Roundtable participants
- Marina Attawar, member of the board of management, DF Deutsche Forfait
- Edmondo de Picciotto, general manager, Intesa Soditic
- Silja Calac, head of trade risk management at Unicredit
- Simon Lay, managing director, London Forfaiting Company (LFC)
- Paolo Provera, general manager, ABC International Bank (and IFA chairman)
GTR: Has activity in the trade finance and forfaiting markets picked up over the last 12 months? How active is the secondary market?
Attawar: From our point of view, the forfaiting market has had several, very different phases in the past 12 months. At the end of 2011 and the beginning of 2012, we saw a lot of activity and some very interesting transactions. Prices were increasing. Subsequently, March and April saw a drop in pricing and deals on offer. Finally, more recently, we have experienced a remarkably quiet market. It seems the majority of the secondary market players are holding on to their assets.
Picciotto: I think it has definitely picked up in the past 12 months. As usual, activity is very restricted in some countries and most of us have seen tenors on transactions become shorter over the last few years. It really depends on what you consider the secondary market; a few traditional players have moved out of the market but new players are emerging, so from our point of view it has been more active than in the past. Syndicated loans in the secondary market have been extremely active lately.
Provera: I agree. Trade finance activity over the last 12 months has increased compared with the previous year. Again, the desire to achieve a proper ‘two-way’ trading relationship with counterparties is becoming more important in the secondary trade finance market with an evident growth activity on various products.
Calac: The secondary market has clearly opened up again over the last year and investors are keener than ever to acquire trade finance-related assets. The financial crisis has clearly shown the resistance of this asset class. The secondary market has not only seen the return of the traditional bank players, but also new categories of investors, such as funds and insurance companies who are playing a more active role.
Lay: 2011 started positively on the back of stronger commodity prices and increased trade volumes, particularly intra-Asia. However, this trend changed as the eurozone turmoil resurfaced with a greater impact on the trade finance markets, most notably as western European banks reduced lending activity in this sector. Notwithstanding the above, the World Trade Organisation (WTO) reported that the fastest-growing region in 2011 was the Middle East, followed by the CIS, South and Central America and Africa.
In addition, we saw an increase in demand from producers in the natural resource and energy sectors, which sought to access liquidity through various structured financings, typically secured against offtake and fixed assets. Secondary market activity continues to be impacted by banks adopting a more cautious approach to cross-border risk, with many deleveraging their balance sheets and selling assets into the secondary market.
GTR: What trends have you seen in terms of pricing over the last 12 months?
Lay: We have experienced significant volatility in pricing over the last 12 months. During the second half of 2011, we saw the refinancing lines of many western European banks increase significantly, which was particularly noticeable considering the low base from which they started. We saw China and India’s pricing trading in the mid-2% levels and peaking even higher, having been below 1% previously.
However, 2012 saw the pendulum swing back as a lack of assets and fewer borrowers approaching the markets moved pricing down. Nevertheless, with the spectre of a Greek default rearing its head again, we do not expect rates to move back to their precrisis levels anytime soon. Structured trade margins have remained surprisingly firm and this has been rewarded with significant liquidity flowing into such deals often leading to oversubscription, demonstrating that if priced correctly, deals can still attract significant interest.
Traditional forfaiting markets like Turkey, Russia, and Brazil have seen a wide differential between what borrowers were willing to pay and pricing expectations in the secondary market. These factors, together with high levels of domestic liquidity have meant fewer deals and loans were concluded in these traditionally strong markets.
Attawar: It looks like a rollercoaster-type of development. A very good example is the pricing for Turkish transactions. Whereas some of our counterparties needed up to libor + 4% a year for a 360-day transaction with the risk of a top Turkish bank in January, we were offered to buy comparable assets at Libor + 1.85% a year in April. Provera: Generally pricing is getting tighter for non-Mena related short term transactions. In the GCC (with the exception of Bahrain) we are still seeing very tight pricing.
In some other Mena markets, still facing the post Arab Spring difficulties, pricing varies from time to time but it is still higher than expected since the number of players has reduced. Market prices have also suffered and we are not seeing too much pressure for lower levels.
Picciotto: Prices increased at the start of this period but since then have come down quite a lot in most countries as the market appetite for transactions has increased again. Once again this is only for short-term deals, whereas prices for medium-term transactions have increased in a lot of cases due to funding issues.
Calac: Due to the Arab spring and Western Europe’s issues over public debts, market appetite is mainly on Asia and Latin America. Add this to the fact that there are more potential investors in the trade finance market; the result is a strong demand for Chinese, Indian and Brazilian true trade finance paper. Pricing has clearly dropped there, while other risks are extremely difficult to distribute. Further, pricing is clearly higher for funded transactions, mainly if the currency involved is US dollars.
GTR: What are the main risks facing your market?
Lay: Ongoing instability in the eurozone continues to pose a signifi cant risk, exacerbated by the destabilisation of the Spanish banking sector and the widespread downgrading in the Italian banking sector.
