Finbarr Bermingham reports on the rise of alternative trade finance and how it might affect the roles of banks in the market.


In an orderly, modern office in London’s West End, GTR is sat before a senior director of the asset management arm of one of the world’s major commodities traders. He’s speaking, in measured, carefully chosen words, about his company’s commodity trade finance funds: its oil, gas and metals lending, participation in syndicates and the potential raft of regulation that might be headed his way. It’s difficult to reconcile this spacious, well-lit office with its wall of windows looking out over the city’s main shopping district with ‘shadow banking’, the term used by authorities to describe any form of non-bank lending.

Shadow banking is not a new thing – markets have always been in part capitalised by non-banking financial institutions (NBFIs). But in the face of the regulation sweeping the mainstream banking sector, it has come to prominence in recent years. The term is often used in reference to commodity traders acting as lenders of note and its usage has escalated in 2013. Earlier this year, traders Vitol and Glencore teamed up to offer a US$10bn loan to Russia’s national oil company Rosneft. The loan – guaranteed by future supplies of crude – was one of the biggest in the history of the oil industry, yet there was no bank involved. While it wasn’t a trade loan per se (the finance was primarily used to purchase TNK-BP) it helps demonstrate the extraordinary financial muscle these companies wield.

According to the Financial Times, between 2000 and 2008, the profits of the world’s top 20 independent commodity trading houses rose by 1,500%. The fall-off in Chinese growth means this spurt is unlikely to be repeated, but cash-rich traders are clearly becoming more prominent in the lending markets, including trade finance, where they often lend to sections of their own supply chain to ensure the steady and stable flow of whatever commodity it is they’re trading. Morgan Stanley has forecast that in the coming years, banks are expected to shed up to US$2.5tn of debt assets. Dealogic statistics for H1 2013 show that overall trade finance volumes fell by 43% year-on-year, to just US$35bn. The gap in the market is becoming wider: somebody has to fill it.

Measuring success

“There’s no lack of liquidity,” explains the aforementioned executive – who asked not to be named – when asked why the firm established its trade finance fund. “We haven’t burnt cash. On the contrary, we’ve printed hundreds of billions of dollars! The problem is that it wasn’t being distributed. Banks are being very selective about the counterparties they want to work with. That’s had a huge impact on commodities markets: what happens when banks aren’t financing the downstream guys? Who will store the commodities? The big guys? Suddenly buffers on origination markets that are essential to the health of trade start to disappear.”

The trade finance fund, managed by former commodities bankers, is currently running nine deals, with an average ticket size of US$10mn, mainly in the pre-export finance (PXF) space. He explains that while there’s a Chinese wall between the trading and funding divisions of the company, it only works one way. Those involved in the trade finance fund can access the mother company’s data, meetings, people and networks. “We can just pick up the phone, call the guys [in the parent] and find out in a few minutes what other people would take three months to find out.” The trader’s name and reputation also allows the fund to participate on syndicates that would typically be closed to NBFIs.

“Banks always want to syndicate deals, but not to just anybody,” he says. “We sometimes get in because of our parentage. We participated in a US$3bn transaction with BP for the export of crude oil from a southern African state a couple of years ago. We bought a small piece of the transaction from a syndicate led by Société Générale. The transaction was priced at 250bps over Libor but we were able to lever the deal twice to put it out at around 500bps. Previously, if you went to an investor and told them that you could offer 5 to 500bps over Libor in the financing of commodities in Africa, you could see the blood leave their faces. The perception is changing now: there’s more appreciation of the low risk of trade finance.”

Traders can also claim certain advantages over large, cumbersome banks due to their sector experience and flexibility. “It’s an alternative way of lending,” Jacques Béglé, co-founder of specialist commodities lender Commodity Trade Invest (CTI) and former head of trade finance at BNP Paribas, tells GTR. “They have flexibility, they know the field, and it’s their area of activity. Consequently, they can take quick decisions which means the facilities they grant are the most appropriate to finance this field of activity.”

Béglé, however, is also aware of the other side of the coin – one which has drawn the ire and focus of the European Commission and its Financial Stability Board (FSB), commissioned to conduct an exhaustive study into the system by the G-8. “Nobody really knows what is going on, how much is financed and this infuriates the authorities. They can’t control this. I really don’t know what goes through this system and what stays in the banking system.”

Shadow boxing

In an age which requires banks to keep their operations fully lucid, it’s the lack of transparency of non-bank lenders which has caused the most controversy. In researching this piece, GTR took a call from the person leading the FSB’s inquiry into shadow banking who, in a delicious victory for irony, also wished to remain anonymous. “Transparency is important,” he said from the FSB’s Swiss headquarters. “If there are real risks, we have to act.”

