It looks likely that 2008 will join 1929 and 1973 as a tumultuous year in global finance. Yet trade finance seems to have fared rather better than most other financing disciplines. GTR asks, Can the same be said of 2009?
Many trade financiers began the year extolling the counter-cyclical virtues of their branch of the financial services industry. And, indeed, many state they have never been busier in structured trade, trade processing, and cash management. Yet the severity of the financial dislocation has meant that even trade services – an area that normally benefits from volatility – has been unable to remain unaffected.
Indeed, for many trade financiers, 2008, at least until September, was a year in the fast lane.
“The first three-quarters of the year were probably the busiest of my professional career,” says John MacNamara, managing director, structured commodity trade finance at Deutsche Bank. “The market was awash with a string of very large deals, and on top of the usual MLA and bookrunner roles, we were fortunate enough to act as agent on a considerable number of them. It’s also always something special to be the co-ordinating bank on a major deal for high quality borrowers – and it’s even better if you then get an immediate repeat mandate.”
And this was not solely for the leading players, such as Deutsche Bank. New entrants also found a relatively benign environment.
“On a personal note, we successfully started up our trade services activity on time and within budget as part of the new Abbey UK corporate banking area,” says Paul Nash, director of trade finance, Abbey UK corporate banking.
“Beginning with plain vanilla products and winning targeted FTSE names as customers, we now have a pipeline of similar companies and are launching across the UK market in 2009. We have made a great start and in the process validated the attractiveness of trade services as a wedge product in developing corporate banking relationships.”
Others focused on longer-term developments that are having a positive impact across the entire spectrum of trade services entities.
“SwiftNet’s Trade Services Utility (TSU) was a definite 2008 highlight for us,” says Dominic Broom, head of business development Emea, The Bank of New York Mellon.
“Along with a number of selected partner banks we have begun to send live transactions through the TSU across a number of different geographies, demonstrating the power of the TSU and the partnership model we’ve been advocating as the future of trade services. There has been an increase in activity for trade and treasury services as a whole – part driven by customers seeking the stability a fully managed trade service can bring them in these volatile economic times.”
Indeed, for the first three-quarters of the year, things looked remarkably stable, with most players citing familiar challenges.
“The challenges remain and continue to remain for banks to be able to respond in a timely fashion to the trade services/cash management needs of their customers,” says BNYM’s Broom. “We have responded with a series of upgrades to our trade services platforms that are serving our customers and expanding our global FI partnership network to bring true end-to-end service to the market-place.”
Abbey’s Nash adds: “Starting up a new trade service business is a major challenge addressing a multitude of issues.
“We were concerned about the Abbey/Santander brand in the corporate banking market, for instance. Also, would our latin American footprint provide a significantly distinctive profile? And would we win the corporate banking business as well as the trade activities? Indeed, we were uncertain whether a new business would be a plus or minus in an already crowded market. Having said this, starting from nothing in terms of a client base, successfully competing with the major players, for the major corporate business, in a very competitive market place, has been a gratifying experience to say the least.”
Crisis gains momentum
Yet the financial crisis, which had been bubbling along since August 2007, had appeared to be benefiting trade finance. It wasn’t until the events of September 2008, that the trade finance market began to feel the negative repercussions of the crisis.
“Initially, we were impacted very positively, since the closure of the capital markets drove even very high credit quality commodity producers to the commodity pre-export finance market, with the inevitable consequence that debt prices also went up steeply,” says Deutsche Bank’s MacNamara.
“However, in the two months since the collapse of Lehman Brothers, we have also experienced a dramatic correction across the board in commodity prices.” “This has resulted in many banks more or less closing their doors to new business while simultaneously having to cope with escalation clauses and top up mechanisms on their existing portfolios – which they probably haven’t seen in operation this decade. This has certainly inspired a degree of angst amongst those who may have been in a credit department for several years but may never actually have seen a trade-related structure used in this way.
However, MacNamara believes the market has enough resilience to work through the crisis. “Clearly, we have to show how these mechanisms work in our structures and I’m glad to see that, one after the other, the borrowers have been able to top up their coverage ratios from uncommitted production or other sources.”
