A long-awaited clarification from the European Banking Authority (EBA) has failed to resolve a divide among EU banks over the capital burden of long-tenor trade finance products.
Lenders had hoped that a technical document published by the EBA last month would clear up confusion over whether they need to double capital buffers on trade finance products with a maturity of more than one year.
But market sources say the document has not shed any new light on how to interpret the rules, and has reinforced calls for a new regulatory definition of trade finance that places less emphasis on tenor.
The EBA approach also puts EU banks at a slight disadvantage to rivals in the UK, where regulators opted not to link the capital requirements for trade finance products to their maturity.
Jurisdictions around the world have been implementing capital rules, known in the EU as Basel 4, that aim to harmonise the amount of capital banks keep in reserve as buffers against financial shocks and economic downturns.
Concerns among EU trade finance lenders arose after the text of the revised Capital Requirements Regulation suggested that the capital burden would more than double on trade finance products with a tenor of over one year.
In the August document, the EBA confirmed that trade finance products will continue to attract a credit conversion factor (CCF) – which denotes how much capital should be held in reserve for a particular exposure – of 20%, on par with existing rules.
But the regulator also reiterated its previous definition of trade finance, which includes a statement that such products should have a “fixed short-term maturity, generally of less than one year”.
That has caused a divide between banks. Some iunderstand it to mean trade finance products can exceed that maturity and still qualify for the 20% CCF, or that the majority of their trade portfolio should have a tenor of less than a year.
But more conservative lenders interpret it as meaning any trade finance instrument with a tenor of more than one year may require a CCF of 50% – a significant capital hike.
This conservative approach has been adopted by many lenders in the Nordics, which last year sparked concerns over price rises on some guarantee products.
Performance guarantees are often used to help finance long-term contracts or projects, meaning they may be issued for many years, and can even be open-ended.
Related products, such as customs and financial guarantees, attract different levels of capital.
Many European lenders have reported strong demand for performance guarantees in recent years, and the importance of the products for European companies in sectors such as energy and infrastructure helped fend off stricter capital treatment of trade finance previously proposed by the European Commission.
Defining trade finance
The uncertainty surrounding capital treatment of long-tenor trade instruments has reinforced a desire among bankers to campaign for a definition of trade finance that removes the reference to short-term maturity.
Last year, the International Chamber of Commerce’s (ICC) Banking Commission published a definition of trade finance that says “guarantees are considered as trade finance instruments… regardless of maturity” if they involve an underlying trade transaction.
The ICC, which has led EU advocacy on Basel, said at the time “that a misleading and oversimplified definition of trade finance may result in unintended negative consequences for the business”.
Marie-Laure Gastellu, global head of trade at Société Générale tells GTR that ”the only way, if we want to fix this for good, would be to revisit the definition of trade finance in the Capital Requirements Regulation”, using the ICC definition.
Another senior European banker says: “ We will still continue to advocate for a better recognition and more standard definition of trade finance in line with its low risk profile as demonstrated by the ICC Trade Register.”
The EBA document still requires approval from the European Commission before it can take effect.
In the UK, the Bank of England last year dropped proposals to apply a 50% CCF for products such as performance guarantees and standby letters of credit, instead maintaining a 20% CCF for all products.
