In light of April’s G-20 talks and announcements of large-scale packages aimed at revitalising world trade, the feeling among UK banks brought together by GTR for a roundtable was far more upbeat than perhaps it might have been six months ago.
Looking at the whole spectrum of the trade finance market, participants discussed both UK and global efforts to kickstart trade and get liquidity flowing again.
Despite a degree of optimism, there were concerns raised that the UK government, and its export credit agency, ECGD, still need to do more to match global efforts to support exports.
If not, the UK market could be left behind as more attractive financing opportunities present themselves elsewhere.
The roundtable was kindly hosted by HSBC.
Robert Parson, partner, Reed Smith
– Peter Luketa, global head of export finance
– Stuart Nivison, head of trade & supply chain, Europe
– Andrew Betts, global head, trade finance & supply chain
– Iain MacDonald, head of trade product, global cash and trade
– Garry Morgan, head of global trade risk
Lloyds Banking Group:
– Tim Hart, director of origination, structured trade finance
– Mike Gilham, director, international finance solutions
Standard Chartered Bank:
– Charles Carlson, global head, structured export finance
Parson: What effect will he ICC, WTO, World Bank and G-20 initiatives have on increasing available trade finance liquidity?
Nivison: I’d probably take a step back first, and have a look at where we are, before we have a look at what the impact is going to be, because the two are intertwined.
I think if we had a G-20 meeting this time last year, it would have been virtually out of the question that the top 20 leaders of the world would spend the amount of time they did on trade finance. So it’s a real measure of how big an issue it is at the moment.
We kept getting told that world trade has reduced for the first time in 25 years, and reduced significantly. I think the World Bank figures were estimating a fall of 6.1% in trade globally this year. Within that, the World Trade Organisation (WTO) is estimating a 9% reduction in export flows globally. We’re certainly at the low point in terms of flows of commodities; so why is there a shortage of trade finance?
Then the World Bank’s Bob Zoellick comes out and says that of the decline in world trade, about 90% is due to an underlying decline in demand, and 10% is due to trade finance not being available.
So there’s an immediate disconnect there between supply and demand. And the reality is that if you look at the markets (and it’s not just a UK issue), there’s been a fundamental change in the number of banks providing trade finance, and the amount that they provide.
We’ve seen a number of the international banks pull out of countries that they used to be in or they are reducing their appetite in– they’re certainly not increasing the finance that they provide – so you have fewer providers on the origination side.
Banks have to look closely at the risk weighted assets in their balance sheet usage. And it’s clear that if you have a long-term financial commitment at the long end of the balance sheet, it’s pretty difficult to actually reduce the risk weighted assets significantly.
But at the short-term end of the balance sheet, it’s quite easy to start cutting back on working capital lines – and clearly some banks have begun doing that.
So you’ve got fewer banks, and some of those providing less, but you’ve also got the secondary market, where a lot of the originating banks would take 10%/20%/30% of a transaction and sell it into the secondary market. And that secondary market has largely dried up now. So you’ve got that sort of added multiplier, where even if someone is still in there and used to provide what seemed like 100%, they can only provide a smaller percentage of it now.
There’s a lot less availability on the market, which has driven up pricing and caused this great concern that a lack of trade finance will stifle any growth whenever it comes. Hence the G-20 focusing on it.
The fiscal stimulus packages that we’re seeing across the world, which are going to increase demand for raw materials, for steel, for construction equipment, for equipment to finance the roads and railways, the schools and the hospitals – that hasn’t kicked in yet. Commodity prices continue to be depressed. And on the consumer and retail side, there’s reduced domestic demand.
Companies are meeting the current domestic demand through running down their stocks that they hold. So even the large companies that we would expect to be importing on a regular basis are reducing the amount that they import in order to reduce their leverage and to build themselves a buffer.
As and when people do begin to start buying again, you’re going to find that actually the stocks aren’t there to support any increase in demand. You’re going to find a jump-up in imports, probably at short notice, and you’re probably going to find that the commodity prices will go up. You can expect the volumes to increase, hence the need to make sure that trade finance is there to support it whenever the revival comes.
Another problem in trade finance is that everybody is looking at cross-border risk, inter-bank risk and inter-company risk, and companies that were happy to trade open account are now looking for means to cover their risks.
They say “credit insurance isn’t as easy to get as it was, so I’ll go to a bank and try and get them to help”.
