Back from the brink

Trade Finance

Back from the brink

October 2019

As the International Trade & Forfaiting Association met in Budapest for its 46th Annual Conference, flow reports on how heads of trade agree that in times of economic stress, flight to trade finance instruments of trust seems to be on the rise

The end of civilisation as we know it or are we back from the brink? The C Suite speaks

Moderator: Sean Edwards – Chair ITFA – Special Adviser, Trade Finance Department, Sumitomo Mitsui Banking Corporation (SMBC)

Panellists:
Daniel Schmand, Global Head of Trade – Deutsche Bank;
Masakazu Hasegawa, Global Head of Trade – Sumitomo Mitsui Banking Corporation (SMBC);
Surath Sengupta, Global Head of Trade Distribution – HSBC;
Minos Gerakaris, Global Head of Trade Finance– Rand Merchant Bank


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Volatility and uncertainty

Sean Edwards: Let’s kick off with Brexit, the US, China and all the volatility and uncertainty. It would be ideal if we all had crystal balls. They don’t exist, but do we have balls of steel?  How do you run your trade finance business amid all this uncertainty? 

Minos Gerakaris: Sometimes in Africa we feel like we are caught between the two massive spheres of influence [The US and China] with not much control either way.  That can either be looked at as a great threat in terms of doing trade or, in the face of any crisis, as creating an opportunity.  I think the opportunity to make individual deals with either party or to continue to operate largely as usual certainly exists.  Just look at the commodities coming in and out of our region - all the food softs as well as unrefined petroleum, minerals going out and food, medicine and infrastructure products coming in. Growth and trade will certainly carry on, as these are all strategic trades.   It is a case of treading cautiously and using the opportunity to advise clients how to best to hedge and de-risk during this time.

Sean Edwards: Does the African Continental Free Trade Area give you a little bit of a buffer to what is going on in the rest of the world?

Minos Gerakaris: I would love to say yes, but I think it is very early days. While there is a huge step forward to have a pan-continental agreement, if you think of the regions that are likely to trade with each other, we are doing so under regional Free Trade Agreements anyway. The ability to trade across the region is there but I think to start with there is going to be limited new traction.

Sean Edwards: Masa, from Africa to Asia, SMBC has an enormous footprint across the region but with very significant operations in other countries, this seems to be the area that has been hit very hard by US-China. I want to ask you what your view is on what is going on but I would also like to ask the question about regional resilience because whilst it may be early days in Africa, the picture is a little bit more mature in Asia.

Masakazu Hasegawa: Our strategy is to be flexible so that we can capture new flows that arise.  At SMBC, I am trying to expand my coverage to be able to follow these new trends.  For example, last week there was a huge conference in Tokyo – TICAD (Tokyo International Conference for African Development). More than 30 Presidents and leaders from Africa were in Tokyo to discuss the South Africa continent.  We have signed an MOU with two of the African commercial banks – BCP in Morocco and KCB in Kenya. The reason we focussed on these two banks is not to just do business in Morocco and Kenya, the Moroccan banks cover the francophone countries in West Africa and the Kenyan banks cover the East African countries.

Sean Edwards: So increasing partnerships globally is a very a valid approach.  Daniel, Europe seems to be one of the most affected regions by this climate of economic uncertainty - especially in relation to Germany and the automobile industry, how are you steering your business through this?

Daniel Schmand: While the trade war between US and China is of course bad for trade, uncertainty and volatility helps trade finance demand. I see a massive opportunity. If I look at numbers on our side, it will be one of the best years from a trade finance perspective, we just need to carefully take the opportunities. Doing cross-border business, particularly in emerging markets is a risk for which there is risk premium. So it is a good time to be in the business, provided you are efficient. If you have a defined strategy from origination to distribution, you are already advanced and are ahead of the curve.  The question is more is how you steer and how you fine tune.

Sean Edwards: At ITFA a big part of our DNA is about distributing risk whether that is through credit insurance, true sale or various other techniques. Surath, that is what you do extremely well, but what is your secret?

Surath Sengupta: I think these uncertainties obviously brings some short-term risks which we need to manage, but there is a long-term shift happening which is creating opportunities.  The where, the what and the how of trade finance is completely changing.

In all of that, we have to manage the risk that we take on our balance sheet and how we ensure there is enough liquidity available for trade finance in terms of getting the secondary qualification in place. That means that we cannot be doing business forever which is either book and hold or book and sell between fellow banks all of which are bounded by various similar considerations. The whole idea is how to extend it so that trade finance is more dematerialised and standardised with more liquidity available from not only banks but also non-bank investors looking for better returns in a low-interest rate environment.

Sean Edwards: Daniel, we mentioned the automobile industry in Germany has been under stress for the reasons that we know and there will be sectors from time to time, South Africa is a good example, or Africa as an example where there is an ebb and flow in commodity values.  Are you dynamically pricing accordingly?

