Lunch Webinar Discussion 'Trade Finance'
This report was originally written in Dutch. This is an English translation.
For centuries, banks have played a major role in trade finance by providing credit and payment guarantees. However, since the capital requirements for banks have been sharply tightened, ‘Trade Finance’ has increasingly attracted the interest of non-bank investors. Reason enough for Financial Investigator to organise a webinar on the subject.
By Esther Waal
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CHAIRMAN Harry Geels, Economist, Senior Investment Adviser, Auréus PARTICIPANTS David Newman, CIO, Head of Global High Yield, Allianz Global Investors Paul van Gent, Pension Fund Director, Member of Investment Committees, Member of Supervisory Board, various pension funds Thibault Sandret, Senior Director Private Markets, bfinance |
For a full hour, Paul van Gent, an investment expert associated with several pension funds, and Harry Geels, Senior Investment Advisor at Auréus, put questions to two content specialists on Trade Finance: David Newman of Allianz Global Investors and Thibault Sandret of bfinance.
Geels first wants to know what exactly Trade Finance is. Newman responds: ‘Trade Finance is a form of financing where, for a certain fee, a financier assumes the risk that a buyer fails to pay a supplier's invoice. It speeds up cash flow for suppliers by paying out their invoices immediately but at a discount, meaning that those suppliers do not have to wait for the buyer's payment period, which is often 60 to 90 days. Trade finance has secondary risks in addition to primary credit risk, or whether the buyer can pay the invoice, such as whether the buyer pays on time and in full, and whether the invoice actually exists. It is a form of financing that already existed in ancient times.'
Van Gent is curious how big the market is currently. Sandret refers to a recent study estimating the funding gap at some $2.5 trillion. ‘So a huge market,’ he points out. 'The market used to be dominated by banks, but they are retreating. That development has been accelerated by the advent of Basel IV, which reduces the extent to which banks' risk-weighted assets can benefit from the collateral that Trade Finance often carries. We are seeing more and more non-bank players entering the market. We now have about 50 non-bank providers in the picture, which vary considerably among themselves in terms of the quality of their capabilities.'
‘What types of transactions, if any, are done by those parties?’, Van Gent then wants to know. Newman replies that the most basic form of Trade Finance is the single buyer form. 'Here you look at the credit risk of the buyer. But you can also set up a structure with a supplier with multiple buyers. Then you have to analyse the credit risk of multiple buyers, but it is also more diversified. Sometimes such a buyer is more difficult to analyse and there is a bank in between that has issued a letter of credit.' He says what makes Trade Finance so interesting is the direct link between risk and return and that you can choose your own risk-return profile. 'Investors can achieve higher nominal returns by investing in riskier structures, with more risk of fraud and defaults, for example. Whether this actually translates into higher returns depends on the skill of the asset manager. There are actually two ways to increase returns. One is to lower credit quality, the second is to add complexity.' Sandret adds: ‘In the higher-risk spectrum, you also have transactions like pre-export finance, where you can face production risk. In the middle part of the value chain, you can finance the transit of goods, where you are exposed to transportation and delivery risks.'
Geels brings the conversation to portfolio management and liquidity and asks Newman how liquid the asset class is. Newman replies that liquidity depends heavily on the strategy chosen. 'Our portfolio shows that about 60% mature within two months, with an average maturity of about 90 days. This makes it a hybrid product between private and public markets. Trade Finance is often seen as the less liquid part of the cash segment. We offer 5% of net asset value for the first month, 5% for the second and 12% for the third month, representing about 25% liquidity over three months.'
‘Is it possible to segment by liquidity and choose a provider on this basis?’ asks Van Gent. Sandret responds: ‘There are several segmentation criteria within Trade Finance. Liquidity is one aspect, as is maturity. Longer maturities often entail higher risk. The quality of counterparties also plays an important role, as does the structuring of transactions and the different layers of lender protection, such as additional credit insurance.'
This brings the conversation to who Trade Finance investors are and what they generally choose to do. Newman: ‘About 35% of our investors are insurance companies driven by the attractive treatment of short-term credit assets under Solvency II. Pension funds, which make up about 20% of our portfolio, are looking at Trade Finance as an alternative or complement to their short-term credit strategies for greater diversification. And then another part is held by companies, for example, that drop it within their treasury operations.' Sandret endorses the diversity of interest among investors, including geographically. He believes that is part of what makes the category interesting. ‘You want a diversified, granular investor base to avoid sudden large redemptions.’ He adds that the asset class is an alternative to cash for some investors, others consider it fixed income and there are also investors who classify it under their alternative credit allocation.
Van Gent wants to expand on the bit of diversification the asset class would offer. ‘Is Trade Finance as diversifying for the cash segment as it is for the high yield risk segment?’ Newman responds: ‘The correlation with other types of short-term credit is relatively low and the volatility is also very low because of the very short duration of interest rates and the credit spread. That gives you a fairly strong Sharperatio.'
The diversification element is not only in play for investors in Trade Finance funds. Diversification is also crucial for providers. Newman: ‘What you need is a diversified loan portfolio, diversified credit risk, multiple sourcing partners and clients, and your own independent credit research and monitoring.’ Sandret agrees. ‘With parties that performed poorly in the past, lack of diversification was often the cause.’
‘Are there cycles in Trade Finance?’ adds Van Gent. Newman: ‘Trade Finance has less cyclicality than you might expect. During the corona pandemic, of course, the hospitality sector had problems. There we moved to extended payment terms. In general, credit risk increases when you're in a recession. But companies need to trade, and as long as they do, Trade Finance is usually the last thing they turn off.'
Geels moves to the final question: ‘What are the prospects for Trade Finance?’ According to Sandret there is clearly room to grow, if only because of the further withdrawal of banks. He cites further digitalisation as a key theme. 'That plays a role in sourcing transactions and can facilitate the construction of highly differentiated portfolios. Digitalisation can also help monitor transactions and prevent fraud incidents.'