Challenging macroeconomic conditions are driving demand for trade finance, while simultaneously exposing financiers to a higher level of risk and complexity. However, so far, the market is attracting not only existing funders of trade assets but also new players, according to new research by Demica.
In its 2023 Benchmark Report for Banks in Trade Finance, the tech-based working capital solutions provider found that 78% of banks operating in the global trade and supply chain finance space saw their trade finance books grow in 2022, with 74% expecting this to continue this year.
Over half of respondents attributed this growth to rampant inflation in many economies, while higher interest rates and more challenging conditions in the capital markets are also pushing corporates towards working capital finance as a means of securing liquidity.
However, in a world where economic fragility abounds, providing financing for trade assets is not without risks, especially against a less-than-resilient financial market backdrop. Earlier this month in its Global Financial Stability Report, the International Monetary Fund warned of a “perilous combination of vulnerabilities” in the global financial system following a number of “severe tests” – among them the recent downfall of Credit Suisse, which marked the first failure of a systemically important bank since the global financial crisis.
To understand whether funder appetite can remain strong in the face of ongoing market turmoil, GTR speaks to three experts: Adam Barrett, head of distribution at Demica, Stephanie Betant, head of global trade and receivables finance at HSBC UK, and Admir Imami, head of trade and supply chain finance at British International Investment.
GTR: To what extent is instability in the financial sector impacting the availability of and appetite for trade and working capital finance?
Barrett: The current sentiment among institutions is cautious and nervous. In the post-Covid world, with rising rates, geopolitical issues and inflation, the cost of working capital financing has increased due to higher short-term interest rates. Additionally, some banks have seen their own funding costs rise, further affecting the cost of providing financing. This has led to a greater dispersion of outcomes, where banks are only modestly raising prices for their important clients, but more significantly for less strategic clients.
Imami: In the markets we operate in, there’s always a struggle to find the right financing for the right price, and this remains business as usual. When it comes to the dollar, specifically, there’s less availability today, simply because inflation means that the same trade volumes now require a higher amount of dollars to import. As a result, the tier one banks who would traditionally provide the US dollars needed to large local corporates no longer have efficient US dollar liquidity. However, that has created an opportunity for the tier two banks to try and bank higher or better risk with the dollars they have, and we are seeing that shift in countries such as Kenya, for example.
Betant: In many ways the recent turmoil has had limited impact on access to trade finance. The longer-term implications are likely to lead to a shift towards more structured, short-tenured or self-liquidating structures that are asset backed, financing companies closer to their actual working capital needs. This would more directly reflect funding institution repayment maturities and point more toward trade finance solutions. This is not just cross-border trade, but supporting how our clients engage in commerce.
GTR: What do rising interest rates mean for the attractiveness of trade and working capital finance?
Barrett: We are experiencing an overdue correction, driven by higher short-term rates and the normalisation of market conditions. This follows an artificially benign environment that has persisted for around 15 years. Despite the adjustment, the long-term trend for working capital financing utilisation remains strong, especially for larger corporates. Although pricing conditions will normalise, making this form of financing slightly more expensive, it will still offer flexibility and more competitive pricing compared to unsecured funding or other capital market alternatives.
Betant: With the rise of global interest rates, corporates have increased the focus on their working capital cycles, something which, unlike the former, they have influence over.
Putting the emphasis on the length of trade cycles and improving working capital requirements will in turn reduce their financing needs – mitigating the increase in interest rates. This has led to a broad review of supplier bases and supply chains, further accentuating the post-pandemic trends of country concentration, near-shoring and regionalisation of supplier bases.
Clearly supply chains take time to change, however, clients are able to look to working capital optimisation solutions to reduce financing needs. Term harmonisation across suppliers and buyers, inventory management including reduced stock keeping unit numbers and cash efficiency across multi-jurisdictional businesses are a few areas where clients are looking more closely.