So, when it comes to what impact the G-20 and the other recent interventions are likely to have, we’ll only know for certain when we see the detail of just what those interventions and what those means of support are going to be.
I think it’s fair to expect that it will involve the multilaterals – we are already seeing the IFC announcing that they are increasing the amount of coverage that they will provide – and the EBRD and ADB are announcing similar plans.
But it’s going to have to involve the various ECAs moving back to shorter-term cover.
Parson: So world trade is a US$15tn business. They say two-thirds of that is covered by trade finance. Is the proposed US$250bn from the G-20 communiqué going to make an impact in bringing us up?
Carlson: It’s definitely a boost but we’ve still got a long way to go. I think the efforts being made by the multilaterals will be helpful, but on the condition that there is some form of public-private partnership going on.
I think we will also see a mixture of liquidity provision programmes and risk cover initiatives. We are also seeing some signs of government aid budgets going into trade finance. I am very optimistic.
Parson: What do you want to see in terms of detail behind the various packages to really get money flowing again?
MacDonald: The package proposed at the G-20 is just one angle of proposed support, but what we would really like to see from all the packages and initiatives is how they will filter through to help us help our customers. For example, we have the work that the ICC is doing on trying to get a revision of the treatment of trade finance in Basel II. If these attempts prove to be successful, then the banks will be able to give consideration to providing more trade finance facilities and with more flexibility over price as their capital costs are reduced.
In terms of the G-20 and IFC announcements, we are now getting greater clarity over how the programmes will work, although some of the details have yet to be ironed out.
One example of what we would like to see is how these packages will help us to share country risk and bank risk so that we can offer even more support to our exporters looking to confirm letters of credit.
Especially when the secondary market continues to be restricted, new options for risk sharing are important. Ultimately, this means greater ability to support more of our customers’ transactions.
Parson: Is that a mixed message though, in terms of changing Basel II when most people are howling out for regulators to introduce more controls and regulation?
MacDonald: For sure, it’s a difficult time to start asking to put less capital aside, which is effectively what the banking community is asking for trade finance. However, we’re asking for fair treatment for trade assets that is based on a fuller understanding of the lower risk profile of trade finance. The reality is that trade finance has an extremely good loss given default track record and has preferred payment status in event of country default. However, we need to prove this to the regulators through hard data. Basel II was not designed with trade finance in mind and prior to its implementation, market commentators were already highlighting the flaws applicable to trade. The reality is that finding meaningful loss data for trade finance is difficult and this is proving the major stumbling block to gaining recognition among the modellers and hence the regulators. We’re simply demanding controls that are relevant and a better fit for purpose.
Parson: Do you see these measures creating an avalanche of new money or will there still be another 12-18 months of tight liquidity?
Luketa: I think the shift in liquidity has already happened. I think banks are prepared to support certain areas of business that make sense to their client base. And I think that trade finance has clearly won.
I’ve also seen signs already in the last couple of months that the banks that practise export finance are getting back in the game. Although not in the same way as before – certainly not underwriting, but certainly in the game of clubbing deals.
So, I think liquidity is less of an issue today then it was six to nine months ago, when it comes to priorities.
But I would also echo earlier views about whether the ECAs will support on the short term. I think they will, certainly. We’re seeing that in other parts of the world, anyway.
I think the UK is inevitably not ahead of the game. It hasn’t been for some time, unfortunately, but I think now it will start to catch up.
Parson: Who do you want to see writing the cheque? What’s the right outlet for this money? There’s talk of persuading the ECAs to be pulling the money out.
Carlson: The desire to help exists with agencies like export credit guarantee department (ECGD), which are probably best placed to take a lead on this. However, the reality of the situation is that many of these agencies might not be set up to take on these responsibilities.
Nivison: There’s no-one I’ve spoken to that doesn’t think that the ECGD is a logical route forward.
The challenge they and many of the other ECAs will have is that it’s been many years since they were involved in short-term cover, and from a sheer personnel and experience point of view, the people that were experienced in this aren’t necessarily there anymore.
In addition, you cannot put the same degree of government due diligence into the invoice finance of a small export to an emerging market as you can in, say, an aircraft or a power plant, or other long-term projects.
They’re most likely going to have to go through the route of a partnership approach where they participate in risk, but where a lot of the due diligence in the underlying transaction is carried out by the banks themselves in terms of portfolio management, credit risk management, transaction verification and customer due diligence.
