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The campaign to get better regulatory treatment for trade finance definitely gained momentum at this year’s IFA meeting held in Berlin in September.

As well as the usual networking opportunities, dinners and drink receptions, there was far greater fervour in finding a way to protect the trade finance market from potentially damaging developments such as the proposed Basel III rules.

One of the keynote speeches was given by Donna Alexander, chief executive officer at Baft-IFSA (the Bankers’ Association for Finance and Trade). She told delegates how the Basel committee’s recommendations on capital and liquidity have had unintended consequences for trade finance. Despite the recommendations being created to avoid a re-run of the financial crisis, she argues that they have the potential to damage world trade by impeding access to trade finance.

Alexander outlined Baft-IFSA’s lobbying action to date, which includes two comment letters to the Basel Committee, one of which explains how the proposed treatment of trade finance under new capital requirements could result in higher costs for trade finance transactions, and may lead to banks diverting capital to other financial instruments.

Faults in risk assessment
But it was not just the proposed Basel III regulations that came under scrutiny, other presentations highlighted how even current risk assessment models can penalise trade finance assets unfairly when banks compare them to other financial products.

Silja Calac, head of trade risk management at UniCredit, noted how current methods of generating key performance indicators (KPIs), used by banks to compare the profitability of different transactions, are not completely accurate in their assessment of trade risk. Variables involved in such calculations include comparing costs of equity, operating costs, and tax against interest and fee income and the return on regulatory capital.

When calculating KPIs for trade deals, a bank should take in additional factors such as low default rates in trade finance.

She argued that when calculating KPIs for trade deals, a bank should take in additional factors such as low default rates in trade finance.

“We have seen at UniCredit that over the last 10 years the default rate for guarantees and post-financing was near to zero,” Calac told the audience.

There is also huge cross-selling potential generated by closing trade finance transactions. Trade finance products are often used as an entry product with clients, with the aim of ultimately encouraging further business with other banking divisions.
In addition, there is a large fee income from trade transactions that are not taken into consideration by current risk models.
“If I forfait an LC, I will also get the negotiation fees and advising fees,” explained Calac.

Getting a fair deal
Calac also reminded the audience of the need to ensure that trade finance gets preferential treatment under restructurings (referring to the Kazakh BTA Bank case), and the need for clear rules to govern the market, such as the already established UCP regulations and the uniform rules for forfaiting (URF) currently being developed by the IFA and the ICC, of which the first draft has been completed and is under review.

Talking to GTR after the conference, Calac expanded on her concerns: “What seems very time-consuming is that on a management level you have to renegotiate the applicable KPIs all the time with different stake holders.
“And this is certainly due to the fact that the risk assessment models are not well adapted to the specificities of trade finance.”

“It is great to see that our business is now getting organised and takes a more active role to improve the future of our business.”

She notes that she is pleased with industry efforts to lobby Basel: “I think it is great to see that our business is now getting organised and takes a more active role to improve the future of our business.

“I think this is really a crucial issue for all of us: if trade finance is getting as expensive as plain vanilla lending from a RWA [risk weighted asset] perspective, it will be hard to convince our customers to accept all the handling fees and documentary constraints.”

The issues surrounding Basel II treatment of trade and commodity finance products were also tackled by Paul Coles, regional head of trade asset management, at RBS.

He broke down some of the key credit risk parameters such as probability of default (PD), loss given default (LDG) and exposure at default (EAD) calculations used when calculating credit risk capital requirements, explaining some of the difficulties when applied to trade finance assets.

He argued that although trade finance folklore suggests that in large sovereign debt defaults, “trade always pays”, efforts need to be made to prove this adage.

The provision of trade finance default data that can be used in risk modelling and by credit committees is one course of action.

“The creation of an industry loss database is vital for the benchmarking of trade LGD and EAD models,” he said.