Banks are increasingly distributing trade finance assets to institutional investors, helped by new technology and a growing interest in the asset class.
While Basel III capital requirements and other new regulations have prompted some banks to dial back their trade finance operations, others are looking to sell trade finance assets to new players to free up capacity to lend more.
Trade finance covers financial instruments that companies use to facilitate trade, such as letters of credit, performance guarantees, supply-chain finance and import/export loans.
HSBC Holdings PLC, one of the world's largest trade finance banks, is seeing an "unprecedented" level of interest from institutional investors in buying trade finance assets from the bank, said Surath Sengupta, its global head of trade portfolio management and distribution.
The distribution of trade finance assets to nonbank investors could to grow to a $3 trillion market in the next seven to 10 years, according to Tradeteq Ltd, a digital trade finance exchange.
Banks worldwide are seeing growth opportunities for their trade finance distribution business. The Trade Finance Distribution Initiative, a collaborative project started last year for banks and asset managers to develop market standards and trial new technology, now counts some of the world's biggest trade finance players as members, including Standard Chartered PLC, Deutsche Bank AG, Crédit Agricole SA and HSBC.
Traditionally bank to bank
"Every other bank product is already getting distributed, except for trade finance. That's why we believe that this is going to happen," said Christoph Gugelmann, co-founder and CEO of Tradeteq, which is the technology provider for the Trade Finance Distribution Initiative.
To date, trade finance distribution has primarily been a bank-to-bank market, with banks using it as a tool to manage country, sector and buyer limits between them.
Tradeteq estimates that of the some $7.5 trillion bank-intermediated trade finance in 2018, around $300 billion to $400 billion was distributed between the banks themselves, while less than $100 billion was sold to nonbank financial institutions.
Bringing institutional capital to the trade finance market is becoming ever more urgent. The trade finance gap, measured in rejected applications, is estimated by the Asian Development Bank to be between $1.4 trillion and $1.6 trillion.
This may worsen as banks face higher capital requirements in 2022 as a result of Basel III reforms, commonly referred to as Basel IV, according to calculations by Tradeteq.
It found that the amount of capital that banks need to put aside when offering trade finance to SMEs will increase to 5% in 2022 and 6% in 2027, up from less than 3% today.
While a growing number of trade finance funds typically give investors access to trade finance deals otherwise rejected by banks, buying bank-originated trade finance is an appealing option for those seeking lower risk investments.
Default rates for bank-originated trade finance have historically been very low across products and regions, according to the International Chamber of Commerce, which analyzed 25 trade finance banks' transactions from 2008 to 2017.
Trade finance is also an attractive proposition for investors because if offers yield, low volatility and low correlation to other asset classes, said Christopher McGinley, head of trade finance at Federated Investors Inc.
The investment manager was one of the early entrants into trade finance in 2009, and now sources trade finance assets from 35 banks, McGinley said.
The approach allows investors to draw on banks' experience providing trade finance, while banks can expand their operations and uphold client relationships.
Sengupta said distribution enables HSBC to provide more trade finance where it has the appetite but might not have sufficient liquidity, particularly on large supply chain finance programs.
In 2019, HSBC distributed $28 billion worth of trade finance assets, up from $2 billion in 2015, he said. To grow this further, the bank recently partnered with Allianz Global Investors GmbH to launch a capital fund that will buy and wrap HSBC assets into notes and offer them to clients.Read more: Trade finance funds grow as investors seek 'recession-proof' asset class
Sengupta rejected concerns that banks are selling off assets they deem too risky. "Our skin is always in the game. Most of the time we have the largest holding among all investors," he said.
Phone calls and Excel sheets
But bringing new players into a market dominated by banks for centuries comes with its challenges.
One barrier is the lack of education among institutional investors about trade finance being an investable asset class, McGinley said.
Another hurdle is that trade finance is a paper-based and manual business. Distribution of assets typically happens on a bilateral basis, managed through phone calls and Excel sheets. The process of finding a buyer or seller, negotiating price, agreeing terms and closing a deal can take months, if not years using traditional distribution methods, according to Tradeteq.
"There is certainly a place for technology to make trade finance more accessible and efficient," said McGinley.
New platforms such as LiquidX Inc., CCRManager Pte. Ltd. and Tradeteq are attempting to do just that, and they may be crucial for the trade finance distribution market to take off.
Such technology solutions allow investors to increasingly buy trade finance assets digitally, on a transactional basis, and from multiple counterparties, rather than having to enter into long-term securitization programs with one bank.