Daniel Schmand: We are pricing very dynamically and are very sensitive to pricing. We do see this largely as proprietary models and are currently more hesitant to go out and create price discovery platforms relating to this because we see that as our value-add which is the expertise in the individual lines, knowledge of the individual commodities with which comes the ability to dynamically price this.

Sean Edwards: Minos, are there trade finance products that work better in Africa than in other places?

Minos Gerakaris: I would say it’s a slow process depending on the development of the individual market.  Interestingly, in times of stress, and I think this was something Daniel alluded to earlier, there is a reversion to traditional trade instruments as the safest form and the most proven.  Likewise, in times of liquidity stress, we see markets going back to more draconian methods of trading, insisting that every import is backed by a letter of credit. Those markets aren’t quite ready for those more advanced receivables or reverse factoring programmes, apart from domestically in-country.

In South Africa, we do have a broad range of products that will finance the full array of trade.  However, what we are seeing is our clients are really focussed on supply chain for their domestic suppliers and cross borders still sticking to the safety and security of the letter of credit.


Risk distribution

Sean Edwards: Surath, is there is a very strong linkage or symbiotic relationship between what we originate and what we distribute? We have got some wonderful payment instruments – the irrevocable payment undertaking for example in payables financing and the ICC is working on some new rules for this in digital form.

Surath Sengupta: There are three primary requirements to which we distribute; number one is to create additional trade capacity in a transaction; number two is create additional liquidity in a transaction and number three, which is probably the most important, is to manage the capital and returns on the transaction. So with those three lenses, it is important to have a specialised distribution secondary market team that works hand-in-hand with the origination team to make sure the transactions are well structured, more evenly structured and, if required, can be sold as well.

The structure is ultimately defined by the customer, and it is our responsibility to be able to advise the customers as far as possible. That said, I think the most important thing is that there is an increasing recognition within the bank that it cannot hold everything. Equally, we do not originate anything that we would not hold on our balance sheets.  That is a very, very important point.

Sean Edwards: I will just throw this question out to all of you, leading on a little bit from what we have already discussed – what is the biggest opportunity for trade finance?

Minos: I see two trends emerging: one is trade finance for services like IT systems, and the other is sustainable cross-border interbank financing for trade requirements, such as supply chains.

Sean Edwards: Yes, I think green finance or responsible finance is certainly a trend that I am seeing.

Masakazu Hasegawa: One of our fastest growing portfolios is receivables finance and supply chain finance.  That is an area where we can bring in more of these kind of techniques or things that we have developed in America and Europe, which is a huge market.  This is a growing area and I think there could be more opportunities in the Asian market.

Daniel Schmand: We see the next big trend as being “pay as you use” finance. For example, you sell an engine or a car and its use is charged by the mile. So there is an opportunity to finance these micro-receivables. The inventory would not be placed on the balance sheet of the buyer and seller – but that of the bank.

Sean Edwards: You have heard it here first.  Minos, do you have something to add to this?

Minos Gerakaris: It’s not about the individual business line but more about the theme – the one here being digitisation, using SmartTech and working with FinTech and embracing them rather than being afraid of them to take advantage of APIs, advances in OCR, document control, compliance regtech and electronic checking.

We use traditional insurance in the surety markets and optimise through portfolio plays to look at the overall portfolio of assets. This brings diversification to the traditional insurance markets where African assets have been typically underweight.

Sean Edwards: The question here is how we make trade finance assets attractive to non-bank investors such as hedge funds,  money-market funds and so on.

Surath Sengupta: I am a big advocate of making trade finance more investable. What does that mean?  There used to be a general thought process within major banks that if we allow other liquidity providers to come into this space they will “eat our lunch”.  I think that this thought process has significantly evolved and is now seen as much more of a complementary liquidity source to what banks will provide from their own capital.  What cannot be replicated is the infrastructure the banks have built, in some cases, over hundreds of years to originate, manage and service chain assets, to risk manage and operationally manage those trade assets. And I don’t think that can be easily replicated by any other liquidity providers, as it would prove too expensive.

These investors are, however, very interested because these asset classes are shorter, it has some decent easing in the current scenario and it’s real-economy assets. And as Minos was speaking to earlier, the reason why they aren’t already in this space is because trade finance is such a non-standard asset class. You have letters of credit and , you have supply chain finance, some people call it supply chain balance, some people call payables finance, some people call it something else, receivables is called various names and there are limited-recourse, non-recourse etc. It is so confusing for everyone to understand this.  So the whole thing is how do we make it as standardised as possible?  One of the ways, has been through securitisation, which is what most banks have done over the years.  It’s a great way of accessing that liquidity pool, but it has its challenges as well.