Where suppliers are based in lower interest rate environments, there could be opportunity to save cost of funds through the use of documentary trade and trade debt guarantees, with buyers in higher interest rate environments paying fee-based solutions and suppliers able to discount in lower interest rate environments.
GTR: What are the implications for banks as tighter liquidity conditions drive more corporates to consider trade finance products?
Betant: When risk appetite is restricted, we have historically seen greater utilisation of documentary trade buyer risk mitigation, while the move toward open account trade accelerates other risk mitigation tools, such as bank guarantees or standby letters of credit in order to backstop an element of seller risk, as well as an increase in the use of trade credit insurance.
Barrett: Corporates are exploring alternative ways to secure liquidity, such as focusing on committed working capital lines instead of uncommitted ones. There are long-term implications for the banking sector’s approach to working capital financing. Banks will need to hold more capital against these deals going forward, which will likely increase pricing. The collapse of Silicon Valley Bank has also highlighted potential risks associated with banks using deposits for funding, prompting banks and regulators to reconsider the structure of banks’ liability sides. This could further increase funding costs for banks, leading to higher borrowing costs for corporates.
GTR: Could current market conditions strengthen the role of non-banks as finance providers?
Betant: Every financier, either bank or non-bank, will have different capital bases, treatment and liquidity availability, and this is therefore individual and specific to each institution. The current market however has placed further emphasis on speed and ease of access to capital, as well as a harmonisation of global practices – something which partnerships will help banks accelerate.
Imami: We are always looking to diversify our partner base, which means working with existing and new partners to support trade in more fragile countries and/or be countercyclical. We see that there is a disconnect between commercial bankers and asset managers when it comes to trade finance as an asset class. Commercial banks will originate assets and trade them with each other. Asset managers are not set up to buy those assets on single transaction basis.
Having said this, prior to the war in Ukraine, there was a more compelling case for these investors to invest in trade finance-related assets, because broader rates in the market were low and they could receive 7-8% per annum on the trade finance asset. With rates now having risen towards the 5% mark, there might be less of an incentive. However, the asset class is still seen as a good part of an overall portfolio strategy, as an uncorrelated allocation to the market volatility but also an opportunity to generate impact or invest in ESG-related trades.
Barrett: Our funding network includes over 250 organisations, with approximately two-thirds being banks and one-third non-banks. We are noticing that a number of large non-bank institutions are starting to become much more active in providing this type of financing, although the origination model that they use is one that’s undergoing constant re-evaluation, because it is quite hard to build a portfolio of transactions, particularly if they’re short term. Non-bank funders also face the challenge of higher funding costs compared to banks, but despite this, they are still becoming more active, contributing to the growth and diversification of the funding pool.
GTR: What will be the main trends shaping the trade and working capital finance market from a funder perspective over the coming months?
Barrett: The first takeaway is that despite – or perhaps because of – the headwinds we’re currently facing, demand for such financing remains strong and is growing. This is reflected not only in our pipeline of opportunities but also in our back book, where we provide services for a range of existing transactions. Many of these are growing as companies’ demand for working capital increases, even for existing deals.
Secondly, the market continues to be opaque in the sense that there are no public prices for transactions or public information to derive pricing. Instead, private bilateral transactions are taking place, resulting in a broad range of pricing outcomes on deals. Different funders are pricing transactions in quite different ways, which may not be well understood, even by the funders themselves.
Lastly, as a structural trend, a much broader range of businesses are looking to access working capital financing today than was the case five or 10 years ago. Lenders are looking to meet this demand, with some now set up to cater specifically to sub-investment-grade companies, offering access they never had before. Some lenders have established themselves to handle small deals, for borrowers who previously wouldn’t have had access to such products. Additionally, the range of jurisdictions and the types of financing available in this space continue to grow. To serve these new consumers, funders will need strong operational processes and simple and intuitive customer experiences. In summary, despite short-term volatility, long-term trends are leading to growth in the asset class.