A breakthrough
Amid the chaos engulfing the rest of the financial world, the trade finance market may have just been thrown a life ring, writes GTR editor Rebecca Spong.
The foundations of the global economy are being battered once more. Eurozone leaders continue to grapple with their worsening debt crisis; banks are facing rising cost of funds and a drying up of US dollar liquidity; and across the globe people are railing against proposed cuts to public sector spending while the “Occupy” protests are attacking the very concept of capitalism.
In recent months, even those working in the relatively safe and stable trade finance markets have voiced concerns that they are unable to close as many deals as quickly as they may like due to the escalating cost of funds.
Trade finance did enjoy a renaissance of a kind during and after the 2008-09 crisis; with traditional relatively low risk trade finance products rising in popularity among banks.
Yet 2011 has not been as successful a year for trade finance as one might hope.
Dealogic tables for the first nine months of 2011 reveal that global trade finance volumes reached US$114bn, which is down 6% from the US$121.1bn recorded in the same period in 2010.
The drop in trade finance activity was particularly acute in the third quarter of this year, where volumes reached US$40.4bn, a 29% fall from the third quarter 2010.
A proportion of this drop could be put down to a variety of factors; the deteriorating Eurozone crisis, the Arab Spring, the slowdown in economic growth across the globe.
Yet many market observers agree that the biggest threat to the long-term future of trade finance is the proposed Basel III regulations.
The regulators intend to stabilise the banking system and avoid another financial crisis, but it is thought that the regulations have unintended consequences by demanding that disproportionate amounts of capital to be put aside against trade finance assets such as letters of credit.
It is argued that such a requirement would make trade finance a more expensive and less competitive product.
The breakthrough
Yet there have been some significant breakthroughs in terms of the negotiations with the Basel Committee and getting the correct capital treatment for trade finance.
In late October, the Basel regulators announced that they would adjust some of the means in which the new Basel III capital requirements are calculated, although they have completely rejected other requests put forward by industry bodies.
Here’s what the committee have decided:
Basel III Rulings
The Basel Committee has decided to:
• Waive the one-year maturity floor on certain trade instruments (letters of credit) under the AIRB system for credit risk.
• Waive the so-called sovereign floor for certain trade finance claims on banks using the standardised approach for credit risk.
The Basel Committee has NOT decided to:
• Change the 100% credit conversion factor used to calculate the leverage ratio for contingent trade finance exposures.
• Change to 20% CCF under the risk-based standardised and foundation internal ratings-based approaches.
Reaction to the Basel Committee’s decision has been mixed.
The International Chamber of Commerce (ICC) has said that although it is “pleased” that the Basel Committee has announced measures that reflect the low risk nature of trade finance, it argues that there is still opportunity to “refine” the rules.
“It is crucial that the cost of capital between a low-risk low margin activity like trade finance is differentiated from higher risk higher margin activity,” notes the ICC Banking Commission chair, Tan Kah Chye.
“We have narrowed the gap today and there is an opportunity for us to do more through continuing dialogue. We believe that banks and Basel have a responsibility to develop a robust banking environment to create jobs through trade.”
What do you think? Have the decisions been fair? Has the Basel Committee made the wrong decision?
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