Trade & Supply Chain

Financial market volatility complicates funding environment

Published: May 2023

The major cash management banks remain bullish about their role in the provision of trade finance despite recent market upheaval.

The collapse of Silicon Valley Bank and the rescue of Credit Suisse by UBS sent shockwaves across the financial sector, with the chair of the Federal Reserve warning in March that lack of confidence would contribute to significant tightening of credit conditions. Also in March, Sunil Barthwal, Secretary of India’s Department of Commerce, told a meeting of the G20 Trade and Investment Working Group (TIWG) that co-operation among member countries was required to reduce the widening trade finance gap. However, most of the leading banks reckon recent turmoil in the banking sector has had limited impact on access to trade finance.

“In general terms any stress in the banking sector affects corporate access to liquidity, though the impact of recent events was more focused on deposits,” says James Fraser, Global Head of Trade & Working Capital at J.P. Morgan Payments.

What has changed in the trade finance space is that the conversation has moved back to reliability of funding and the concept of ‘backstop’ providers for critical credit facilities such as supply chain finance, he adds. “If you are a large multinational and your entire supplier base is depending on access to cost-effective lending because of you, reliability of funding is non-negotiable.”

Tighter liquidity conditions and higher interest rates may lead suppliers to rely on their buyers more to ensure the financing of the commercial contract, in order to lighten their balance sheet, suggests Marie-Laure Gastellu, Head of Trade Services at Société Générale. In this respect, trade finance programmes enabling the financing to be extended directly to the buyer may be favoured, she says.

“The potential contagion risk to banks in Asia has been limited as banks in the region are well-capitalised with relatively small direct exposures to the affected banks,” says Sriram Muthukrishnan, Group Head of Global Transaction Services Product Management at DBS Bank. “Against this specific backdrop, we see limited impact on trade finance.”

Sam Mathew, Global Head of Flow and Financial Institution Trade, Transaction Banking at Standard Chartered agrees that the effects of bank failures in North America and Europe have been less acute in emerging markets. However, he also acknowledges that there has been a review of financial institutions’ counterparty risk appetite and exposures.

“What we have seen is a flight to quality and some banks are benefiting more than others, but overall there has been no real impact on capacity,” says Javier Sanchez Asiain, Global Head of Global Trade Finance at Crédit Agricole CIB. “If anything, we have seen more companies look at their working capital initiatives recently to be better prepared for future potential turmoil.”

According to Stephanie Betant, Head of Global Trade and Receivables Finance at HSBC UK, the longer-term implications include a shift towards more structured, short tenured/self-liquidating structures that are asset backed. “This would more directly reflect funding institution repayment maturities and point more toward trade finance solutions,” she adds.

In terms of demand for specific products, Asian Development Bank research indicates that letters of credit accounted for more than 37% of the trade finance market in Asia last year, compared to the global average of 26%. Fraser reckons there is always a ‘flight to security’ back to letters of credit when there is a risk event in the market.

“The primary purpose of letter of credit is to mitigate counterparty risk, whether that is a corporate or a financial institution, and right now players in the market are naturally evaluating which counterparties they are comfortable depending on,” he says. “I don’t see corporates making dramatic shifts in their counterparty risk appetite – though decisions are being made in measured and strategic ways.”

Case study

Semiconductor manufacturer AdvanIDe (Advanced ID Electronics) provides components for RFID transponders, chip cards and RFID readers and terminals. The company recently sought a trade finance facility including import invoice financing to extend credit terms on vendor invoices and receivables financing for the credit terms it extends to its customers explains Chief Financial Officer, Joseph Lian.

“We also needed a banker’s guarantee for vendor purchase and participation in government tenders as well as a letter of credit for export, a revolving short term loan, and a long-term loan,” he says. “In addition to our existing bank relationship we looked at a number of other banks to give ourselves options.”

The company eventually decided to go with Standard Chartered having received what Lian describes as a competitive proposition. When asked to characterise the application process, he suggests that if the onboarding process could be improved and the lead time reduced, it would be advantageous in terms of helping companies become more competitive.

Betant notes that when risk appetite is restricted there has historically been a move toward documentary trade buyer risk mitigation. “As the move toward open account trade accelerates, other risk mitigation tools are assessed by sellers such as bank guarantee/standby letters of credit issuance, in order to backstop an element of seller risk,” she says.

However, Mathew observes that global letter of credit throughput was down year-on-year in the first quarter of 2023 with financing demand affected by the prevailing SOFR term rates and higher cost of borrowing. He also refers to a redenomination trend from USD to local currencies for trade finance as cost of borrowing differentials between USD and local currencies diverge, especially for local/regional flows.

Liquidity has not tightened due to recent turmoil in the trade finance space, as the impacted banks were not active trade banks and had very limited trade exposure, claims Asiain. “The evolution of the product mix is mainly driven by credit risk appetite, regulations for the various products offered in the space, and working capital optimisation,” he adds.