This positive outlook also played out in the trade processing arena. “Both corporate and FI partners alike have sought to ensure that they are working with strong and knowledgeable partners to service their trade finance needs,” says BNYM’s Broom. “And the good financial strengths, established partner bank network and strong reputation of BNYM have meant we have continued to provide the required levels of service to our clients.”
Reflecting on trends in cash management, Marilyn Spearing, head of trade finance and cash management corporates at Deutsche Bank, comments: “While 2008 was a turbulent year for many banks, trade finance and corporate cash management activities have proved to be particularly resilient to the ongoing crisis.”
“Deutsche Bank’s global transaction banking (GTB) intends to drive growth by focusing on two key strengths: best in class products and delivery, and the capabilities of our global network.”
New players in the market are also remaining upbeat.
“In truth,” says Abbey’s Nash, “Abbey and the Santander Group have weathered the storms very well. A combination of the old and the new; Abbey the new UK corporate bank and Santander the experienced international parent. The value of Santander’s conservative approach to risk and relationship banking is now heralded as a sound policy enhancing Abbey’s corporate credibility at a time of great financial uncertainty.”
Equally, the more boutique providers of trade finance are looking on the bright side of the crisis.
“Naturally, like the whole market, prices were an issue; however our business model has allowed us to manage the circumstances successfully,” says Falcon’s Will Nagle, chief executive officer of Falcon Trade Corporation. “In many ways the role of a ‘specialist’ provider is to be nimble where others are constrained, and to fill the gap between what the market needs and what the conventional offering can provide. This year was certainly an example of that.”
Crisis becomes entrenched in real economy
Yet such a seismic event was likely to eventually have an impact, especially with respect to syndicated structured and pre-export facilities.
Deutsche Bank’s MacNamara comments: “Risk simply became increasingly difficult for banks to take, and it became increasingly difficult for those of us who rely on syndicated deals to predict who would be able to come into any given deal.”
And while trade finance is in a good position to weather increasing credit risk concerns, it is unlikely to prosper as the financial crisis feeds down into the real economy.
“The consequences of a global banking and liquidity crisis preceding and impacting upon a cyclical global recession has maybe previously only been of interest to academics engaged in hypothetical economic debates,” says Abbey’s Nash. “Co-ordinated government action may prove a key factor in mitigating its impact; and narrow self-interest may make it worse. Certainly, 2009 will be challenging for everyone.”
BNYM’s Broom says “We expect liquidity to remain tight throughout all of 2009 and for there to be a greater focus at corporate and FI level for secure solutions to help manage the pain-points”.
“Corporates are more concerned today about the strengths of their financial supply chains than they are about sourcing the lowest cost sources of liquidity. So we are likely to see a continued reversion to trade as a risk mitigant, rather than as a liquidity support mechanism.”
Deutsche Bank’s MacNamara, however, is torn.
“There is a very plausible view that this has to be the best time to go back to basics and concentrate on things like collateralised trade finance in all its forms – where the bank takes security over goods while directly financing the asset conversion cycle,” he says.
“We also anticipate that the colleagues handling the export credit agency (ECA) business are going to have a busy time since ‘government guaranteed’ is the new black, and that becomes the only way to achieve any sort of significant tenor.
“On the other hand, a lot of banks are making decisions on grounds that have nothing to do with trade finance, or even with the individual client in question. For the time being, club deals seem to be the only game in town and, sadly, the firms furthest down the food chain are going to find it increasingly difficult to raise debt commercially, which may result in the need for further intervention to help them before 2009 is out.”
Impact on emerging markets
One major area of concern for trade financiers will be the impact of the economic slowdown on emerging markets, which have, so far, remained comparatively unscathed by the financial turmoil. Clearly with recent IMF intervention in major emerging markets this trend is changing.
“The problems are still filtering through to the emerging markets,” says Falcon’s Nagle, “and will doubtless have a knock-on effect. The credit constraints are simply too endemic for it not to hit even the well-secured transactions backed by export receivables for example.
Yet the upside is that these markets, we hope, will have learned from past events and more immediate support, if required, will be forthcoming. A further upside is that lending constraints among the larger or domestic players will provide opportunities for others.”
BNYM’s Broom adds: “Most emerging markets have had limited exposure to the structured finance products that have been at the heart of the credit crunch. “Yet a slowdown in consumption by the developed markets will inevitably lead to a decline in exports from many emerging markets, and it is quite likely that whilst these markets are in significantly better economic shape than in previous downturns, there will be casualties if the slump turns out to be a prolonged one. Unlike crises of the past, this one has its roots as a developed market crisis.”
