With trade finance volumes falling and the capacity of traditional banking players reducing, it is time to think differently about how to finance this market. Rebecca Spong reports.
Total global trade finance volumes fell by almost 20% year-on-year to US$26.8bn in the first quarter of 2012 according to Dealogic. This marks the lowest quarterly volume recorded since the third quarter of 2009. Activity fell to just 173 deals, down 39% compared to the first quarter of 2011.
The reduced volumes reflect the widespread deleveraging seen across the European banking sector towards the end of 2011, resulting in traditionally strong players in trade and commodity finance, particularly the French banks, retrenching from the market.
Although the European Central Bank’s long-term refinancing operation (LTRO), which injected US$1tn of capital into the European banking sector in December last year and February this year, has eased pressure on banks’ lending capacity to a certain extent, it is still evident that the appetite to lend remains poor.
This is in part a reaction to Basel III, as the requirements of the new regulations tightened their grip over the market, ensuring that banks have to allocate more capital against trade deals and thus further reducing lending capacity.
Yet as supply shrinks, the demand from borrowers is ever-increasing. Oil prices alone could hit US$150 a barrel this year, resulting in rising borrowing demands of oil traders and producers. Against this backdrop, there is much market discussion on how to untap additional liquidity for trade.
In the commodity finance market there have been a number of new bank lenders, with the American banks such as JP Morgan and Citi, flush with dollar liquidity, looking to increase their exposure to commodity finance. Similarly the Japanese and Chinese banks are becoming more active.
There are also a number of boutique trade finance outfits and trade finance funds ready to offer an alternative approach to financing trade, and add to a more diversified pool of liquidity. The wider use of securitisation of trade finance and the creation of so-called trade finance collaterised debt obligations (CDOs) is yet another method both banks and non-banks are exploring with the intention of boosting lending capacity.
One alternative provider of trade finance is the Dubai-based Falcon Trade Corporation. The company has been able to capitalise on the dearth of banking lending capacity to build its business.
“Our selling point is that we are an alternative provider of funding for corporates diversifying away from traditional banks. We are complementary but we also go where banks cannot,” explains Kamel Alzarka, chairman of Falcon Trade Corporation.
“The banking crisis has been very good for our business. And the changes caused by the crisis are here to stay. It has opened up new horizons for us in that some large corporates who wouldn’t have considered or needed us five years ago, are today more than happy to sit and discuss solutions we have to offer,” he notes.
Such is the demand for alternative sources of trade finance that Falcon is looking to launch its inaugural bond issue of as much as US$250mn.
The three-year issue is expected to be launched in the third quarter of this year, with the aim of helping boost Falcon’s lending capacity to US$2bn and increase its maximum transaction size to more than US$100mn.
GE Capital is another non-bank financial institution, owned by GE, the world’s largest technology and industrial company. Inwha Huh, managing director, working capital solutions, at the company reports that it has seen growth of deal volume throughout 2011 and early 2012 across various clients and sectors, particularly in energy, oil & gas and aviation.
“Corporate demand for trade financing has remained strong, with increased sales to emerging markets,” she adds.
She sees the current market environment as an ideal opportunity for non-bank providers of trade finance to increase their market share.
“Given the various factors including Basel III, European bank liquidity situation and the changes within the securitisation market, it is an opportune time for non-banks that have a strong capital base to enter the trade finance market, which has been traditionally saturated with banks.”
Cat Financial, the financing arm of the equipment provider Caterpillar, has also been very active in boosting the available liquidity for structured commodity finance and project finance.
Dan Cox, managing director of Cat Mining Finance within the structured finance group, tells GTR that the structured finance team’s funded volume in 2012 is set to increase by approximately 50% over 2011’s level. However, he adds that Cat Financial’s increased business volume is not necessarily in reaction to a lack of bank capacity, but linked to the company’s wider growth plans.
“In the past two to three years we have begun to take on the role of mandated lead arranger with other banks who also view us as a key partner,” Cox explains.
“We do not see a gap in funding alternatives for well-capitalised and structured projects,” he adds. His business is further buoyed by the fact that commodity prices have stayed high enough to allow new mines to come online or current mines to launch expansion projects.
