Trade finance is currently facing some short-term challenges, but as global trade evolves, the medium to long-term opportunities remain compelling. Emerging markets are expected to play a key role as the unbundling of global supply chains and digitisation fuel trade growth, and banks will have to innovate to stay ahead, writes Michael Vrontamitis, head of trade at Standard Chartered.
Despite short-term challenges, outlook is positive
Over the past four decades, the growth of trade has always outpaced that of GDP. Trade growth has historically averaged about 1.4 times GDP growth, but since the 2008 peak, world exports have risen only 5% while nominal GDP has increased by more than 10%. In April this year, the World Trade Organisation also reduced its forecast for world trade growth to 3.3% in 2015 and 4.0% in 2016.
Part of the decline in trade volumes is can be attributed to China’s shift to a consumption-based economy from the export-led model of previous decades: exports are no longer contributing to GDP growth that has reduced to the ‘new normal’ of 7% from 10%+ over the past decade. The fall in commodity demand and prices, China’s reduction in demand, and other factors, such as the rise of shale gas moving global prices downward, are also at work.
In the trade finance space, there has been increased liquidity in the market place in a number of jurisdictions, particularly in Europe, China and Japan. In other jurisdictions, the supply of trade finance has also slightly decreased, particularly around de-risking and capital management, as banks increasingly focus on conserving capital and improving their returns whilst minimising risks to contend with significant regulatory challenges.
At first glance, the breakdown of the multiplier between trade and GDP growth looks like bad news. However, this breakdown is because low inflation is putting pressure on the cost of goods and is likely to be short-lived. In the longer-term, global trade growth will exceed GDP growth: McKinsey’s Global Payments 2014 report, released in September 2014, forecasts annual growth of 8% in the years to 2018.
Standard Chartered expects emerging markets to increasingly drive trade: by 2035 they will represent around 35%
of global trade volumes compared to 24% today. Trade financed on open account terms will also grow faster than trade financed under traditional documentary terms.
Trade finance is evolving
Trade is increasingly ‘unbundled’, with countries no longer trading in goods so much as in ‘tasks’ such as design or assembly, and goods are now ‘made in the world’, with components and partial assemblies frequently traded several times across borders before the final product reaches consumers. Given this, there will be greater SME involvement in supply chains and more inter-company flows within the supply chain; the supply chain will be more dispersed; and increasingly, moving closer to the point of consumption, leading to greater demand for financing from smaller corporates.
The next leg-up in trade is likely to be fuelled by a further unbundling of the supply chain, by continuing growth and opening in emerging countries, and by increasing horizontal trade in both intermediate and finished goods. This is demonstrated by the fact that the import content of exports has risen to 40% of total exports currently from 20% of total exports in the 1990s and is forecast to reach 60% by 2030.
As trade grows, it will continue to evolve. One change already underway is the growth in use of China’s renminbi, which is expected to become a G3 currency by 2020. Even as China’s economy turns inward, it will remain a global trade powerhouse, with its trade expected to double by 2020 as its companies expand globally – China’s outbound foreign direct investment is expected to surpass inbound investment this year.
Digitisation is a critical enabler
Digitisation is a critical enabler for the evolution of trade finance. It is not just about digitising trade finance, but the digitisation of trade itself. We are seeing a number of early moves by large companies, and this is leading up to a tipping point sometime over the next couple of years, where more and more trade will be done digitally, positively impacting trade finance.
Networks dedicated to facilitating the interchange of trade-related data will continue to gain ground, partly driven by the ongoing migration to trading under open account. By some measures, 80% of trade is thought to be part of global supply chains which drives open account transactions, and factors such as relative wage costs and robotics are among a number of factors that will determine if global supply chains will increase in number and length or reduce in number and shorten.
Much of recent innovation in trade finance-related networks has come from outside the traditional banking system. It has resulted in a wide range of solutions– from dynamic invoice discounting platforms to peer-to-peer supply chain finance and cloud-based trading communities – which is to be welcomed.
The multiplicity of solutions means that there is no clear leader and volumes for most platforms in Asia remain low. Consolidation of platforms is unlikely in the short term. More importantly, to date, attention has been focused on post acceptance export finance rather than
the entire supply chain. Banks will need to disrupt their own business models to compete in this evolving space. This is a great opportunity for the evolution of trade finance, and will ultimately benefit the customer.
While the real shift is expected in the open account space through an increase in innovation and risk appetite, to support unbundling of supply chains and in the process stimulate global trade growth, the traditional documentary trade business will become more efficient as companies start leveraging technology such as electronic bills of lading and electronic issuance to reduce or even entirely eliminate manual processes.
The trade finance industry – in its broadest sense – needs to find compelling solutions for trade to move towards electronic document exchange. While the cost reduction story has yet to be compelling enough to spur companies (and banks) to make the necessary investment, the emphasis should not only be on taking costs out of the supply chain, but also in transferring risk effectively, for the benefit of all buyers and sellers.
Responding to change
Standard Chartered has been responding to the challenges faced by its clients. The bank has reported robust Tier 1 capital figures under Basel III criteria and has also invested ahead of time to ensure that it can meet regulations on financial crime, for example.
Most importantly, Standard Chartered recognises the need to address companies’ entire financial supply chain rather than simply focusing on individual products or aspects of the supply chain. The bank is focusing on its clients’ eco-systems to ensure clients and their supply chains receive efficient and consistent financing and banking services. Few other banks can reach such a wide range of companies, especially in emerging markets. Standard Chartered’s business model enables it to be embedded into the supply chain at every stage – other banks often only have relationships in one segment.
Being at the heart of the most dynamic trade routes in the world, with a unique presence in Asia, Africa and the Middle East, Standard Chartered is well placed to facilitate cross-border collaboration and a comprehensive range of supplier financing solutions. The bank’s breadth means it is also able to respond to changing client needs by offering market-leading Renminbi capabilities and growing
South-South trade corridors, for example.
The bank’s teams serving each client segment work together with aligned platforms, metrics and strategy. Consequently, Standard Chartered is able to offer a continuum of solutions – across cash, trade and FX – for the entire supply chain whether a supplier is in China, Indonesia, Nigeria or Pakistan, for example. It can also avoid problems encountered by banks when implementing solutions such as supply chain finance, where the credit function and coverage functions are not aligned, making the execution of supply chain solutions in the South-South corridor a reality for our clients.
Trade finance is going through some short term pain due to economic growth and multiplier effects. As the market evolves through a combination of the unbundling of trade, the digitisation of trade and a further rise of the South-South trade corridors, the winners will be those that are able to leverage their networks and offer innovative, relevant solutions across the supply chain.