It’s impossible to treat it in the same way as project finance. There’s a different approach needed, and the resourcing challenges that come with that are going to be one of the biggest challenges in terms of execution.
Hart: It is a question of priorities, from a Lloyds TSB perspective, as one of the largest UK banks, we need to support UK plc in the first instance. Nonetheless, we have good expertise in the trade arena, specifically in structured trade solutions where we have developed a good quality portfolio of business partners.
In terms of ECA financing, not withstanding that there are short-term initiatives currently being looked at, liquidity costs for some banks in the medium term are prohibitive.
Nivison: But you made a particularly important point there in terms of allocation of capital and prioritisation.
Going back to the discussion on Basel II and the regulatory framework, there was an open letter from the ICC to Financial Times at the end of last year, which discusses the procyclicity of Basel II and the impact of this on banks.
It talks about the fact that Basel II is predicated on counterparty risk. And by nature, in an economic downturn, the probability of default of the average company goes up, so therefore, the required capital goes up.
This is irrespective of what you’re lending to – whether it’s trade or not – so on a constant capital basis, the amount of lending that you can do reduces. So what we are talking here is actually about capital requirements increasing as things get worse, and that has a counter-cyclical effect which affects liquidity, availability of credit and this can heighten the possibility of defaults.
Arguably, instead there should be a framework which increases capital requirements in good times and eases capital requirements selectively in times of crisis – so that you can use that capital more effectively where you want it.
This is not about broad-brush lending to everything that moves, but it is wholesale acceptance that trade finance is insufficient and there needs to be more of it.
Parson: Are banks talking to each other now? Is that going to help banks get the limited funds that are out there to the right people?
Morgan: Yes. But just to return to some early points. The trade finance community needs to assist in streamlining access to these multilateral programmes. Previously it has been a bit of a stumbling block for a number of banks. For example, banks lay off risk in the EBRD trade facilitation programme, but most of the money earned in those types of transactions is paid to the guarantor and you, the bank, end up with the operational risk, marketing costs and so forth, which have to be covered with a very fine margin.
With regards to ECGD, it came out of the short-term market because of the claims record for its short-term cover, which meant that claims paid significantly outstripped premium, contrary to the principle that ECGD be self-funded. It transpired that amongst other things for the ECGD short-term policy there appeared to be a disproportionate number of marginal or poor deals. If ECGD goes back to short-term finance, which we as banks welcome, then it needs to be treated as a partner not an insurer of last resort.
All of us have also seen deals dressed up as trade in the previous benign credit markets when we had suspicions these were simply balance sheet financing. So when we argue that trade is a preferred asset class, a lot of our credit guys will say: “What about these other deals that you said were trade, but were not in fact genuine trade deals.”
But yes, in answer to your question – of course we talk to each other. A number of us are on various forums with Baft and the ICC and I think we all have a common purpose.
On the topic of Basel II, it is here, and it is too soon to radically change it – but we do need recognition that short-term trade does need to be treated differently. We all use the same generic grade calculation for counterparty risk regardless of whether the transaction is capex, trade finance or balance sheet financing. What we need to do is demonstrate to our respective regulators that genuine trade transactions should be treated preferentially. But for this to be successful, we need as a group to be able to support our case with tangible data to demonstrate that trade finance, for the most part, works well in stressed credit conditions.
Parson: But are you talking that bit more at the moment to ensure that money goes in the right direction?
Hart: Of all the segments within the banking industry, I think that trade bankers definitely tend to speak with one another on a regular basis. Having up-to-date market commentary is absolutely vital, particularly in difficult times. When there is any whisper of any trouble, you are well-placed to exit a potential problem. Having up-to-date quality information is paramount to successfully avoiding the pitfalls and ensuring that money goes in the right direction.
Carlson: The other aspect is credit. In the 1990s, there was a review of how trade finance actually performed during the reschedulings and it came out very well. What we need is an update of that and it is worth pursuing because it would help in the Basel II argument. Basel II doesn’t recognise the self-liquidating nature of the trade business. You’ve got to get the data and the hard facts and we will be in a better position.
Gilham: This is definitely something that has been apparent in the ICC meetings. In order to address some of the shortfalls in terms of Basel II and how it treats trade finance, we, as an industry, need to provide the data to substantiate what we all know to be low default rates and low issues of non-repayment due to credit issues.