Role of trading companies
Some trading companies are also playing a role in providing additional liquidity support to the commodity and trade finance market.
Trafigura’s fund unit known as Galena has a specific commodity trade finance fund, and the fund confirms to GTR that it has seen inflows picking up since the beginning of 2012.
Galena was looking to create an additional commodity finance fund and was set to raise US$300mn to support such a venture at the end of 2011; however such plans were ultimately scrapped. Yet, the existing fund is proving to be successful, according to a Galena spokesperson.
“We are planning to continue the asset raising activities throughout this year as this asset class is increasingly appealing to institutional investors. The fund is currently managing a well- diversified portfolio of syndicated transactions of US$75mn and is constantly optimising its stance in terms of financing structures, commodities and geographies.”
The spokesperson adds that the fund is expecting a performance this year in line with its target of returning 500 basis points over Libor net to investors. He puts the success of the fund partly down to the retrenchment of the banking sector.
“The situation with the European banks created a positive environment for the commodity trade finance fund, especially in the last quarter of 2011. The exceptional concurrence of different factors such as the lack of US dollar liquidity, historically sustained commodity prices and increasingly stringent regulatory requirements for financial institutions has increased banks’ willingness to syndicate high-quality transactions,” he says.
However, the fund is keen to indicate that in no way is it a competitor to the banks, placing its focus on the secondary market and partnering with banks.
“Replacing the banks and becoming a direct lender in the commodity space we are proficient in would require large resources both in terms of people and capital,” the spokesperson states.
The trade funds
Other trade finance funds, many of which have been around for a number of years, are observing a change in the trade finance lending landscape.
“In October and November last year, we saw a pick-up in sales by banks of trade finance exposures to the fund, especially in the pre-export finance area, when the European crisis flared up and US dollar funding became very expensive for many European banks,” remarks James Parsons, portfolio manager at BlueCrest Mercantile Fund, a specialist non-bank investor in trade finance exposures.
He notes that volumes resumed more normal levels once the European Central Bank’s LTRO temporarily reduced funding pressure. However, he has observed a change in attitude among banks towards funds, in that a broader range of banks are looking to sell down risk to them.
“When BlueCrest Mercantile Fund started in 2006 only a few of the larger and more sophisticated banks were interested in selling risk to the fund, while many banks were simply not prepared to do the work to find out how they could sell down the risk to funds,” Parsons notes.
He remarks that from mid-2011, there was a “big jump upwards” with many more new banks approaching BlueCrest.
This interest is driven by the increased capital ratios banks have to meet, which Parsons argues is forcing many banks, particularly European ones, to move from an ‘originate and hold’ model to a model where they have to actively manage or distribute more of their assets.
“As a consequence we are seeing much more interest in techniques for achieving capital management and risk distribution in a sizeable, systematic and continuous way, such as securitisation,” remarks Parsons.
Yet banks will, he believes, remain the main originators and structurers of trade finance transactions. “We don’t think it makes any sense nor would be feasible for any other type of financial institution to be the primary originators of trade finance,” he remarks.
James Prusky, partner at the US-based trade finance fund, Crecera Finance Company, has seen an increase demand from its borrowers. Crecera focuses on small and medium-sized companies operating in Latin America, and these enterprises have seen decreased availability in lines as a result of European banks cutting their lines to regional corporates or to the local banks that would usually finance these companies.
He also notes that more banks are approaching Crecera to find out how the company securitises its trade finance transactions.
“Banks are inquiring as to how we operate our fund, and how we provide these trade finance transactions to private investors. This is what we have been doing for years now, bringing in new categories of investors, including university endowments, multilaterals, family offices and institutional investors. They are participating in trade finance in a way that very few private investors are,” he remarks.
Packaging up trade
Given the experience of trade finance funds, it seems that banks are becoming extremely eager to sell off or at least share trade finance risk and therefore boost their liquidity.
Such market sentiments were expressed by Jacques-Olivier Thomann, then managing director of BNP Paribas’s Geneva office (he is leaving his role at the end of April) during a commodities conference in March.
