Concerns are growing that new banking regulation will not only make trade finance markets tougher, but also cause global trade and commerce to slow down. Leading market players discuss what action should be taken next.


Roundtable participants

  • Marc Auboin, counsellor, economic research and statistics, World Trade Organisation (WTO) (chair)
  • Peter Sargent, head of transaction banking, ANZ
  • Dominic Broom, managing director, market development, Emea, Treasury Services, BNY Mellon
  • Jason Barrass, EMEA regional sales head, JP Morgan
  • Bruce Proctor, trade and supply chain product management executive, Bank of America Merrill Lynch
  • James Cunningham, practice leader, political risk & structured credit practice, Marsh UK
  • Edward Till, head of product management, trade and supply chain, Europe, HSBC
  • Rosali Pretorius, partner, Denton Wilde Sapte
  • Aidan Applegarth, consultant, BankingWise
  • Mark Weston, joint head investment banking and UK country manager, Nedbank


Auboin: Will you be worse off under Basel III, than under Basel II? What are the expected consequences for the industry, and what aspects of the proposed Basel III regulation do you believe might affect you most?

Applegarth: With regards to the question about whether Basel III is better than I or II, looking at the evolution of Basel regulations, I’d say that Basel I provided a level playing field, it was a game we could all play.

Basel II established new rules and disadvantaged those players who couldn’t meet the rules in respect of eligible credit risk mitigants, and advantaged those who could.

But Basel III has changed the game itself. The game is no more about delivering trade finance solutions with an eye to the balance sheet, but it’s now about delivering balance sheet with an eye to trade finance solutions. The focus has changed – it has become all about competing for capital within an institution.

Although some people argue that a change in the leverage ratio shouldn’t affect risk appetite, it does because the leverage proposals would require more capital, and since there’s a cost for new capital, trade has to stand its ground against other products to compete for the limited capital that’s available.

If the returns don’t look good enough, because risk models aren’t geared for trade, then trade won’t justify its existence. On that basis, Basel III does threaten to change the landscape, but there’s a question mark over how significant the change will be.

The impact will differ from institution to institution. For example, a large institution may say that trade assets are less than 2% of their overall assets, so they will have to ask themselves whether it’s worth the fight.

The Basel committee is trying a one-size fits all approach, but we are not all one size – the impact will be different for each of the players. We now have to learn that game and equip ourselves to play that game – and I don’t think we are there yet.

Sargent: I am still not sure that fundamentally I understand what is going to happen going ahead. There is a big issue around the communication of changes that will be made. I don’t see much communication between banks themselves and with the regulators.
The problem is that regulators seem to be charging ahead without giving any thought to the needs of banks and their client base within our product area. It seems that it is a regulatory system that will be imposed on us – rather than one we will have a say about.

Trade finance has stood the test of time. It is not overly complex, it is real, and relates to actual economic activity.

Basel I was simple, easy to understand and applied globally – and that is a sensible approach for what is a global business. Trade financiers help oil the wheels of international commerce.

The current discussions are taking place within a very narrow context of the financial services industry, with little regard given to the broader commercial activity that sits outside that.

Perhaps the problem is we haven’t got our act together in terms of creating a voice. There is no doubt that there are other areas of the banking industry that have a unified voice when things are implemented that affect them.

Viewing our business against the more leveraged, more speculative types of business that we are being bucketed in with is wholly wrong and ultimately threatening to broader commerce.

Bankers have to accept we are not the most favoured group of people at the moment, but if we can make the case that the real damage is going to be done to commerce, particularly developing country commerce and with SMEs, then perhaps people will listen and take note.

Sargent: The irony is that while the UK government is encouraging SME lending, aspects of Basel II such as increased capital weighting for non-investment grade clients is fundamentally disadvantaging that.

Proctor: In the US context, as is no doubt the case with many economies at the moment, there is a sharp government focus on supporting exports. But it will be really hard to increase exports if you are constrained by limited financing capabilities.

I was at a meeting with US Ex-Im, and it appears that the bank is caught between a policy request from the government to promote exports, and banks who explain that it is becoming more difficult from a capital allocation and pricing point of view to support such a broad range of exports. It will come back onto US Ex-Im to provide more direct lending, more than it perhaps wishes to.

At the meeting there were strong feelings that the regulatory rule changes will make it more difficult internally within banks to make the argument that trade is a preferred form of corporate credit.

It won’t just be the banks bringing up this issue, but it will also be raised by banks’ corporate clients, who are being asked to increase exports, but can’t always finance them.