Without an industry response, without the banks actually sharing information through a conduit such as the ICC or an impartial body in that way, I don’t think we’ll be able to change this.
Parson: One of the thoughts that is bound to come out of the G-20 announcements, is that people are going to look at the papers and say: “Fantastic, US$250bn in trade finance – but who is going to look after it? Are we going to trust the bankers?”
Nivison: If we don’t have banks trusting each other in trade and being encouraged to provide trade finance, then you’ve got the very real risk that as banks deleverage and reduce their balance sheets on a collective global scale, that trade finance is one of the bits that gets squeezed as a result of this.
And when world trade begins to revive, you’re going to end up with things not being shipped that are needed. Literally countries not getting rice and food and raw materials, and companies that can’t get working capital finance. And that’s ugly. And that’s why G-20, WTO, or ICC – every collective body is focusing so much on trade finance at the moment.
Betts: We all agree that trade and trade finance is a central requirement for the recovery of the economy. RBS and other banks are supporting clients throughout these difficult times.
There are also key roles to play for export credit agencies and credit insurers to provide additional risk mitigation and potentially address issues such as the removal of some level of liquidity and the pullback of private credit insurers. World trade is slowing this year, so we should bear in mind that international trade flows are reducing too.
Parson: British exporters will no doubt be wondering how this US$250bn will be of assistance to them?
Luketa: The one key factor to remember in these discussions about the provision of liquidity, is that there is no doubt that when it comes to medium-to-long-term export, which is my area, we’re not going to necessarily prioritise the smaller exporter.
So that does have an impact. But I suspect that a bank such as HSBC will have a role to play throughout the country, and we’ll have the demand coming through our retail corporate network, asking for that type of support. The problem we’ll have is the problem we talked previously about the role of ECGD, and in terms of manpower.
Nivison: Across the country there are companies that are finding that domestic demand has reduced. There’s less buying going on in the country, so they’ve got excess capacity. At the same time, sterling is struggling, so their goods are cheaper overseas.
So they’ve got a choice here: they can either just scale back and reduce staff, reduce manufacturing and try and weather the storm, or they can try and look for new markets to export to, and this is where banks like HSBC can help.
And that’s where organisations such as UK Trade & Investment (UKTI), who we at HSBC are working very closely with, can play a role on the advisory side, helping corporates decide which markets to look for, how to enter them and how to prioritise markets. It is then the duty of the banks to advise on structures and how you can get credit protection, and on how to structure an export so you can get paid at the end of the day.
And then you’ve got the ECAs in the background to help support the bank risk that is taken under those letters of credit. There is a need to separate the commercial transaction from the bank risk that’s involved.
Hart: The present economic situation is challenging for UK businesses and, at Lloyds TSB Corporate Markets, we fully embrace our role in supporting any initiative that helps the recovery of the UK economy. Although the details of this particular scheme are not fully disclosed, our aim is to make sure that our customers get the support and advice they need during the current economic downturn.
Gilham: Lloyds TSB Corporate Markets has always been relationship-focused and will continue to work with the SME market. As a sign of the commitment that we have to that market we’re holding 120 nationwide charter events to support SME businesses.
These events incorporate trade finance generally, as well as other aspects. Essentially they offer the SME customers an opportunity to come in and speak to the bank, and ask the bank questions directly. It’s also a chance to speak to some industry representatives – people like solicitors, lawyers, and the DTI will be there, the chamber of commerce, etc.
This is something that we kicked off in March, and it will be running into the year as well, and demonstrates our commitment to this market.
Nivison: However, there are going to be SMEs – like in every other type of industry – that do not survive. Some of the companies that have already failed may have failed anyway, but the crisis has exacerbated things. I think that the companies that all of us would like to focus on – big or small – are the companies that have the potential to survive, but might need the support in the short-term.
What we don’t want are companies that could have survived, not surviving because of short-term liquidity issues through a lack of finance.
One of the simplest and easiest ways that companies can ensure they get paid is through a letter of credit. But the problem you now have is that you could find yourself in the position where the banks don’t want to take risks on the counterparties at the other end. And let’s face it, the credit default swaps (CDS) on most countries have gone up, and certainly on the banks within those countries – some of them are prohibitive – and one role that the likes of the ECAs and multilaterals can provide is mitigating that risk.
