GTR garners the views of those active in the forfaiting and trade finance market, finding that uncertainty over regulations and the eurozone crisis are key concerns.
Discussion participants:
Simon Lay, managing director, London Forfaiting Company
Lucio Matassoni, regional head, financial institutions, OCBC Bank
Paolo Provera, general manager, ABC International Bank (and IFA chairman)
Marina Attawar, member of the board of management, DF Deutsche Forfait
GTR: How serious will the impact of Basel III be on the forfaiting and trade finance market? Is it the greatest threat to your business?
Lay: Basel III in its current guise could have a significant impact on trade finance. We must hope for changes to the final version to recognise the relative benefits and security in trade finance transactions.
Basel III proposes that all off-balance sheet items have a credit conversion factor of 100%, a fivefold increase from Basel II. This large rise in the credit conversion factor for trade finance instruments could disadvantage trade finance-focused banks.
Defaults on trade finance obligations are generally minimal. The ICC issued industry data, covering 5.2 million trade finance transactions over a period of five years, confirmed that trade finance has historically had low default rates, even during the financial crisis.
Sourcing of good quality new business is a constant challenge facing the forfaiting and trade finance markets, as world trade into emerging or developing countries remains fairly depressed. There are also concerns about ongoing financial strife in Greece, Portugal, Spain and Ireland as well as the conflict in Libya and certain Arabian Peninsula countries.
Matassoni: I believe Basel III should relax its provisions on trade (particularly where it states that 100% of trade financing should be accounted for in terms of use of capital) and I believe eventually this will happen, as the increase in the trade volumes worldwide is a key priority of the G-20.
Provera: I feel confident that the financial sector’s lobbying efforts will succeed in making the necessary efforts to change some parameters. Regulators need to understand how important trade finance is to support economies’ growth and I hope that the proposed Basel III rules will be corrected.
GTR: Over the last 12 months, what trends have you seen in terms of banks’ and financial institutions’ approach to trade finance?
Provera: Relationship banking, cross-selling and the desire to achieve a proper two-way trading relationship with your counterparty are becoming more important in the secondary trade finance market.
Trade finance as we know is a cyclical product and as a result of the recent banking crisis and the return of back-to-basics banking, trade is back in the limelight and has become more fashionable. This is evident by some of the larger banks now investing heavily into the product by recruiting people and expanding their trade product offerings.
Lay: Market liquidity for assets has improved, but it is largely being driven by the slow influx of new transactions. Classic supply and demand factors have made competition for new assets much more aggressive in the last six months, resulting in pricing being driven down quicker than market fundamentals suggest they should.
To maintain transaction volumes and income levels, we have seen banks reducing their reliance upon the traditional letters of credit and structured trade finance transactions and focusing more upon commodity finance, bilateral lending and syndicated loans.
Attawar: In general we have seen an increase in appetite for trade assets from the banks and financial institutions and definitely a tendency towards ECA-covered transactions and bank risk in stable regions, usually for 180-360 days.
There is also a preference for unfunded risk participations. Anything outside that scope needs to come from a primary customer to be of interest to a bank.
Matassoni: It looks to me that there has been an increase in trade finance activity although I am not sure this has translated to secondary business; at least not yet.
GTR: What are your perspectives on pricing? Is it on a downward trend?
Provera: Generally, pricing is getting tighter for non-Mena related short-term letters of credit-based transactions.
We seem to have reached the bottom in terms of China and perhaps a small increase in pricing has taken place recently. In the Gulf Cooperation Council countries (with the exception of Bahrain) we are still seeing very tight pricing.
In some Mena markets, such as Egypt, Tunisia, Morocco and Bahrain, pricing has come off a little in the last one or two months following the peak of the turmoil, but is still higher than where it was at the end of 2010. Market prices have remained stable in Turkey over the last six months and we are not seeing too much pressure for lower levels.
Lay: The returning market liquidity has put pressure on pricing to fall. A number of financial institutions are chasing pricing down towards their own cost of funds and this, coupled with increasing capital allocation constraints, leaves a dilemma of whether to try to increase volumes, or withdraw from the market until rates improve.