“You probably need to be quite brave to call the bottom just yet,” says Deutsche Bank’s MacNamara. “Having said that, genuine offshore cashflow self-liquidating pre-export finance structures are usually robust mitigants of country risk events whether they involve currency inconvertibility or local banking crises. Also the insurance sector, both public and private, seems to remain open for export or trade-related business.”
Future of open account business
Indeed, emerging market crises are a potential boon for trade financiers. Will 2008, therefore, be seen as the high-water mark for open account trading?
“Open account is still a very important component and one that will find it’s feet again as confidence returns to the market,” says Falcon’s Nagle. “LCs will see a resurgence in the short-term but ultimately we live in a competitive world where open account cannot be ignored and will remain in demand. Trade financiers would be wrong to use the current hiatus as an excuse for not adapting to the fundamental changes in trading patterns that have been underway for at least a decade.”
BNYM’s Broom agrees. “Having said this, there has been an understandable upturn in volumes for letters of credit and standby letters of credit in recent months – and I foresee demand for more structured solutions, to the detriment of open account. Structured solutions will come more into vogue but open account is here to stay for the vast bulk of trade activity – the world has changed too much to go into reverse.”
As for other developments in the year to come, supply chain concerns remain paramount.
“I think that corporates are going to look at a unified focus on supply chain risk management,” says BNYM’s Broom. “Not only will there be an increased focus on mitigating the financial risks of the supply chain, it is also likely that corporates will focus on managing the risks in their own supply chains – such as inventory management, logistics management, supplier financial strength, supplier concentration and even in some cases physical proximity to market.”
Others are more focussed on the banking institutions themselves.
“Consolidation among banks is going to be an issue,” says Deutsche Bank’s MacNamara. “For example, many commodity traders have seen two of their top three providers of bank lines just merge, and the fear is that 1+2 does not equal 3. We’ve also seen other banks exit altogether – primarily because it was much more attractive to get out quickly either from self liquidation of short-term trade lines or by selling trade finance positions more or less at par, than to take huge hits to exit some other sector of business which may now be completely illiquid. That said, lower commodity prices should take the edge off some of this pressure because they drive down working capital need and interest expense.”
Potential threat of protectionism
More widely, and more negatively, protectionism is a concern that may impact trade in 2009 and beyond.
“Clearly, there is concern about increasing regional protectionism and whether this will actually jeopardise global trade growth and overall global economic growth,” says BNYM’s Broom.
With respect to geographies, there is no broad agreement as to where the action will be in 2009. As expected, it may depend on the trade finance discipline being executed. Trade processing, for instance, is looking at where trade growth is most likely.
“In 2009 the Middle East, Indian sub-continent and China will be the most exciting economies to watch,” says BNYM’s Broom, “as they will suffer less from the economic travails as their governments will pump huge amounts into their economies.”
Meanwhile, structured commodity finance cannot ignore Russia and the CIS countries.
“The 800 pound gorilla in the room was, and remains, Russia and the CIS,” says Deutsche Bank’s Macnamara. “Certainly, they have been the backbone of profitability of most structured commodity trade finance teams for the past decade, and, mercifully, the gorilla is showing no sign of losing weight any time soon.”
“Latin America is the most exciting market for us,” opines Abbey’s Nash. “Having the backing of Santander is a big advantage but with Santander’s global presence and unique Latam profile, Abbey could offer something a little different that attracted companies to Abbey UK Corporate Banking through its trade services.
“Latam is the least recognised regional trading opportunity for the UK in spite of the wealth of natural and manufacturing resources and its large population. Indeed the latter provides both a competitive source of labour as well as a market for quality products largely overlooked in the UK.”
“For us they are all exciting as we are constantly seeing new opportunities and growing organically,” says Falcon’s Nagle. “In this respect it would be unfair to single out one market – we have an established presence in the Middle East, a newer but growing presence in Asia and we are the new kids on the block in Turkey and Brazil – and our ambitions are not ending there.
“The emerging markets remain the key growth focus for the world economy and trade services needs to be in the vanguard of that.”