If you get the backing of ECAs or multilaterals, it means that in the event of a non-payment, you don’t just have a bank knocking on another bank’s doors. Instead, you have a government saying: “We’ve supported trade with your country – your bank is not meeting its obligation.” That’s a very powerful way of making sure that the machine keeps flowing and confidence comes back from that.
Parson: Do you think our perception of risk and the way that impacts on the supply chain has changed dramatically?
Betts: Risk arguably governs the ability of banks to structure trade transactions in the current climate. For example, doing credit analysis on a supply chain where you have obligors in emerging countries makes a significant difference under Basel II. And with pure emerging market transactions, it is more difficult still, as the risk-weighted assets required to cover commercial and counterparty risk for both buyer and supplier increases considerably. Additionally, clients need to determine if they want to use their credit capacity with lenders to support their funding needs or indirectly improve working capital by providing liquidity to their supplier base. Both the bank’s and the client’s view of risk impacts these decisions.
Carlson: The multilaterals are not just looking at exporters in markets such as UK but also the importers in emerging markets.
I think we’re looking at risk differently. I think a lot of people around this table feel that Basel II does not itself recognise the self-liquidating nature of trade. But this is the role of the multilaterals to make the perception of risk in an emerging market a little more palatable.
We have to remember that it was a G-20, not a G-8 meeting, and it was also about emerging markets, not just developed markets. There is a need to have prosperity in emerging markets and there is a growing middle class there.
Hart: We will always gravitate to quality, that is to say good quality counterparties that create quality revenues. Nevertheless, whilst there will be a flight to quality in challenging times, having the ability to provide sensible solutions for our customers is what drives our trade offering and makes the business a success.
Morgan: What would you regard as being a good quality counterparty these days? If you look back 20 years, and then compare with today, some of the problems in recent months have been with counterparts in the OECD banking sector. If you look at the developing and emerging market banks, for the most part these counterparties are holding up.
Nivison: It’s not just the banks’ perception of risk that has changed, but companies’ perceptions too. We’re finding companies asking us to confirm letters of credit that you’d never even thought of a year ago. Secondly, their perception of risk of each other is changing, because, a year ago, everybody was sitting happily – at least in larger companies – and were shipping on open account terms, and in the bottom drawer, had a credit insurance policy.
Now, they’ve taken that credit insurance policy out, and have blown the dust off it, and they’ve read the small print, and they’ve either been told that the cover is not available, or has been reduced. Or even if it’s there, they’ve read the actual requirements that they’ve got, and found that claiming may not be as easy as they thought.
Hart: We’re being asked more and more to silently confirm payment obligations of large majors.
Gilham: Corporates are reviewing their trading activity and considering the payment risk in their transactions. They are now very aware and considering payment risk where they didn’t previously.
When liquidity was cheap and readily available – not just in trade finance, but across the board – they might finance a transaction by another means – through a working capital loan, through an overdraft or something not necessarily trade-related. And as those facilities are withdrawn, and as those facilities become scarcer, they come back to trade finance, not only to mitigate the payment risk, but also to create financing opportunities.
MacDonald: A key trend is a back to basics move away from clean lines towards more structured facilities. Transactions need to be structured carefully and there is an emphasis now on increased monitoring and control. Another trend is that the worsening perception of risk is driving a return to letters of credit and other documentary trade products, as exporters in some supply chains are less comfortable with open account.
Parson: Open account business has obviously shrunk. A year ago, people were saying that the letter of credit is dead, and would never be resuscitated. But now people offering and amending letters of credit have got a smile on their faces. Has the market got the capacity to cover the difference?
Nivison: Well, we got to the height where we’ve got some banks providing supply chain financing with no real regard for the underlying trade, and then selling it to the secondary market.
We’ve got a lot of the supply chain finance structures where a very large buyer could get a cheap large revolving loan, and then use that to make a return on the financing supply chain.
But now those revolving loans are much harder to get, if they are available at all. So, is there now a role for structure? I think more so than ever. That doesn’t always necessarily involve a letter of credit in it, but the point is that the lumps of cash aren’t there so you have to structure it around buyers, sellers, supply chains, underlying goods, etc.
Gilham: We are seeing requests for confirmation on LCs coming from sources that we wouldn’t typically expect to see. However, that said, perhaps in line with world trade, I think the Swift statistics actually show a decrease in the level of LCs being issued.