Dave Skirzkenski, CEO of Raistone also rejects the idea that tighter credit pushes companies toward letters of credit. Rather, he suggests that companies looking to mitigate risk and obtain liquidity against receivables are increasingly choosing open account transactions, which has resulted in increased adoption of receivables finance.

“We have not seen a marked shift towards the use of letters of credit in the past few months,” says Muthukrishnan. “However, the high cost of funding and inflationary environment could contribute to a greater preference for letters of credit to mitigate the risk of non-payment.”

While letters of credit and bank guarantees still have a place in the trade finance suite of products, companies are increasingly turning to digital trade products such as supply chain finance to increase their control over working capital.

That is the view of Thomas Mehlkopf, Head of Working Capital Management at Taulia, who says his company’s latest supplier sentiment survey report found that 59% of respondents expressed an interest in taking early payment for a discount.

One of the key themes to emerge from the TIWG meeting was that adoption of fintech solutions for improving access to trade finance needed to be accelerated. According to research by Valuates Reports – which estimates that the global trade finance market will expand by an average of 5.4% annually between 2023 and 2029 – there is a growing desire to move away from banks towards non-traditional sources of capital. Mehlkopf reckons smaller businesses are questioning whether their existing bank strategy is the right one.

“Flexibility and security of access to funding have consequently increased in priority,” he says. “For smaller regional banks, we have seen significant outflows of deposits as businesses dash to more established larger banks and money market funds. Our expectation is that credit appetite will shrink further and we can already see this taking place as regional banks limit access to trade finance.”

On documentary trade products we have not seen many non-bank providers successfully entering the market.

Marie-Laure Gastellu, Head of Trade Services, Société Générale

Institutional buy side investors continue to increase their interest in trade finance due to its short term, self-liquidating nature, especially as trade finance platforms connect this capital to additional opportunities to hold private credit.

“This is a continuation of the trend which began with the introduction of Basel III,” says Skirzkenski. “Small and medium sized enterprises are benefiting as trade finance providers can offer solutions to companies from distressed through investment grade by tapping bank and non-bank capital.”

Fraser suggests bank capacity has remained relatively resilient, although he also recognises the increasing role of insurance balance sheets as an alternative source of funding, particularly where supported by alternative asset platforms increasingly active as originators in the trade finance space.

“On documentary trade products we have not seen many non-bank providers successfully entering the market,” says Gastellu.

“In the open account trade finance space, non-bank players are not really active on the financing side – most of them provide technology-based solutions to facilitate the corporate experience by exposing its transactions to its banking pool, as well as facilitating and receiving financing offers from its banking pool. Other platforms also facilitate risk distribution and buying or selling of trade assets on the secondary market, but these platforms do not provide the financing, which is still done by banks.”

Asiain and Mathew both observe that non-banks are growing their presence in trade finance largely through partnering with banks rather than replacing them, with the former referring to alternative investment models “achieving some minor success on small sized companies or non-investment grade flows but having limited impact on main trade flows.”

In bank intermediated flows such as letters of credit, the bank plays the role of a trusted intermediary that also mitigates the credit risk and provides settlement, adds Mathew.

Inevitably, the largest corporates are best placed to ride out any issues in the funding market due to their access to multiple banking relationships and the resources to develop a standardised approach to trade finance.

Srinivas Koneru, CEO of Triterras refers to the trade finance market as cyclical, but adds that stricter capital requirements have reduced the amount of funding banks can make available for trade finance over the last five years.

“Lack of availability of capital from the banks creates opportunities for fintechs,” he says. “But it becomes challenging to deploy funds across multiple jurisdictions because of the need to hold a regulatory licence in each market.”

Then there is the issue of higher costs of capital and a generally higher cost base for providing trade finance services. “When a platform is redeploying capital from different lenders it will have additional costs and these platforms have to make a profit,” says Koneru.

Case study

Paxton Access designs and manufactures security solutions for a range of buildings that are exported to more than 60 countries worldwide. The company has banked with HSBC for nearly 20 years, over which time revenues have increased tenfold.

“Trade financing had not been something we had previously required, running things lean as we did,” explains Adam Stroud, CEO. “However, with increased stocks, slower transportation methods, and new equipment and infrastructure required, we had a clear funding gap.”

He describes the discussions as straightforward and says the company’s relationship director understood exactly what it needed and why. “The terms were acceptable to us and, after completing the due diligence of seeking competitive quotes, we went ahead,” adds Stroud. “Within around a month, we had access to a new multi-million pound facility that funded the gap and was straightforward for our finance team to administer. Now, a few months on, the new facility is being used and we are starting to enjoy the cost and productivity benefits – as well as the business security – that our investments have allowed.”

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