What we are trying to do is standardise it as much as possible, but we need all banks and other industry bodies to take part in it and then create it in a format which investors understand and are able to invest in.

Sean Edwards: One of my concerns is we have all invested a lot of money as banks in fintechs and probably will invest more.  Are we creating digital islands that we don’t manage to interconnect and what implications does that have on the sorts of products that we might create through that?

Minos Gerakaris: It can be very confusing as to whether there is interoperability between certain platforms and this underlies everything. I’m thinking it will be a slow process.  So instead, we should focus on the client. If they want to sell something, then you speak to the buyer and ask, “what do they need?” and “how can we best provide a solution?”. This may be on one fintech network or another so banks cannot be prescriptive. Clients will trade with each other in the simplest way, and we are there to take away risk and provide the funding and rails. We also need to be faster in tokenising invoices. We need to be able to put invoices into a note and then be able to repackage and make it investable. We also need to fully understand the investor base as not everyone in the investor base will buy everything. For example, insurance companies want term assets because that matches their obligations – that’s different to banks and specialist trade funds. So you basically have to do a completely different repackaging if you address each investor base.

Investors buy what they need and whoever provides what investors easily can buy and digest will be the most successful.

Masakazu Hasegawa: SMBC is Member of R3 and Marco polo. The reason I am very interested in this space is because only a part of global trade flows has been backed by commercial banks like ourselves. The reason for this is the tremendous inefficiency. Usually it’s a small amount or a short tenor, which makes it very uneconomical for banks to invest.

But with blockchain technology, there are many opportunities that we can go into. For example, where the tenor is 20 days or 30 days. Where paper transfers take two weeks and the tenor is only ten days it doesn’t make sense for us to go into that market.  But with the blockchain technology, we might be able to do it in two days, which completely opens new horizons for markets.

In the trade finance area, maybe with this efficient, secure technology, we might be able to identify a new opportunity in the existing market. That’s why we are putting so much effort into this.

Sean Edwards: Thanks, Masa. That’s very helpful for that second question – how do we make trade finance to SMEs? It’s partly operating costs, partly tenor. So it will enable us to take different risks.

Question from the floor: At the moment, at the European Union level, the CRR are being discussed and re-negotiated and one issue, for instance, in trade finance is the maturity flow.  Will we still have that also in the new CRR coming out in 2020? Are banks doing advocacy work in order to convince the European regulators how important trade finance is?

Daniel Schmand: If you look at CRR II, or Basel IV – whatever you want to call it – it is actually reflecting the needs of trade finance and there are little pockets where you can do even better. The point we want to make is that if you make ECA financing so beneficial for banks, why don’t you look at ESG or green financing in the same way? We need to lobby in two ways. One is to get what is good for trade, but we should also not forget what is good for society. We need to lobby in a balanced manner and I think it is going in the right direction.


Tomorrow’s trade finance professionals

Sean Edwards: I would like to finish with talking for a minute or so about the people who are going to take over us – the youth.   After the Global Financial Crisis, there was a lack of investment in trade and not enough people going into trade finance. What are you doing in your businesses to encourage them? 

Minos Gerakaris: I think it’s taking a more holistic view of the working capital cycle and having specialists across that cycle rather than the historic view, which is where we developed trade specialists and moved them through the ranks and business areas, eventually involving them in structuring transactions.  Where we are involved is hiring and mentoring staff with very different backgrounds as technology will increasingly take care of developing and checking documents. What we want is lawyers, actuaries, accountants and engineers who can apply that information and engage with clients on solutions.

Sean Edwards: Surath, how are creative minds being encouraged at HSBC?

Surath Sengupta: We are very focussed on the next Gen Z and the millennials.  We have to create smart workplaces, you have to attract that.  The one thing that is definitely working in trade finance’s favour is that we are actively moving away from being seen as a stale, paper-based business – with blockchain, distributed ledger technology helping to pushing the new agenda out to the mainstream financial media.

Masakazu Hasegawa: What I am trying to do fundamentally is talk to my younger bankers about the features of trade finance as a business, maintaining trade flows in difficult market conditions during economic crises and doing the right sort of trade. And while fintech is bringing in new talent I want the young bankers to understand the fundamentals of trade that have been going on for centuries because there are reasons why documentation has been going backwards and forwards. So it is important the younger generation understand and engage in the fundamentals but help transform trade finance with new technology.

Daniel Schmand: What we have done is we let our young bankers, very early, fully run their own projects, decide, spend money and make mistakes, observe and learn. I see our roles as one of learning and listening so they make best use where their strengths are.  You need a bit of courage to take away the traditional way of how you manage within a bank.

The International Trade & Forfaiting Association held its Annual Conference in Budapest 4−6 September 2019, hosting around 270 delegates from all around the world. www.itfa.org

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