There is a large macro impact to consider, certainly in US markets and there will be a similar story across much of Western Europe. There is a clash between the direction of public policy and how this is policy is going to be facilitated.

Pretorius: I think the other major policy drive is to try and address and improve regulation so that we don’t have repeat of the last crisis.
Bank of England governor Mervyn King has already said that Basel III has watered down the consultation proposals too much – so you have that to consider on the one side when asking for changes. There is still time to argue that trade finance should be treated differently. There is definitely still scope for argument.

Till: To give a counterview, Basel III is only related to the liquidity position of banks. Thinking of banks here today, no one here should be having huge concerns about their liquidity issue overall.

So my suspicion is we’re thrown back on to Basel II. And have we really taken full advantage of Basel II to create a differentiation for trade?

If we are not careful then we could talk ourselves into thinking the situation is a lot worse than it is.

Are we doing enough to structure our facilities properly to ensure that they have the lower Loss Given Defaults (LGDs)? Are we doing enough promote these products internally? There is a lot we could be doing for ourselves.

I worry that we would just get ourselves into a panic about this.

Barrass: But unless you have common interpretation of the regulations, it could potentially put you in an inferior position.

It comes down to interpretation – one bank might interpret it in one way and result in higher capital allocation given, whereas another might have a lower allocation. So this is a risk, and I’d argue that you can’t have this whole regulation issue open to interpretation – there has to be a level playing field across all the banks to allow us to compete very similarly.

Applegarth: One of the things that came out of the announcement is that the CCF [Credit Conversion Factor] for trade is changing. On the unconditionally cancellable facilities, you will have 10% CCF on the undrawn portion (previously 0%).

It’s a reduction on the 100% originally proposed, but still represents a more punitive treatment. But if I understand correctly, derivatives, which started this problem in the virtual economy, have had concessions made.

They are able to retain the standardised approach. Where are the losses in trade that have crippled the economies?

Where is the problem that trade has created? It seems to be that as trade is what they can measure – that it is tangible – the Basel Committee have gone for trade. They are trying to show some strong arm tactics, but at the weakest link. I am a bit disappointed that there is not a more balanced approach in how these directives have come out.

Sargent: You have to have consistency across regulators – my concern here is that it is all very well criticising the Basel regulators, but you also have the governor of Bank of England Mervyn King making it clear he intends to do something different – and the American regulators will have their own rules as well. One problem you may have is that there are people that, for political reasons, will be building their own regulatory systems on top of Basel III.

Applegarth: There’s a global bank bashing going on, you can’t escape that, but it is for the wrong reasons. A small minority screwed up the banking system for the vast majority, and we are all suffering as a consequence.

But this anti-bank stance is on the global political agenda now, and nobody wants to listen to those doing global trade finance, that is until economies start drying up.

Of course, trade finance was on the G-20 agenda last year, and you are seeing more chief executives of banks talking about trade. But at the moment it is all talk, and as yet I don’t see it being felt by the wider economy on a sufficient level for someone to say that we need a two-tier approach.

Let’s have guidelines for a virtual banking economy and one for a real economy, as they are very different but currently being treated the same.

Broom: Over the past few years, government intervention, including via export credit agencies, has allowed commerce to be maintained. As this intervention disappears and they expect international commerce and the financial community that supports it to stand on its own two feet, I see some significant problems ahead of us.

Cunningham: The insurance market reflects that issue. The transactional deal flow into the private insurance market is at an all-time low.

But, if you talk to the Berne Union and have discussions with the ECAs, they are seeing an incredible increase in direct lending and guarantees.


Auboin: A trade finance specific programme of US$250bn was created to specifically mobilise trade finance in 2009, so global leaders did recognise that there was a need to maintain levels of trade finance to support global trade.

So why then as an industry, have you been unable to get your arguments accepted during negotiations over Basel II and III?
Is there a miscommunication?

Applegarth: It comes back to trade being insignificant in the broader scheme of things.

We know trade is very important – but if you look at the volumes and numbers in trade finance compared to what is blown on derivatives– we pale into insignificance.


Auboin: But putting together a package of US$250bn, this can’t be insignificant? The G-20 in London also acknowledged the need to show some flexibility regarding the regulation governing trade finance – ie the possible exemption of the one-year maturity floor affecting short-term finance?

Applegarth: In isolation, yes, it is big ticket, but in the broader scheme of things I don’t think people have felt the pain.
The pain won’t be felt until the things people want to have aren’t available to them. Too many people making decisions on these regulations are removed from reality.

