The global trade finance gap – the difference between the need for financing and the actual lending – has dramatically increased since the onset of the pandemic. In Asia, small and medium enterprises are particularly affected, and although technology solutions show promise in addressing their needs, fintech alone cannot plug the widening gap.
The estimates may be different, but they tell the same story: a staggering number of companies are still being rejected for trade finance. The Asian Development Bank (ADB) estimated the global trade gap in 2018 was a staggering US$1.5trn. And since then, the numbers have only got bigger. “The coronavirus pandemic has only worsened the situation,” says Steven Beck, Head of ADB’s Trade and Supply Chain Finance Program.
Now the International Chamber of Commerce (ICC) estimates another US$1.9trn to US$5.0trn would be needed to plug the gap. Add this to the original figure, and a total of US$6.5trn is missing when the financing needs are compared with the actual lending that is taking place. If businesses in Asia don’t have access to trade finance, it ultimately affects their ability to bounce back from the pandemic, stunts economic growth and could halt development in the region. While corporate treasurers may think that trade finance for small and medium enterprises (SMEs) does not affect them, shocks to their supply chain will, and the current lack of financing could be an issue for their strategic suppliers in Asia.
Covid has accelerated and exacerbated trends that were already in existence. For SMEs and the trade finance gap, “the urgency of access to finance has been amplified,” says Alexander Malaket, President of OPUS Advisory Services International.
The trade finance gap is by no means a new issue, and various industry experts in Asia have been grappling with it for a number of years. Malaket comments on one of the reasons for the gap: “We haven’t yet solved the economics of deep-tier financing into global supply chains.” He adds that traditional trade finance providers cannot finance micro-enterprises and SMEs on commercially viable terms. “It’s not that the banks don’t want to lend – the economics do not make sense,” says Malaket.
There are multiple reasons for this, including the due diligence, know your customer (KYC), onboarding and compliance costs, as well as the complexities in trade finance and in supply chain finance – including payables finance – and negligible margins generally earned in SME financing. Also, there are “significant demands on time and resources to help coach SME founder-managers on the esoteric mechanics of trade financing,” says Malaket.
Beck also points to the anti-money-laundering (AML) and KYC requirements as a major barrier for banks. In the wake of the financial crisis, when tougher regulations came into force, banks cut back on their correspondent banking relationships, as well as corporate and commercial relationships – in a move dubbed as ‘derisking’. This left parts of the world dangerously disconnected from the global financial system and, therefore, from international trade, says Beck.
Explaining the existence of the financing gap, however, is more complex – it is not just about shedding business that was deemed too risky. “De-risking has been justified based on the need to exit relationships that failed to meet thresholds related to financial crimes compliance. This is undoubtedly the case in some instances. But profitability and the commercial viability of relationships were also part of the calculus, even if they were less widely discussed,” comments Beck.
Newer regulations are also looming over the banking industry, which also affects its willingness to lend. Christoph Gugelmann, Co-Founder and CEO of trade finance platform Tradeteq, comments on the hurdles for banks in bridging the trade finance gap: “The single biggest external concern for the industry is the incoming Basel IV rules. This will significantly increase the capital requirements that banks are required to put aside when extending trade finance to corporations and small businesses,” he says.
In the face of such pressures, one way to address the gap is for development banks – which don’t have the same profit motive as commercial banks – to step in. The ADB, for example, has been active through its trade and supply chain finance programme. Beck explains that in 2020, the programme executed over 7,000 transactions valued at over US$5.8bn, a 50% increase in transaction numbers over 2019. And in the first five months of this year, there has been a 45% increase in the value of transactions that the programme has supported. “These transactions, executed with our bank partners, have helped, albeit in a small way, to reduce market gaps. Over 2,000 of the 2020 transactions support small and medium sized businesses,” explains Beck. He adds that the programme is active in 22 countries in the region, with the most active being Bangladesh, Pakistan, Sri Lanka, Vietnam and Uzbekistan.