There is no reduction in our willingness to confirm letters of credit – we remain very keen to do so. However, we are not seeing a huge increase in the volume coming through.
This may be related to other issues, such as the ability of the importer to open a letter of credit, but is more likely due to a lack of demand for those goods in the first place as companies have been destocking.
Nivison: A year ago they were looking at the cost of a letter of credit as being expensive. Now they’re looking at the cost of not getting paid.
Gilham: At a time when they’re structuring their transactions, we would encourage them to speak to the banks to see what the expected tariffs will be. They can factor that into their margin in the overall transaction. So the fact that the cost of confirmation may have gone up is miniscule when compared with either not conducting the transaction or not getting paid when they expect. It’s something that they can manage effectively.
To return to an earlier point, there was an awful amount of liquidity that went out to the emerging markets in the guise of trade finance in the past, but in all honesty, in some instances its link to trade may only have been tenuous – and instead, was providing loans and working capital to corporates and banks.
Now, as western banks, we’re less likely to provide that sort of financing to those emerging markets, so that’s where the role for the multilaterals really comes in to fill that void and to stimulate those flows again.
Betts: It’s interesting. We’re not seeing a black and white ‘either or’ switch from open account to traditional trade products but rather a ‘what if?’ attitude from clients asking us for help. In times like these, there is scope to innovate and see what can be done to bridge the liquidity gap for companies with complex supply chains.
As capital markets have changed, a number of clients are looking for alternatives to securitisation products that still give them the flexibility to move receivables off balance sheet.
Pooled receivables transactions are an example being brought to us, more and more. With these, you can either do a pool methodology – ie assess the aggregate total facility needed for all parties – or a credit assessment of each of those debtors. So the market is changing.
Luketa: We’re doing export credit with clients we’ve never dealt with before. That’s due more to a shortage of capex financing than a shortage of trade finance. They need that kind of support and these are the clients we will be focusing on. ECGD has got to start thinking about a wider prospect.
The world has changed dramatically since the 70s and 80s, and we now see a number of other opportunities, such as the Czech Republic’s and Korean export credit schemes, which are very competitive.
Several ECAs has direct funding capabilities, for instance – and the Scandinavians are doing it all the time, and US Ex-Im has developed a powerful direct lending programme to help exporters. The UK is going to have to think about what its role is in terms of helping exporters in this business.
Parson: We’re looking at higher margins and much tighter structures, how do you see those developing over the next 12 months?
Morgan: At the end of the day, it’s not just pricing and the structure, but more importantly, are we, as trade finance banks, adequately rewarded for risk and associated costs? We need to be comfortable that the risks around source of repayment are identifiable and mitigated where possible. For example, we have financed customers against LCs issued or confirmed by prime European banks but in a few cases we have struggled to secure payment.
Gilham: In terms of pricing in the short-term export trade market, we are seeing some signs of some lesser sophisticated banks trying to bring that pricing down and not understanding the risks that they are taking. We don’t chase business based on pricing, we price according to the risk as we perceive it.
Hart: If you look at classical pre-export structures in Brazil just by way of an example – Brazil is historically a very dramatic economy – everybody has had to look very closely at the business they do in that part of the world because the global crisis has certainly impacted liquidity in the region.
The Brazilian market had a couple of high visibility failings in 2008, and of course there’s always going to be a negative knee-jerk reaction when this happens. Business in Brazil is very tight right now, and margins in that part of the world have risen significantly. We have actually seen transactions with pricing of up to 6% over Libor for deals with a two to three-year tenor for example.
Nevertheless, banks who have historically done business in this part of the world generally have a very good understanding of the market and understand the associated risks very well and will continue to do business with Brazilian exporters.
In the European market, structures are getting tighter too, and in general terms we feel relatively comfortable with the business that is available and the counterparties that are very well known to us in the commodities marketplace.
North America is very interesting and is actually quite buoyant right now. Particularly in the US around the agribusiness and oil and gas sectors – there is a tendency to look at shorter-term, 12-month and two-year borrowing base-style facilities which have become fashionable in the current climate. These facilities are very popular since they provide senior secured, over-collateralised working capital structures that can be made available to both medium-sized and large businesses. They also provide security in the business, which includes inventory, whether in tank or warehouse, and receivables. It’s an extremely popular way of funding, particularly as the facilities are secured and over-collateralised.