While these uncertainties remain, they are bound to feed market volatility, and will result in unreliable levels of liquidity and put upward pressure on margins. Another macro risk is the prospect of slower economic growth and fewer exports from the eurozone, plus the moderation of growth rates in both China and India.
This is likely to depress price levels in the commodity sectors and put additional stress on exporters and importers worldwide, which will test the resilience of assets in banks’ portfolios throughout 2012. Even if this does not translate directly to increased credit risks, lower commodity prices mean lower deal sizes and less potential to make profit on financing these flows.
Picciotto: I agree. The main risks are a spread of Greece’s problems to other European markets and the issues of funding medium-term deals, especially in US dollars. It is also a market full of opportunities for institutions that have a long-term view of the markets.
Provera: Covering Mena-related risks might be seen today as a high-risk activity. However, knowing our markets very well and counting on a local presence, we feel like we are in a fortunate position as we may determine the level of risk we are taking. This doesn’t mean that we feel on the safe side but, generally, our historical experience on these markets, even during last year’s crisis, gives us adequate comfort.
Calac: I would say the largest issue we have to deal with now is the implementation of Basel III regulations. It is of utmost importance that the lower default risk, clearly evidenced by the ICC default registry, is taken into consideration for the required capital allocation. Otherwise, if trade finance required identical risk-weighted assets as plain vanilla lending does, the higher costs due to the safer structure would make trade finance unattractive.
Attawar: We can see that the primary, as well as the secondary market, are underlying massive changes at the moment. More than ever, we need to prove that we are flexible and are able to adapt to a totally different market environment.
GTR: Has the European banking sector, and the eurozone problems, weakened the trade finance and forfaiting market?
Lay: European banks are trying to repatriate capital from overseas markets back to their domestic heartlands. Many are reducing or withdrawing debt, letters of credit and trade finance lines to customers. A recent report suggested that the European banks would reduce trade fi nance lending in Asia by as much as US$3.9bn in 2012. We are not sure if this will prove to be accurate, but our clients tell us that many banks are withdrawing lines or only doing contingent trade finance business. While it is hard to predict the outcome of the eurozone crisis, it is clear that even in these difficult conditions, trade will continue, although it is essential that it is supported by sound financial markets. We strongly believe that every crisis provides an opportunity and we remain optimistic that capital introduced either via the forfaiting or perhaps the fund market, will be attracted into what has historically proven itself to be a superior performing asset class.
Calac: On the contrary, corporates in Europe, having limited access to plain vanilla lending, will try to turn their trade finance receivables into cash. Our forfaiting and supply chain finance activities have shown record results over the last three years. In addition, corporates are more risk adverse and will therefore revert to safer financing techniques.
Provera: The lack of liquidity, the higher cost of funds and the willingness of the European banks to preserve their capital has created new opportunities in the trade finance market. We see more short-term opportunities than in the past and we still believe trade finance remains a valid market niche where we will continue to invest with good returns.
Attawar: The eurozone problems have had and still have an effect on the trade finance and forfaiting market. Exports out of many of the European countries are receding, along with the need for trade finance.
GTR: How is the eurozone crisis affecting how you deal with counterparty risks?
Picciotto: It has affected the way we deal with a very limited number of counterparts as most of the transactions we do are done on a funded basis so the risk we carry on our counterpart is relatively short.
Lay: LFC’s key markets have been less affected by the eurozone crisis but we cannot claim to be completely impervious to its effects. As part of a European banking group we have to remain cognisant of any knock-on effect that a downgrade may have on risk and capital weighting at the consolidated parent company level. This may force a requirement to lift margins in order to maintain return on equity levels.
One aspect of counterparty risk, which we have scrutinised more closely over the last few years is settlement risk, especially in countries that were facing continued downgrades. However, this has not hampered our ability to close transactions and in my experience, settlement risks often arise from sources you would not predict through credit analysis alone.
Attawar: If a counterparty bank is downgraded, this change of risk has to be reflected. Luckily enough, we so far have not had to take any drastic measures to change the way we are dealing with our counterparties.
Calac: When distributing risk on an unfunded basis, the rating of the partner is crucial for the reduction of risk-weighted assets. If I get mitigation through risk participation from a client who has a rating which is worse than the obligor, the risk cover no longer makes sense, as it will increase risk-weighted assets while reducing the gross revenues. However, although some EU partners have been downgraded, they still have better ratings than most of the emerging market risks we deal with in trade finance. Otherwise, we will try to do more on a funded basis.
GTR: What are the effects of Basel III on your business? Do you foresee it limiting your capacity for business?
Provera: Absolutely not, regulatory issues are a part of it, even if currently it’s the most important one. However I feel confident that the financial sector’s lobbies will make any efforts to change some parameters. Regulators need to understand how important trade fi nance is to support economies’ growth and I hope that the proposed Basel III rules will be corrected.