What politicians acknowledge is that voters don’t like bankers being bailed out while the voters themselves are losing their jobs, and that’s why bank bashing is so easy at the moment.

Broom: But are we doing a good enough job in spelling out to the general public, and certainly to those who influence certain decisions, the long-term sustainability and fundamental stability of this business?

Trade finance instruments have not only survived this business cycle, and the previous one, but have been in existence for a very long time.

According to the findings of the ICC, the percentage of losses suffered by trade finance facilities is considerably lower than other forms of lending.


Auboin: But isn’t the fact that you are a safer asset class than others actually a potential weakness in trying to secure a preferred status, rather than an advantage?

A regulator might think that if the industry is not suffering, it doesn’t deserve preferential treatment.

Applegarth: What we witness is that trade debts do get prioritised in the event of a moratorium. In certain countries that rely on exports to earn hard currency, they will repay their trade debts.

But this is not what the man in the street sees, especially perhaps for those in the US, where it has become a political game. It is about appeasing the voters, and this is whipping up a frenzy against bankers.

Who’s debating this issue? Who from outside our markets hears our arguments? Frankly no one wants to understand, until one day people can’t get a PlayStation – as no-one has been able to finance it. Then they will start asking.

Proctor: Perhaps as an industry we need to spend more time with CBI [Confederation of British Industry] and other industry groups. These are the people who will feel the effects of the lack of finance, before the guy on the street.

There is going to be this increasingly obvious disconnect between the policy statements of governments on exports and the ability to actually translate that into how you are going to make it happen.

None of the banks here today are going to disappear from lack of liquidity. But what we have to contend with is the internal allocation of risk, and the returns you earn on those allocations. We all compete with other product areas in our institutions.

The issue is more about how do you get in front of the commercial and manufacturing groups to work with them, and then jointly approach the legislators to explain how the impact will be felt on corporations, and how it will limit their ability to increase employment. In the US, this is certainly a huge issue.

We’ve all convinced ourselves of these arguments, but we need a broader audience on the commercial side that really allows us to go forward with them to tell people what the impact of these regulations will be.


Auboin: What is in Basel II, and the proposed Basel III, that you specifically think is making trade finance less competitive compared to other products? What is bothering you most?

Sargent: We don’t know yet, in terms of Basel III, we are discussing something here that we are not 100% clear on what is or will be proposed.

What we do need is the same lobbying level that the hedge funds had when the UK government went to the European Union to demand changes to be made to regulations to hedge funds. We haven’t raised our profile high enough.

Barrass: The prime minister of the UK, David Cameron, has been spending time in Turkey and India promoting greater trade and business ties. This is a lot of time and political will spent in order to get the economy moving again.

Yet at the same time we don’t have one consolidated body representing our industry, knocking on the doors of Westminster, Washington and the Basel committee, representing not just vanilla trade, but structured trade finance, commodity trade finance, the whole spectrum, and explaining how the potential new rules are going against what the politicians want.


Auboin: Have you been successful, as a community, in raising awareness of trade finance among policymakers in the last two years? What do you think has been successful and what hasn’t been so successful?

Sargent: Have we come up with an alternative?

There are consequences to changes to current legislation. For example in respect of tightening rules on capital allocation, I could have 10 customers, but I can only lend to nine in the future, so the tenth one goes to the wall because it cannot access finance due to capital constraints.

That seems to run against sentiment expressed by the UK government which is trying to get banks to begin lending, especially to SMEs.

The alternative is that if you change the basic ratios such as loss given default (LGD) by 5% – then I can lend to all 10.

I am not suggesting complete alternative to the Basel system, but there are certain parts of regulations or specific parts of the underlying mechanism, that can be changed, for instance the LGD calculations. If you change this, banks could lend more.
Weston: We do a lot of business in Africa, so what are our issues?

Our issues are around currency convertibility and country risk. If you look at the defaults history, it is fairly low, but our feeling is that the regulatory regimes in terms of the Basel II models don’t give us sufficient weighting.

Generally, trade finance is low risk kind of business, and it should be in the banking industry and governments’ interest to promote it, not be ambivalent about it.


Auboin: The regulators informally suggest that you as an industry are not losing anything in the new system as the CCF for on-balance sheet commitments remains the same?

Till: I think the answer is in our own hands. We already have a mechanism under Basel II where we can apply lower CCFs and lower LDGs based on historical data or with the use of an expert panel.