There is definitely business to be done where deals are sensibly structured and secured.
In the near term, I cannot see a lessening of structures or a reduction in margins.
MacDonald: A lot depends on the position and financial strength of the individual bank. The important thing is that we support our customers as much as possible and create the right structure to help them achieve their risk and financing objectives while managing our own risks responsibly. Of course there is a link between the risk profile of a transaction and the margin. So if we take structured transactions to illustrate the point, if we ensure we have control of the goods throughout the deal we may be able to lend more or negotiate a lower risk margin.
Parson: Are we seeing credit committees pushing back and wanting more structure?
Morgan: A lot of credit committees are looking at CDS rates of countries and this has in some cases meant a push back on credit limits for some regions based on the CDS rate. What we have to demonstrate is the disparity between CDS and trade finance risk rates, ie that we are comparing apples and pears.
Having said this, some might argue that if the CDS rate for a specific market is a multiple of the trade finance risk rate, why not just buy the risk (through a CDS) and do away with the operational risks and costs associated with trade transactions?
Gilham: In terms of the CDS, I would just add that there have been instances in the recent past where CDS has been viewed as a benchmark in terms of pricing for any particular risk as well, and of course, trade finance risk is very different to the drivers behind a CDS price. As such, CDS shouldn’t be used in isolation as a benchmark for trade.
Parson: With the correction in commodity finance that we’ve seen – where does that leave commodity finance? Do you see a change in the way banks view the commodity markets?
Hart: Trading in strategic commodities in global markets remains strong, with lower volumes in the US and Europe as a consequence of the recession compensated by exports to the developing economies of India and China. Commodity prices are down almost across the board and, therefore, transaction sizes are down. However, credit pricing has been increasing and we are actually seeing increases in income from our silent guaranteed and discount business despite lower transaction values.
The benefit that the customer has is that where he was financing, say, a cargo of crude oil, at those historical highs, you’re talking about US$300mn for a cargo. Today, you’re only talking about US$88mn – US$90mn.
So the impact on his ability to cover on his purchases is to his advantage because he has excess credit lines. So, for him, it’s a relief in two aspects – one, the cost of covering that finance, but more importantly, he doesn’t need the volume of lines that he previously did.
Lower commodity prices have benefited our commodity trading customers in two major ways – firstly they are able to have easier access to receivable cover, and secondly, the pressures that had mounted on their balance sheets in working capital terms has ameliorated and thus their short-term borrowing requirements are less.
In Brazil, April is traditionally the time when sugar producers are harvesting and traders are obtaining finance from their traditional off-takers, but with sugar prices radically down on where they were last year, producers and traders are deferring business in the hope of price recoveries. However, with the passing of time we will inevitably see decisions being made and business concluded.
Luketa: Some countries, such as Turkey, for example, are still quite buoyant. But what we are seeing is a tightening in terms of covenant. So instead of a straight corporate loan or straight bank loan, we’ll see some areas of increased security and elements of cashflow management.
The benefit for HSBC is that we tend to be on both sides of the equation, because we are present in many of these countries, as well as in origination countries.
Parson: Have you seen some areas that are oversupplied that people are going to draw back from? Are there any no-go areas?
Hart: Of course people are going to withdraw from markets that do not suit them – that is their prerogative. We have declined deals in some markets where our risk appetite is reduced, but we keep the situation under regular review and strive to work with our customers where they need assistance. Of course we continue to write business in LTSB legacy markets to support our relationship clients, and we will continue to give preferential consideration to those markets in which we have a physical presence and a developed understanding.
Parson: Is Russia generally considered a no-go area?
Gilham: I think you need to consider the nature of the business, in short-term trade. We might take some risks, but we will be selective in terms of the counterparty risks that we’re taking and the transactions that we are undertaking. In the short term, there is potential, whereas in the medium term the appetite may be different.
Banks will focus on their core operations and their core business at this time. There will be few opportunities to go into businesses that aren’t critical and aren’t core and don’t support their overall strategic aims.
Luketa: The ECAs are finding business in Russia in the medium term, and yet I think all of us will say that we’re all extremely cautious.
And I think the trend I’m seeing in particular is the Russian corporate risk that was being undertaken has changed again – it has gone back to bank risk – going back to state-bank risk – so you will see some deals being done that way. The trend is totally reversed. It was becoming a middle corporate market during the last three years, now returning to bank market.