There are other ways for the difficulties with trade finance to be solved. The Legal Entity Identifier (LEI) system, for example, makes it easier to do the KYC and AML checks on small and large companies alike. This in turn lightens the load on banks, reduces de-risking, and increases the access to finance for SMEs as there would be more reliable information available about them.
One initiative that supports the use of LEIs is the Digital Standards Initiative (DSI). “The pandemic showed just how vulnerable global trade and supply chains can be when confronted with shocks. The pandemic also showed how important it is to make supply chains more robust and reliable to ensure critical goods get quickly to where they’re needed,” says Beck. He explains how the DSI aims to create digital standards and protocols so that the various parties – fintech platforms, exporters, shippers, ports, customs, warehouses, banks, importers and so on – are using standards that are interoperable. “This will make global trade and supply chains more robust. Interoperability and connections between supply chain stakeholders will also lead to greater transparency, enabling ‘tracking and tracing’ of component inputs throughout the supply chain. This will underpin greater sustainability controls throughout the supply chain,” says Beck.
This is an example of one initiative that seeks to make the wheels of global trade turn more efficiently. There are numerous other ways that technology – particularly digitisation – can be used to solve the issues that are affecting the financing of small businesses in Asia.
Alisa DiCaprio, Head of Trade and Supply Chain at R3, a blockchain development company, comments, “Trade finance has earned a reputation for an industry reluctant to adapt in the face of change. Characterised by unwieldy and cumbersome legacy processes, the industry has seemingly remained stagnant whilst other sectors have steamed ahead with digitisation.”
DiCaprio continues: “The pandemic has prompted the call for change that the trade finance industry has sorely needed for years, and steps towards technological innovation have been made. These technological advancements are helping to revolutionise the trade finance space and, hopefully, trigger a coordinated, global approach to creating more efficient trade.”
“Companies of all sizes will benefit from better visibility into trading relationships and easier access to financing options, narrowing the trade finance gap as a result,” DiCaprio adds.
The move toward digitisation echoes the thinking of entrepreneur Gert Sylvest, Co-founder of Tradeshift. Prior to establishing the trade technology platform, he worked on a digitisation project in Denmark that moved the public sector to electronic invoicing. From that project he realised that there was very little digitisation with trade finance – ultimately affecting billions of invoices globally – and an outdated model was being used. “It seemed fundamentally that the economic model was wrong,” Sylvest says.
In addressing this, the first step was to digitise the antiquated way of doing things and move to e-invoices, for example. Corporates were communicating with thousands of suppliers using reams of paper, emails and pdf documents. The starting point for Tradeshift, Sylvest tells Treasury Today Asia, was to make this process digital and create a system so that the seller could send information directly to the buyer.
When it comes to the trade gap, even getting access to data in a digital form is a challenge, says Sylvest. Also, there tends to be a one-sided view; someone could say they sent the invoice, for example, but only they really know if they did. When processes are digitised effectively, there is a two-sided view and the data relating to such transactions can be checked – and looks more like a ledger.
Sylvest comments that it is not digitisation alone that helps address the inefficiencies in trade finance, but rather getting the digital data into a network setting. Although Tradeshift is known for its e-invoicing and accounts payable automation, for example, digitisation is just the first step. The real impact comes when companies are able to participate in a network: “That has 1,000 times more value than just digitising,” Sylvest says. Tradeshift aims to connect companies and create economic opportunities through such a network, he adds.
There are various other efforts under way that seek to apply the latest technology – and thinking – to finding ways to close the trade finance gap. For example, in March this year, the ICC announced that it was teaming up with technology vendor Finastra to tackle the trade finance gap by developing a financing marketplace for small companies. This ICC Tradecomm marketplace would give SMEs more financing options and would aim to match supply and demand. Bank and non-bank lenders would be able to transact on invoices from SME suppliers and later versions of the marketplace may also include other trade documents, such as letters of credit, bills of lading, and other bank-syndicated products, the ICC said in a statement at the time of the announcement.