Trade finance has fared well in the crisis. For example, none of us has seen a huge run on guarantees, with claims coming in thick and fast and no reimbursement from our corporate applicants. So the question that arises is if you are getting low claim rates of guarantees and most are being honoured by the applicant, why should you apply a CCF of up to 100%? That simply doesn’t reflect how much guarantees will ever trouble the balance sheet. And yet mechanisms to reduce CCFs already exist in Basel II.

Where Basel III may affect the trade business is through charge-backs. In the process of calculating liquidity ratios, a particular bank may decide that it will apply some kind of “liquidity charge” to certain profit and losses (P&Ls) – so the fact that CCFs for trade are 100% could mean that trade product would attract a higher “liquidity charge” than is used for calculating the risk weighted assets (RWA). Individual banks will have to make this decision, and my own feeling is it is unlikely to be applied if a bank is safely above the required level of liquidity.

Potentially in the future, there is also the risk that the fact that 100% CCFs are being applied in the calculation of a bank’s liquidity position may lead regulators to believe that the same high rate should apply to risk-weighted assets.

That would be much more damaging.

Sargent: One of the problems is that in many banks, there are not many people that are trade experts in Basel II implementation. When it comes to influencing the relevant people, which is what we are saying we need to do, the single most compelling argument is to say that exporters are in danger of facing higher costs, making them uncompetitive.

It is our clients that I fear will miss out most in the event we do not refine the proposals as they seem to exist.

Applegarth: Firstly who pays the cost? We do what we do for our customers.

We have someone at the end of the line, and we pass the cost on to them.

In the virtual economy, it is proprietary trading on behalf of the banks. They do it for themselves – there is no end customer to suffer the loss.

So we need to raise the profile in the broader market that these trade issues may have an impact on customers, particularly those in the middle market.

The danger is that banks will otherwise just lend on a clean basis to investment grade clients, as the cost of using trade instruments as mitigants for the middle market is unable to compete effectively for capital allocation.

With CCFs being calculated at 100%, in structured trade finance you can end up getting charged three or four ways just for one risk.
We as a group need to deconstruct what Basel II and Basel III will mean from a trade finance perspective. We need to take a deal scenario, break it down into its components, and explain what the consequences of all the different charges are, and then compare it to another product.

I have had experiences where a clean lending facility to a marginal investment grade client looked more attractive (based on the risk models) than a secured facility to a marginal sub-investment grade client. More efficient trade models would be a great help.


Auboin: The arguments advanced by ICC and Baft over Basel II issues seem not to have convinced the regulators that business will become more expensive, and that the customers would support the cost of it.

However, the counter argument suggests that there will be no CCF change for on-balance sheet operations. The one-year floor remains something to be considered by the regulators, and the issue about counterparty and country risk and the provision of data covering five to seven years of trade deals, this seems to require more engagement of the industry.

Weston: All these statistical models advanced under the Basel regulations work brilliantly when you are talking about US credit card receivables and mortgages.

But how many deals are there in Burkina Faso – where we are financing transactions?

There is not a sufficient bulk of statistical data to do relevant statistical samples to prove what we intuitively all know. These markets are tiny. You’ve got a first world statistical model, but applying it in the least developed markets, you have no hope.

You take a transaction that works well in a domestic market, and then overlay convertibility and transfer risk and then get more and more penalised.

Broom: Within one transaction, you cannot isolate a geography, and say these statistics are applicable for xyz region, as transactions typically traverse many geographies.

Under Basel I, we had a level playing field. This model may not have worked for other financial institution sectors, those that are more localised for instance, but trade finance is global by nature, and needs regulation that is easy to understand and which is applicable to all. By creating a level playing field, it will stop unfair competitive practices.

The insurance industry gives fantastic examples of this. Under Basel II, we have such a variety of interpretations of where insurance fits as a credit risk mitigation technique.

There are hardly any banks I deal with that have an approach that is consistent with another bank, in terms of what they require, and in terms of the policy structure, conditions and warranties in order for them to get capital relief. And even within capital relief there are varying degrees of weightings. There is a total lack of consistency in the interpretation of Basel II and in how banks use the insurance market.

That provides significant advantages and disadvantages. There are some FIs that use insurance on an almost deal-by-deal basis, and that is part of their risk distribution strategy, and there are others that will dip in every now and then when they can, because they cannot get relief internally through use of the product. The lack of consistency means it can be difficult for the insurance market to support trade finance markets.