Attawar: It seems that there will be two sides to the story. We expect an increase in business opportunities as banks will have to comply with stronger regulation. As a consequence, exporters will have to develop alternative funding sources. On the other hand, for that very same reason, the possibilities to place secondary risk in the market will be reduced with some counterparties. Therefore, the need for strong market expertise is going to be more valuable than ever.
Lay: It is important to remind ourselves that Basel III is a regulatory response to the recent global crisis and trade finance was not the driver behind such a widespread crisis. The main criticism of the proposed Basel regulations is that they do not reflect the underlying nature of trade finance, the historic low default rate figures evident in the ICC Trade Finance Register and the shorter tenors, which characterise trade finance.
Although pressure from the WTO resulted in reducing capital charges for low-income countries, the lobby has not been successful in reducing the 100% credit conversion factor for off-balance sheet items. Hence, as they currently stand, the proposed changes will not remove the impact of Basel III on trade finance, which will see the credit conversion factor increase from between 25% and 50% presently to 100%. This will undoubtedly lead to higher capital and funding costs.
Whilst banks, which offer more diverse product ranges, will be less affected by this change, trade finance-focused banks and commodities trading houses will suffer from these effects as letters of credit and other trade fi nance products will become more expensive. The recent ICC banking commission report ‘Global Risks – Trade Finance 2011’ highlighted that trade finance supports approximately US$16trn of trade each year. The ICC Trade Finance Register for off-balance sheet transactions showed average tenors of less than 80 days and only 947 defaults in a sample of 5.2 million transactions. Although it seems unlikely that the lobbying will successfully revise the credit conversion factors, it is important that all trade participants continue to appeal for a revision of such conversation rates.
Calac: I see Basel III as a main issue for trade finance as it might result in too high capital costs for our business, which can’t be covered anymore by the underlying transactions. The secondary market, however, is clearly boosted by the new regulations. Until the financial crisis, most banks would simply keep trade finance-related assets on their books. With the new regulations, transaction banking is also obliged to manage its portfolios actively. Therefore there will be more assets for sale and a larger diversity, and not only for the really difficult risks, which can’t be approved by credit departments.
GTR: Do you think initiatives such as Baft-IFSA’s definitions for trade finance products will help boost the profile of forfaiting as well as correctly reflecting the risks related to it?
Picciotto: Potentially yes but the issue in the market at the moment is not finding new investors, but instead increasing the general volume of forfaiting deals coming from the exporters.
Lay: I believe that definitions such as those agreed by the Baft IFSA- global trade industry council provide more clarity for banks servicing trade finance transactions and result in consistency when trade finance banks approach regulators and other stakeholders. This is also similar to other initiatives we are seeing such as the launch of the Uniform Rules of Forfaiting, which should be finalised in October 2012. The fact that organisations such as Baft- IFSA and ICC are taking on more initiatives and standardisation, surveys, rules etc all help to raise the awareness of forfaiting.
However, the ‘Traditional Trade Finance Definitions’ issued by Baft-IFSA in February 2012 are very generic, particularly with regards to those given for forfaiting, as they make no mention of any risks related to the product. Consequently, I do not anticipate that they will have any marked effect on the profile of forfaiting.
Calac: Yes, I definitely think that this will help to better explain our product. I mainly think that the trade risk clusters are very useful. They show the relative riskiness of different trade products. Knowing what you are dealing with in trade finance is one thing. But what degree of risk is related to your activity is, at least, of equal importance. Thus I find both official definitions and risk clusters most useful when explaining our business to potential investors. Further it is definitely helpful that forfaiting has received such a favourable ranking as this is clearly further proof that our business represents a good use of risk-weighted assests.
Provera: Baft-IFSA’s initiatives are always welcome. I personally hope that trade finance definitions will finally contribute to the correct Basel III treatment on forfaiting. Trade finance in general has always been safe and supported by a clear documentation and this must be taken into consideration by the regulators. I hope that Baft-IFSA, together with the IFA, will correct some of the parameters.
GTR: Where are you finding new business opportunities?
Calac: The open account business shows a huge potential. Only about 20-30% of world trade is covered through the so-called traditional trade instruments. The remaining ever-growing part is still mostly done without the bank’s intervention.
Lay: As the eurozone crisis persists, investors may again seek new opportunities within the emerging markets. It is too early to see a meaningful resurgence of business in North African countries like Libya, but we are monitoring this country closely together with any effect on neighbouring areas in the Mena region. After being closed to foreign lending, Belarus was recently upgraded by Standard & Poor’s from B- (negative) to B (stable). There are signs of stabilisation in Belarus even though the economy remains fragile and high inflation levels persist, although they are beginning to slow.
Foreign reserves were also aided by the sale of various significant state-owned assets, so we are monitoring this market and have identified selective trade finance opportunities. Over the last few years, we have also managed to diversify our Asian portfolio by closing various structured trade financing, particularly in the agri, natural resource and energy sectors. Again, given some of the apparent reduction in Asian lending by the eurozone banks, we expect reasonable growth from this business line. Markets like Indonesia and Mongolia have offered good opportunities for this product line. GTR