Following on from this March announcement, the ICC had more to reveal on how it was addressing the trade finance gap. A couple of months later, in May, the ICC launched Trade Now, which is a suite of digital solutions. ICC Trade Now aims to connect SMEs to a number of providers, and the small businesses will choose the one that suits their needs best. Three solutions were announced under the ICC Trade Now campaign, including the already-mentioned Tradecomm marketplace with Finastra. Another solution, TradeFlow Capital, enables investors a solution based on the direct ownership of commodities – rather than extending credit. And FQX uses IBM’s distributed ledger technology Hyperledger Fabric to digitise promissory notes.
Frank Wendt, Chairman of the Board at FQX, explains to Treasury Today Asia how the company has taken the promissory note – a debt instrument with a 2,000 year history – and brought it into the digital age with the eNote. These eNotes, like the traditional paper-based promissory notes, are an unconditional promise to pay. These securities are attractive because they can be sold and transferred to other parties, such as investors – thus encouraging the flow of financing. And, because they are based on an international framework, the eNotes are enforceable in courts around the world. Unlike the paper version, these notes can be settled instantly, creating new efficiencies for the trade finance process.
Such a solution can aid the trade finance gap by making the process more efficient and ensuring smaller companies get paid quicker. One area that is ripe for disruption is in government contracts. “The government is one of the worst payers,” says Wendt. This exacerbates problems that suppliers are already experiencing. Wendt estimates that the government can take the largest share of GDP – in some cases 50% – and if eNotes were used, it would make a massive difference.
Elsewhere, there are other issues that have been addressed. Gugelmann at Tradeteq also comments on the inefficiencies his company has tackled. The first was to develop artificial intelligence so that banks and issuers could accurately assess the riskiness of clients, vendors or individual transactions. This technology is now being used by participants of Singapore’s Networked Trade Platform, which includes multinational corporations, SMEs, financiers and shipping companies.
Also, so that banks can reduce their balance sheet pressures, Tradeteq has made it easier to repackage trade finance into capital markets products. “The ability to distribute these assets can free up cash which banks can lend to corporations and SMEs that otherwise would not be able to access financing. Of course, this requires a buyer to purchase that asset. Fortunately, there are many ‘cash-rich’ non-bank investors looking to invest in the trade finance market and benefit from the lower levels of risk and potential yields it offers,” says Gugelmann.
Gugelmann also explains how Tradeteq operates an electronic trading platform that allows banks and institutional investors to transact trade finance assets with each other.
These are just some of the ways in which technology companies are seeking to make the trade finance market more efficient, and in turn facilitate the flow of funds to those companies that need it.
However, on plugging the trade finance gap, Malaket says, “Neither technology nor fintechs alone will solve this issue.” He adds, “Technology will play an important role in changing the cost of servicing the SME segment, and fintechs have advanced matters through agility and innovation, as well as inspiring the banks to raise their game.”
Also, he says, fintechs have realised that banks are important to the overall ecosystem. “A collaborative posture makes more sense,” says Malaket, who in his years as a consultant to the industry has seen new entrants take a more combative approach. “Fintechs do not bring balance sheet capacity, clearing capacity or relationships with central banks.”
There are other factors that can address the growing trade finance gap. “There are things that should be done on the policy front to help drive liquidity to the SME sector, and one might suggest that SMEs themselves can help by actively working to become more compelling to lenders,” says Malaket. He also makes the point that not all of the trade finance gap should be filled. “A material amount of [the trade finance gap] is legitimate and includes transaction that simply are not bankable or represent bad credit risk,” says Malaket. Unfortunately, it is difficult to assess the proportion of this compared to the overall trade finance gap.
“One thing that may happen, as it did in the context of digitisation, is that the Covid crisis will accelerate a confluence of events to help address the SME finance and trade finance gap, given that trade – and SMEs – will be critical to our shared recovery,” Malaket adds.