I’m not saying that the private insurance market is a key player here, but it is a small part of risk distribution. Certainly getting a consistent way of supporting banks is extremely challenging. Getting a balanced playing field; a clear determination of what a credit risk mitigation technique is and where insurance fits will be a welcome development.

Broom: Basel II was developed at the high point of the era of the money centre bank, where the banking business was going to be controlled financially and operationally by a few players.

Operationally this is still the case, but what I have noticed in recent years, is the importance of working with local financial institutions that have a high level of knowledge about a local customer’s credit and business activities. If you create rules that are subject to a high degree of interpretation, it could hinder the development of this new business landscape.

Barrass: There are certain product areas that have got it right. Look at project finance – they have been successful in going back and pushing their mandate and getting concessions from the regulators.

We have just got to so the same thing, we’ve got to get one common voice and hit in three different directions: the politicians, our customers and the internal debate between institutions. I like the idea becoming more engaged with exporter or industry associations. It can be done – it is just not being done right at the moment.


Auboin: What do you think the trade finance industry should do to move forward in making its case for a adequate regulatory proposal for trade finance?

Sargent: It’s a bit like going to the dentist. Sometimes the anticipation is worse than the actual event. I get the feeling I am going to the Basel III dentist. What are the alternatives? To understand that, we need to know what Basel II will ultimately look like. Then we need to work out who actually is going to take action. Do we need to build a proper trade industry body to do that for us? It is all very well talking about it, but we need someone to physically do it.

Till: What could really make a difference would be the compiling of trade finance loss statistics and the creation of the historical loss document by the ICC.

We haven’t been very effective in showing that our facilities are lower risk. If we can get past this, then it’s evident that trade assets should attract less capital.

It therefore follows that we can do more of it, price it at a finer level, or offer it to a company that might be a slightly weaker credit, but just landed a big export deal. And this is exactly what governments want us to do. I think we’ve got to get this point across clearly.

Applegarth: There are no rules that are being universally applied, so we no longer have a level playing field. But what does it really mean for us all?

What isn’t out there yet are the numbers. What’s the impact for certain businesses? There’s nothing that says “my cost of capital has gone up by this amount”. We’ve got to put some tangibility around our claims.

Then we might find that some of the issues aren’t issues anymore. But the market needs that common understanding – only then can we find a common voice… and that voice should be calling out for a two-tier approach; guidelines for the virtual economy and guidelines for the real economy, as they are very different but currently being treated the same.

We need to do a more effective job within our own organisations. We work in institutions that had some real problems and it’s hard to say “banks aren’t at fault”.

You have to show people the simple link between trade finance and the real economy, and that if government policy is to support exports, then the banking industry needs to be in a position to support this.

Weston: The argument that I’ve used internally, is “this is not investment banking – it is proper merchant banking”. That is the fundamental distinction. This is a “good” form of banking.

Pretorius: I think these sentiments are fantastic. But I think you need to consider which parts of the regulatory system are causing you the real problems.

Basel II is the real toothache, as yet you don’t know what the real problems with Basel III will be, and it may not be that bad, as they’ve set the limits so low. If you do decide to lobby you need to work out what the biggest priority is. GTR.


Maintaining trade…

Marc Auboin, counsellor, economic research and statistics, WTO, talks about the possible impact of new regulations on trade finance.*

Since Basel I, regulators have been responding to the challenges posed by the rising internationalisation and complexity of cross-border finance.

While under Basel II, the basic credit conversion factor (CCF) for short-term trade credit remained unchanged, in a risk-weighted asset and internal ratings-based system, the cost and availability of trade finance could be affected in a negative way in periods of financial stress.

This is in part because the Basel II system is pro-cyclical in its design, and hence counterparty and sovereign risk tends to deteriorate during downturn, which results in trade finance costing more in capital.

Hence in these periods, the ICC and the Baft have shown that for mid-level companies and banks, economic downturns would lead to considerable upwards revision in capital requirements on individual trade credit deals.

On top of some of the constraints raised by Basel II on on-balance sheet trade commitments, the proposed changes to off-balance sheet treatment of trade finance made by the BCBS [Basel Committee on Banking Supervision] consultative document “strengthening the resilience of the banking sector” raised fears in the trade finance community that trade finance could face additional regulatory hurdles.

There is little question about the fact that a better regulated financial system is a good thing in general, so the question under the current environment is how to make sure that trade finance remains as affordable and safe as before?

*Marc Auboin’s views do not necessarily express the official views of the WTO.