Parson: Is Asia looking healthy?
Luketa: I would say it is mixed. Japan is open for business. JBIC and Nippon Export and Investment Insurance (Nexi) certainly are. I don’t think there’s any change in their attitude particularly. A number of countries are offering new opportunities such as Vietnam and Indonesia. And Hong Kong is business as usual.
Carlson: The long-term fundamentals of our core markets in Asia remain intact. 2009 will be a difficult year but we expect the downturn in Asia to be shorter and shallower. We firmly believe that Asian economies are in a better position than they were during the Asian crisis.
Parson: What about Africa?
Luketa: I think we’re seeing business there, though it’s back to the point where we’re doing it with good clients. I think we’re doing it in certain countries where we haven’t for some years. Nigeria has been a very active market in the last year and a half – that hasn’t changed. Overall, Africa is an area of opportunity.
Parson: Has anyone seen their export finance business grow through the crisis?
Carlson: Yes there have been growth and demand, despite a difficult syndication market.
Hart: More enquiries, that’s for sure.
Parson: What more could and should be done by governments, the international community generally, and by banks to make sure that trade finance does go back up, however slowly it takes?
MacDonald: We the banks need to take the initiative and avoid relying on the international community too much. Through Baft, the banks have come together to provide one industry voice and to identify solutions we can control ourselves. The support coming from the government, the combined forces of the WTO, the World Bank and the ICC is welcome and we hope it will help to kick-start the flow of trade finance. I think we’ve got enough momentum and focus there to give us what we need.
We’ve got more to do ourselves in terms of looking at the bank-to-bank market, so we don’t need to rely on the government or another body to help us, we need to make the case internally. That way we can look to do more deals on a reciprocal, risk sharing, basis.
Gilham: For the short-term trade secondary market to work, it needs to be more reciprocal-based. As banks become less opportunistic and focus on core strategies and business, if we looked only to distribute risk and not participate in transactions with partner banks, I believe that we would be less effective in the secondary market.
There are plenty of opportunities to take on transactions in the market. I would far rather participate in a transaction with a partner bank who I know will also buy transactions that I distribute. As such, there may be a preference in terms of a partner bank, which will also recognise the wider relationship.
Betts: Trade finance is definitely coming out of the shadows. Capital markets are clearly not what they were. There’s more of a focus on traditional kinds of trade instruments. If I wanted to change anything, I would encourage export credit agencies to operate more in the short-term trade finance market.
Additionally, if we discuss the loss history of trade products, I believe we would find that trade historically outperforms more standard ‘clean’ lending.
However, within existing regulatory frameworks there is limited scope to reflect this in the capital charges for trade products. Agreeing on parameters that allow trade to reflect its better historical performance would be helpful.
Luketa: Regarding the UK, it has to be competitive with the other ECAs. In particular, ECGD certainly has to get off its seat and start making things happen.
The other point I would make is about direct funding. It has been raised many times with the UK treasury and I think that would kickstart a lot of the UK export finance business.
At the moment it’s much easier to go to Sweden or US to get a dollar funded deal. If we’re not careful the UK is going to be left behind. In the 1980s, ECGD was the pioneering ECA.
Gilham: Whether the banks are in a position to support exporters – I think they very much are. There may be individual countries or counterparties that we don’t have available risk appetite to deal with. Banks won’t be writing bad business just because it’s related to trade finance, but we will look to support viable businesses and viable transactions.
And I would like to think that trade finance is due for somewhat of a resurgence as other financing opportunities diminish, both in terms of the protection it provides and the mitigation against payment risk. There are opportunities to provide working capital for specific transactions rather than the generic combination finance and Swift structures that we have seen in the past.
Nivison: In the short term, I’m very encouraged by the G-20 and the G-20 communiqué and the recognition of the importance of trade finance and the need to take action. I am very encouraged by the move of the ECAs towards short-term cover, which will help to replace some of the missing secondary market and reduce costing.
I am also very encouraged that it is pretty clear that trade finance is probably going to play a more central role in working capital finance than has been seen in recent years.
But if we’re going to take a longer term view of the problems we’re faced with today, we have to move towards a more dynamic regulatory framework, one that requires banks to raise more capital in the good times, and then enables them to use this effectively in the bad times.
I think in the near term there are very encouraging signs, and I think that the ability of the banking industry to finance international trade is much better now than it was six months ago.