But any kind of action would appear to be a long way down the line. In its Global Shadow Banking Monitoring Report 2012, the FSB estimates the global shadow banking system to be worth US$67tn. However, due to a lack of reporting, it is unclear how much of this is trade-related. Its main sources of concern are money market funds (MMFs), repurchase agreements (repos) and long-term lending based on short-term funding. But the data is highly unspecific and doesn’t differentiate between one form of non-banking lending and another.

At the moment, the board is attempting to establish a system-wide monitoring framework, since “authorities don’t know what’s going on with NBFIs and how much they’re lending even at a very macro level – especially with commodity traders”. However, the system would be heavily reliant on the honesty and accuracy of both lenders and local authorities in their reporting. “The system is like a national census,” says our source. “National jurisdictions collect data from a template submitted by NBFIs and then submit it. If traders enter their statistics then at least we should be able to capture some figures and this has already started. The problem is the granularity. Many authorities can’t differentiate between trade and non-trade lending.”

The FSB’s plan is to make policy recommendations once there is more transparency, but as yet, refuse to be drawn on what they might be. Speculation is rife, however, that NBFIs may be subjected to the same capital holding requirements as the banking sector and also be forced to adopt uniform risk management frameworks. The FSB assures GTR that it supports non-bank lending as long as it isn’t “very dependent on short-term funding structures, extending long-term finance or investing illiquid assets”. But the fear is that unless the data collected becomes more granular, non-banking trade finance may be subjected to the same legislation as riskier securities such as repos and MMFs as was the case with the initial Basel III framework, which would potentially be another choke on the supply of capital to the markets.

Into the light

The term ‘shadow banking’ seems a good fit for commodity traders and their subsidiaries, given their notoriously secretive natures. But there are plenty of NBFIs that happily broadcast their activities and for whom, at least linguistically, the cap seems a less snug fit. Many (arguably including the traders) lend as a direct result of the gaps in the trade finance market. They fund companies and transactions that can’t hope to obtain finance from the mainstream banking network, either due to their size, location or sector and many would be happy to comply with any regulatory reporting they may need to do in future.
Gary Isbister is the chief operating officer at Barak Fund Management, an asset management company that through its trade finance fund, finances agricultural and commodities trade in Africa. “There isn’t regulation to say we have to disclose every transaction,” he tells GTR. “But if it did come in, we’d feel comfortable that we could do it successfully. We’d prefer it wasn’t the case, it complicates our lives, but if it has to happen then so be it.”

Barak typically finances short-term repeat business in Sub-Saharan Africa (its largest markets are South Africa, Zimbabwe, Uganda and Tanzania). “One of our clients is importing large volumes of chickens to South Africa,” Isbister explains. “He has a R50mn or R60mn facility that he takes out on a regular basis.

We have an Eskom coal offtake agreement for US$2.5mn that we’re financing; another client is buying bitumen from a seller at the port and distributing it to large, South African construction companies; we have a rice project in Tanzania which we finance on a structured trade finance basis for US$500,000 on a rolling basis. They use it to finance their working capital and the rice then goes into Zimbabwe.”

He says the fund will look at any product as long as it satisfies their risk assessment criteria and they can afford it. Because the transactions are short-term, it operates at a premium compared to a bank, charging 15 to 16% on transactions. But, says Isbister, the client can typically turn the facility over five or six times a year, meaning the net costs are minimal compared with the profit margins the finance allows them to achieve. In the most part, Barak is funding transactions the banks tend to avoid. “You have to understand that in Zimbabwe,” he continues, “a lot of the deals going through aren’t the size the banks want to look at. We’re not doing the big ticket, US$30mn stuff; we’re looking at US$2mn to US$3mn at a time. A lot of the banks aren’t interested in those sizes.”

Consider CTI, run by two former trade finance bankers. The company lends to midcaps along the oil and coal supply chains that can’t raise capital from the banks. “Some of the banks’ criteria is around equity; they won’t consider your request if you don’t have at least SFr5mn, for example,” explains Béglé. “It kicks out all the small guys that have three to five transactions a year, since they may not have the level of income banks require in order to lend.” He goes on to explain that such companies are often also fearful of borrowing from larger commodity traders, since they would have to give them full visibility of their accounts. If the company looks healthy, there’s a fair chance the big boys will buy them out.

Bringing sexy back

They say it takes two to tango, but in this case, the buy side has come late to the dance. There is certainly demand to be satiated from borrowers, but it’s also worth exploring why Barak’s and CTI’s investors – and thus, investors in general – are increasingly keen to buy into trade transactions. Led by non-banking lenders, capital is flowing into transactions from across the investor spectrum: from hedge funds and pension funds to the capital markets to family offices. Trade finance is at the nascent stages of being repackaged as a distributable asset.

