as the middle income population (and thus aspirational market) in Asia climbs to 3.5bn by 2030. This, suggests McKinsey, will see intra-region trade soon account for over 40% of all goods volume growth.

So, whether it’s a requirement for traditional trade mechanisms – documentary trade, guarantees, and trade loans – or structured trade products (such as receivables finance and supply chain finance), trade finance remains a cornerstone product and an essential service.

Investor interest

Investors in trade assets are typically banks and the ‘alternative’ investor grouping that includes fund and wealth managers, the TFD target of insurance and pension companies and, potentially, large corporate investors. Although institutional investors in particular have become very interested in this asset class, Surath Sengupta, MD, Global Head of FIG, Portfolio & Distribution for Global Trade and Receivables Finance, HSBC says many banks have in recent years become “less active” in trade finance. With most becoming “more pointed” in terms of their capital efficiency, it seems to be raising questions as to whether trade finance is the best way for them to deploy their capital.

Such a view is not surprising. In the last few years, as commodity prices fell, the value of trade finance dropped, with margins reduced by a QE-fuelled excess of liquidity. Meanwhile, with intensified scrutiny by financial crime investigators of trade finance in general, costs were rising, this all serving to call into question its profitability, mounting pressure on trade as a viable asset class.

New view

But there have been some major changes in the trade distribution space in the last couple of years, says Sengupta. HSBC as “the world’s largest trade finance bank” (US$740bn trade facilitated annually), has shifted its stance from a ‘book and hold’ operator of trade finance assets to one of ‘originate and distribute’, its distribution volumes have expanded from US$2bn to US$20bn in just 36 months.

The bank is now highlighting its commitment to trade by rolling out the final piece of its global trade asset distribution network. It’s established four regional asset distribution hubs (Singapore, Hong Kong, London and New York) with “industry first” desks in Mumbai and Shanghai focusing on local-currency trade (regulation dictating that it can’t be distributed beyond its own market). A desk in Dubai is to follow later this year. The bank also now expects every trade finance transaction it executes above a certain threshold to be passed through its distribution lens for possible secondary market trade.

Much of the bank’s increased hub-based asset distribution activity is facilitated by the “future-proofing” transformation of its entire global trade technology piece, explains Sengupta. This is an essential part of expanding this market’s uptake. Indeed, unlike a syndicated loan which is distributed just once amongst participants, trade finance requires the distribution of multiple invoices for the entire period of the facility; a level of complexity that he says can only be managed digitally.

More than simply distributing single-risk supply-chain assets (payables for example), the technology facilitates coverage of “each and every product” in the bank’s trade finance spectrum (and most of its new volumes are coming from the more complex distribution of receivables finance. This, adds Sengupta, is possible not only within each hub region but also across them (Europe to Asia, US to Europe and so on), enabling access to far more investors (albeit always from its own client base).

Potential

The secondary market of trade finance is modest at around US$300bn of unique sales. Currently, alternative investors constitute around 10% of this. But these investors have limited scope for low-risk, short-tenor real economy assets, notes Sengupta. Trade assets are therefore a viable alternative to money markets and government securities, possibly giving a slight yield pick-up. From an alternative investors’ perspective, he declares it “a beautiful asset class that most have not yet invested in”.

Yet given its potential, its growth as an asset class is not as strong as it could be. This is because alternative investors do not have the infrastructure to understand and service trade finance assets, explains Sengupta. They are typically only set up to work with simple single-risk assets, where a standard format is available. Historically, aside from ICC’s UCP trade finance rules, trade finance is barely standardised. The key to standardisation, he believes, therefore lies partly in the deployment of more technology.

Standardisation

For a typically bi-lateral, manually intensive and slow process, if the benefits of automation (wider investor reach, processing speed, efficiency, cost et al) are to be leveraged, the kind of standardisation afforded by technology is arguably essential. Only then will trade assets become sufficiently “simple and attractive” for every investor (not just the banks) to feel comfortable with the relative risk and pricing offered.

To reach this state, internally, banks need technology to extract an asset from a portfolio, send it to a distribution engine, and be able to mark it as ‘sold but not paid’. They then need to be able to manage the risk and service those assets.

Although currently many fintech solutions in this space offer origination rather than distribution, to help trade assets reach a wider cross-section of investor, a symbiotic relationship between the banks and fintechs is developing, notes Sengupta, particularly around risk analytics solutions. And where collaboration is sought, standardisation is on the agenda.

Collaboration

HSBC is investing large sums in this programme, says Sengupta. But it’s clear that what happens in the primary markets will drive progress in the secondary. This is why wider collaboration is on the agenda. TFD is already working towards a unified approach. By bringing together the global banks that sell trade finance assets, the vendors, fintechs, and alternative investors, all are “pushing the initiative forwards because we believe it is something that will happen”, he comments. “We all need to make sure we are driving it in a positive fashion because if we don’t, it might be driven for us.”

In terms of discovery for investors, standardisation means it could “very easily be quoted on a Bloomberg screen”, says Sengupta. He’s confident that it will get there “sooner rather than later”. Already in the US there are market places where corporates can directly place assets. But if the stars align and the industry develops “in a joined up manner”, it is possible that, one day, assets could be featured on an exchange too. That may well be “a long way off,” but the progress being made towards standardisation and automation of trade as asset is encouraging. For corporate treasurers, it is definitely a market worth watching.