He reportedly told delegates that the bank would be exploring methods of creating some form of triple-A rated trade finance asset to sell to investors. He added that the aim of such a scheme would be purely to raise liquidity and that the bank would remain exposed to some trade finance risk and not sell off everything.
In April JP Morgan reportedly began testing investor appetites for such trade finance securitisations or CDOs, but more banks are expected to jump on this bandwagon.
However, the concept of banks doing trade finance securitisations is not a completely new phenomenon. Back in 2007 Standard Chartered closed its first synthetic securitisation of trade finance loans in a transaction known as Sealane. Phase II of this transaction was closed in 2011.
The transaction was structured as a collaterised loan obligation (CLO) and involved Standard Chartered selling the credit risk of a diversified pool of 13,000 trade finance loans extended to more than 1,500 borrowers.
But as the implications of Basel III hit home, banks’ interest in securitisation methods has inevitably grown, and the market expects to see more and more of these types of transactions.
“I believe JP Morgan’s securitisation of trade finance obligations in April is a landmark deal. We will see more and more like it. Indeed, several banks have already told us there are working on something similar,” confirms Alzarka at Falcon.
What is key to the success of these securitisation programmes is that investors have a clear understanding of what trade finance is, something potentially lacking at the present time.
“Investor appetite for trade finance securitisations is still scarce because they don’t always understand this market. But understanding will come and prices will come down,” argues Falcon’s Alzarka.
“In this respect the market is making slow but steady progress. And when investors begin to understand that trade finance is one of the best-secured asset classes, the change will speak up. Falcon is already working with a couple of our banks on similar solutions.”
The spokesperson at Trafigura’s Galena also confirms that it is likely banks will look to securitise part of their portfolios as a way to circumvent regulations and the US dollar funding issue, but there will be a number of obstacles for the banks to overcome first.
“It [bank trade finance securitisation] is a totally different offer to investors [compared to Galena’s commodity trade finance fund], as banks will probably sell only the highly-rated tranches backed by blind pools of assets selected by the bank themselves. It is a real challenge and many banks have been working on this for several months now,” the spokesperson says.
Only a temporary fix
Despite the chatter surrounding the concept of securitisation, there are some that suggest it is not the panacea for the lack of lending capacity in the trade finance market. First of all, the use of the term CDO has become somewhat tainted by the role of mortgage-backed CDOs in the recent global financial crisis.
This might lead to fears that the reputation of trade finance being a low risk form of financing could be damaged.
“My concern is if the banks start doing this that it actually could dilute the high credit quality of trade finance through packaging it up, essentially allowing the inclusion of less creditworthy loans, similar to what happened in the previous crisis
with mortgage-focused CDOs.
This would create a negative effect on the whole sector and could have a greater negative effect on the ability of companies to trade with each other,” comments a source familiar with the securitisation market.
Speaking at a GTR commodity-focused roundtable held in April, John MacNamara, managing director, global head of structured commodity and trade finance at Deutsche Bank, argues that trade finance-related CDOs would unlikely lead to any of the negative consequences seen with mortgage-backed CDOs.
“That is simply not what you have got in trade finance when referring to trade finance CDOs. Do we say, ‘It could not happen here’? Hopefully it could not happen here, but who knows how inventive people will get. But the great thing about trade finance is that there is an underlying real transaction, where real people make real goods, move them from A to B, and real people consume them at the other end.
“If you stick to that real world asset conversion cycle, then we are in the socially valuable part of banking and finance, and as the trade finance default register shows, it’s one of the lowest risk ends of the market.”
There is still much work to do be done in creating a trade finance CDO that would be attractive enough to investors, with a robust enough structure to meet regulatory requirements.
It is therefore doubtful that CDOs will be the sole solution to the trade finance lending capacity problem. Indeed, Crecera’s Prusky refers to the CDO notion as a “temporary fix” in reaction to the impact of Basel III on trade finance.
However, it will form one element of an increasingly diversified pool of liquidity for trade and commodity finance being developed, and it is evidence that the banks are beginning to think up new tricks to help them operate in an ever-evolving lending environment. GTR