“For a long time trade was viewed as the ugly duckling,” says Marina Attawar, a director at DF Deutsche Forfait, which has just launched its first trade finance fund. “I remember when sub-prime was on top, I had a friend working at a top bank in Germany and he would say: ‘Go away with your little €2.5mn deal, give me a break! I have this really top, ‘A’-rated sub-prime asset and I can do €50mn in half an hour…’ But now he’s out of a job. In the past, people would wonder what was attractive about financing 150 trucks. But it’s important for a real economy. You’re connected to a real economy and investors like that.”

Béglé reiterates the notion that investors are keen to finance something tangible. “You can feel it: it is commodities, which is sexy, I guess. You have an underlying asset which is liquid and short-term, because it’s traded. It’s collaterised – there’s a pledge on the goods, and it’s self-liquidating – it’s a loan repaid by the transaction itself. It’s easy to understand: what you put in, you get back.”

Trade finance, then, has been a beneficiary of the times. It may not have the high yields of some other areas of investment, but it’s demonstrably more secure. Last year, after months of speculation, BTA Bank, Kazakhstan’s third largest lender, defaulted on its debts. Creditors across the board were forced to accept haircuts, with the exception of trade finance, the only asset class to escape unscathed.

The banks involved were able to convince the government and regulators to make sure trade finance wasn’t clubbed in with general lenders, like the bond builders. US$350mn of outstanding trade finance debt was repaid and the other US$700mn was restructured into revolving credit facilities which will be paid in another two years, without any haircuts.

Manoj Menon, head of trade services at RBS, tells GTR that for reasons such as this, banks too are beginning to consider packaging trade finance as an asset class for investors. (As this issue of GTR went to press BNP Paribas announced the sale of a bundle of commodity trade finance loans to institutional investors.) He envisions a time in which liquidity from debt capital markets, insurance companies, commodity players and hedge funds will be leveraged by banks to fund trade finance transactions. Last year though, growth in global trade fell by 2.3% and with Basel III on the horizon, banks have been sitting on their liquidity. The spare capacity in the market means banks are unlikely to be opening the floodgates to investors just yet. But, says Menon, many will be putting plans in place to tap the markets in future.

Cut loose

Trade River is a funding solutions provider which matches Santander’s finance with SME lenders, covered by a blanket trade credit insurance agreement from AIG. Toby Lanyon, the company’s chief operating officer, tells GTR that currently just 1% of trade finance is provided by the non-banking sector, but estimates that the figure will rise to 20% in five years and over 50% in a decade. In researching this piece, Lanyon’s is the most extreme prediction of bank disintermediation we encountered.

The issue has been a hot topic of late, given the alternative finance zeitgeist of recent years, but the general consensus seems to be that despite more diversity in the lenders pool, there will always be a role for banks to play in transactions.
For a start, some of the lenders, such as CTI, would happily utilise the funds of banks in order to offer credit lines to their own clients. “If the bank feels comfortable and wants to give us leverage, that’s fine, we’ll take it,” is the view of Jacques Béglé. “Then we have a perfect model whereby we have a bank giving us leverage and we can put down the production costs. In fact, the hedge fund [CTI’s primary investor] is keen to involve leveraged solutions.”

Equally, Barak’s Isbister views banks not as competition, but as potential sources of investment. Banks don’t have the wherewithal to arrange the sort of small-scale transactions that Barak specialises in. But by co-financing some of Barak’s deals, they can gain access to the high returns without investing their own time and resources in co-ordinating. This arrangement acts as a security buffer for Barak and is something they’re hoping to utilise more as the fund grows. Investors typically have a three-month lockdown period, meaning if they need to withdraw, they must give 90-days notice. Partnerships would mean that if a number of investors wished to withdraw simultaneously, the fund could tap liquidity from the banks.

But perhaps the most overwhelming case for the future of banks in trade finance is the structural expertise they bring to the table. In deals over a certain size or of a certain nature, it’s inevitable that the banking channels will have to be utilised in some way or another: be it the issuance of a letter of credit, providing supply chain finance or collection services. Banks are so intrinsic to transactional business they’ve made themselves almost impossible to ignore.

In March, the Asian Development Bank released statistics showing that US$1.6tn of global trade finance demand went unmet in 2011. A month later, the ICC’s banking commission published a study showing that trade finance transactions are more than 30 times less likely to default than other forms of lending. The likelihood is that non-bank lenders will continue to put two and two together and increase their involvement in trade finance. On the other hand, banks won’t give up on big ticket transactions at all easily. But as the statistics show, this town is big enough for both.