More than two years after Deutsche Bank closed TRAFIN 2015-1, a US$3.5bn synthetic collateralised loan obligation, investor awareness in trade finance securitisation has increased. Neil Jensen asks what this means for issuers
Mention the word ‘securitisation’ and some people still get a little nervous. The global financial crisis is still relatively fresh in the memory and instruments, such as collateralised loan obligations (CLOs), were, after all, one of the products singled out as problematic.
After a decade of intense regulatory change and greater controls, trade finance CLOs have become something of a sought-after asset class and are distinctly different from the sub-prime mortgage-backed CLOs that contributed to the turmoil of 2008.1
In this changing paradigm, Basel III and the Capital Requirements Directive IV (CRD IV) have made trade finance increasingly expensive from a regulatory capital perspective,2 despite representations made by the industry that the asset class cannot be treated the same as more riskier assets.3 This has prompted banks to turn to inventory securitisation as a way to obtain balance sheet relief, while also offering investors healthy margins. A variation on this is the securitisation of trade finance payment rights under traditional instruments like letters of credit (LCs).
This market has a limited number of players, but Deutsche Bank is among a small band of issuers that has included Standard Chartered, Citi, Santander and BNP Paribas. The market is currently niche and that’s largely because the deals take a lot of preparatory work and, once issued, comprehensive management. Guy Brooks, Global Head of Risk & Portfolio Management, Deutsche Bank Global Transaction Banking, explains, “The barriers to entry are quite high and most regular trade finance (TF) teams don’t have the expertise to undertake a transaction of this scale. Aside from getting buy-in across the firm, you have to be structured appropriately to execute and administer a TF securitisation.”
Deutsche Bank has issued three transactions under its TRAFIN series. The last one, a US$3.5bn synthetic CLO and the largest-ever TF securitisation, was announced on 10 December 2015.4 The structure made it possible for the bank to hedge a globally diverse short-term trade finance portfolio of corporate and financial institutions via the sale of a first loss tranche. More than two years later, the market continues to eye up banks that can handle what is a very different type of investment.
The benefits for the issuer are fairly clear – regulatory capital relief and re-risking, both prerequisites in this age of increased scrutiny and regulatory requirements. But what makes these deals attractive for would-be investors? Edward Hickman, of legal firm Dentons, a specialist in securitisations, explains, “Increasingly, investors appreciate the historically low default rates of trade finance,5 as well as the diversity and granularity of trade finance loans. They want to gain exposure to the asset class without becoming lenders themselves and they like the ability to transfer their investment easily without borrower consent. Above all, a trade finance securitisation allows them to choose different risk profiles – the more senior the notes, the less risky the investment, but the lower the yield.”
At the same time, investors have to factor in some of the disadvantages of embarking on this journey. While there is significant originating bank risk from a servicing and administration perspective, adverse selection, says Brooks, is less likely with synthetic CLOs “because the assets are chosen using an algorithm”. Fundamentally, there is low yield payable on stable trade assets, which may not appeal to all investors. Other elements, such as lack of standardisation and the absence of comparative data, also have to be considered.
However investors do seem engaged in the asset class. Brooks explains, “There are a number of peculiarities that appeal, not least the rarity value. We do have strong structuring and risk management skills and we have significant cachet in this field. Investors are scanning the markets for the best avenue for their money and, with spreads compressed, the appetite for risk has definitely increased over the past few years. Deals like TRAFIN allow investors to become more diverse.”
The value of TRAFIN 2015-1, the CLO Deutsche Bank closed in 2015
The impetus behind creating these pioneering transactions really started just after the crisis and resulted in deals such as BNP Paribas’ Lighthouse issue 1 and the Citi/Santander venture, Trade MAPS 2013-1. Standard Chartered’s Sealane also hit the market around this time, packaging Asian and Middle Eastern loans.
Although all of these deals had similar intentions, they differed in their construction and composition. BNP and the Citi/Santander deals were both what is known as “true sale” structures, while the Standard Chartered issue was a “synthetic”.
A true sale structure involves the originating bank selling its rights to receivables to a special purpose vehicle (SPV) and, in doing so, isolating the receivables from originator insolvency. “Under English law, the underlying debtors do not need to be notified for there to be a true sale,” says Hickman. “The SPV issues different classes of notes with varying degrees of risk and the SPV uses the proceeds to purchase receivables from the originator.”
Hence, in a true sale, the originator gets funding at the time of the actual sale, which contrasts with a synthetic structure, where the originator is paid upon a credit event such as bankruptcy or fail. “The synthetic is more versatile,” admits Hickman. “These enable banks to transfer credit risk under, for example, standby LCs, rather than loans. Also, because there is no sale of loans, less due diligence is required.”
Skin in the game
"We are, traditionally, a trade finance house;
we like the risk and have retention in all our deals "
- Guy Brooks, Global Head of Risk & Portfolio Management, Deutsche Bank Global Transaction Banking
Structure of deals
How are these deals constructed? Basically, they’re baskets of assets, such as supply chain finance, LCs and documentary credits. They’re not longterm, they have an average life of 180 days, with many being less than 90. Therefore, the assets have to be replenished on a regular basis, which entails a considerable administrative commitment. Deutsche Bank hedges its portfolio with a first loss tranche that is placed in the market and carries an inflated yield. Investors are comfortable with this structure as default rates are exceptionally low.
This makes trade finance securitisations an attractive proposition for banks, both as a portfolio management tool that distributes risk, and also as an investor product with a difference. “With low interest rates on the agenda for the foreseeable future, clients can benefit from good yields from a solution that is underpinned by high-quality risk controls. It is not unreasonable to expect the market to gather considerable momentum in the coming years,” concludes Brooks.
Neil Fredrik Jensen is a freelance finance journalist and a former Co-Editor of flow
1 See one explanation of this at https://bit.ly/2HZ6WsZ at thebalance.com
2 See ‘Basel yesterday, today and tomorrow’ at https://bit.ly/2Hum3gP at db.com/flow
3 Former WTO Director General Pascal Lamy was the main advocate of this with his WTO Expert Group on Trade Finance. See https://bit.ly/2HPglpi at wto.org
4 See 2016 article, ‘Trafin the trailblazer’ at https://bit.ly/2HXYuKv at db.com/flow
5 The ICC Trade Register Report is the recognised evidence of this. See https://bit.ly/2Hq77jL
Global Head of Risk and Portfolio Management | Deutsche Bank Global Transaction Banking
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