Attawar: Pricing is coming down further and further for popular transactions and risks. It seems that interesting assets are scarce, and that some banks price transactions quite aggressively in order to get the deal. Having said that, Deutsche Forfait’s specialty is the longer, more difficult risk and we are quite happy with the margins that can be achieved with these transactions.
GTR: Is there growing pressure for traditional trade finance and forfaiters to develop their product range and move further into the supply chain finance space?
Provera: I believe that most serious trade finance banks also offer supply chain financing, but I do not think that there is necessarily a natural area for forfaiters to move into.
Supply chain financing tends to be short-term, high-volume, highly-tailored structures together with being fairly labour intense, and often involves large investments into technical booking systems to support the business. I believe there is pressure for forfaiters to develop their product offering but do not necessarily think that supply chain structures is the most obvious move.
Lay: In its Uniform Rules for Forfaiting, the ICC recognised these changes in product range, noting that “modern forfaiting has changed considerably over the last 20 years and now encompasses many more instruments, structures and concepts than has previously been the case”.
There are very few specialist trade finance and forfaiting players in the market, as most are divisions within larger banks. Consequently, banks tend to have separate competing divisions offering alternative financing products, so customer interface is often diluted between these departments.
GTR: What are the main risks in today’s market?
Provera: The main risks are in those economies that are overheating and for which a correction is inevitable. The question is when this will happen? The eurozone is suffering from the impact of the Greek crisis and this will inevitably affect the European banking sector and weaken its trade finance market.
Lay: We are optimistic about the apparent peace achieved in Tunisia and Egypt, as it will encourage similar arrangements in other Mena region countries to help resolve their upheaval.
These countries managed to re-establish a ‘business as usual’ level of operation without wide-scale disruption to their economies, which is a great achievement. Inevitably the regional problems have increased the general risk perception, but flight of capital to ‘safer’ environments like the UAE has improved their liquidity and international risk profile recently.
However, the crisis in the eurozone looks set to continue for some time. Problems within the economies of Greece, Portugal and Ireland are deep-rooted and cannot change overnight without painful economic measures, for which neither the population nor governments seem to have any appetite. Contagion to other markets also remains a worry.
Attawar: It is interesting to see that some Mena countries are still considered pretty safe in spite of the upheavals there.
The sovereign debt crisis, however, has such a huge potential for a dramatic effect on our markets that it seems beyond a ‘normal’ crisis perception.
GTR: Are forfaiters now returning to markets such as Belarus, Ukraine, Kazakhstan – markets that were close to off-limits to banks during the crisis?
Lay: In the search for new business there has been an inevitable return to these markets.
Re-scheduled loans are generally performing well, giving lenders the opportunity to recover value for these assets, put the problems of the past defaults behind them and focus on new business. Bankers, by necessity have short memories.
A slight setback to this generally improving trend is in Belarus where the country suffered various downgrades and the imposition of sanctions by the EU.
However, this does not seem to have impacted too much on recent syndications, which have been well subscribed, although largely by Russian banks.
GTR: Are you seeing any signs that the trade finance and forfaiting market is beginning to close more “synthetic” trade finance deals that might not directly correlate with the underlying trade flow?
Lay: Synthetic trade finance transactions were a pre-crisis element in the market, being popular with a number of commodity companies utilising their global trade flows to facilitate lending to emerging markets but not necessarily directly to the borrower’s country of risk.
Immediately after the crisis this business subsided as lenders returned to more traditional trade transactions. However, we are slowly starting to see the return of these synthetic transactions, as investors look for ways to increase their assets and yield.
Provera: We are not seeing signs of more synthetic transactions being finalised, but perhaps that is mainly because we stay clear of them. In general I believe that banks still require quality trade transactions and this synthetic market will never be significant.
The key is for the market to encourage and insist on transparency so that there is no doubt what kind of transaction one gets involved with. GTR
