Strengthening trade flows and a return of confidence post-Dubai World restructuring makes the market for trade finance in the Middle East and North Africa region increasingly attractive. GTR gathered together a number of industry specialists to debate current trends.
Roundtable Participants
- Asif Raza, managing director, head of treasury and securities, Mena, JP Morgan (Host)
- Jose Kochanthony, regional head of product management, transaction banking, Mena, Standard Chartered
- Kersi Patel, regional head of trade and supply chain, Mena, HSBC Group
- Lakshmanan Sankaran (Laxman), head of trade sales and services, Commercial Bank of Dubai
- Abdel Rayman El-Tayeb Taha, chief executive officer, ICIEC
- Ehsaan Ahmed, GTS head, global transaction services, Noor Islamic Bank
- Phiroze Mogrelia, head of commodities, Mena, ABN Amro
- Simon Cook, partner, SNR Denton
- K Nizardeen, head of trade services, Al Hilal Bank
Raza: Trade finance seems to have done very well. What are you seeing in the region?
Patel: I share your view that, considering the scenario in H2 2009, trade business has done exceptionally well this year.
There is a fundamental reason for this. With Mena housing close to 60% of global oil reserves, most countries in the region are big energy exporters and with oil prices at levels substantially higher than those needed to balance budgets, many regional governments have continued to invest in upgrading the infrastructure needed to support business growth and improving lifestyle.
“With such increase in volumes in insurance cover – does that reflect any shift towards more open account business?”
The benefit of this capital investment has been filtering through the economy, fuelling business growth across all segments and ending in higher purchasing power for the local population, which in turn boosts consumption. As the region imports almost all goods needed for development and consumption, this has led to the good growth in underlying trade flows.
Results of HSBC’s half yearly global trade confidence index surveys also support the above, showing that global trade growth is now increasingly driven by growth of trade between emerging markets and by growth in intra-regional trade flows.
It is also worth remembering that the huge drop in regional trade turnover seen by us in 2009 was largely on the back of a substantial fall in commodity prices rather than a drastic reduction in underlying trade volumes. By the second half of 2009, most commodity prices had levelled out and we have seen a steady growth in trade business throughout 2010.
Kochanthony: After bottoming out in the second quarter of 2009, world trade volumes have grown steadily since the second half of 2009, with momentum continuing into early 2010 and the second quarter of 2010.
Emerging markets are driving the trade recovery with their imports approaching the 2008 peak. In early 2010, emerging Asia exports and imports crossed their 2008 peaks as regional domestic demand, inventory restocking in Asia and abroad, and Chinese commodity demand boosted intra-Asia trade. The Middle East and Africa’s trade has also revived decisively, whereas de-leveraging and fiscal austerity are weighing on Central and Eastern Europe’s trade.
The largest rise in trade volumes was in the Bric countries (Brazil, Russia, India and China) where export volumes rose by as much as 15% as compared to the previous quarter (Q4 2009).
As the Asian success story continued, the Middle East and Africa, being the major trade corridor for key economies in Asia, benefited from sustained economic growth. We would see the growth predominantly being led by the emerging markets.
Laxman: Exports and re-exports are growing by approximately 23% year-on-year in this region. Oil prices stabilising has also helped the market. The African market is also demonstrating great potential and India and China are major trading partners for the UAE, helping contribute to the growing trade volumes in the region.
Ahmed: The impact of China and Asian markets on UAE trade flows seems to be steadily growing. In 2009 there was close to US$70bn of trade flows between UAE and China. There is clear evidence of this on the ground if you look at the huge investments and projects being developed by China in the region. China’s expansion into Africa is also something to watch in terms of opportunities for UAE traders.
Taha: I’ll speak from the point of view of an insurer; what comes through is some indication of what is happening.
“We are looking at developments in Iraq. It is not a member of ICIEC, but we believe it will eventually be a good market for the PRI product.”
ICIEC [the credit and political risk insurance arm of the Islamic Development Bank] is a 15-year-old business, our business volumes have really picked up in the last few years. Before that, there was no understanding in the region about credit insurance being used as an effective way of risk mitigation – this was true not only for exporters but also for the local banks.
For European banks, export credit insurance is ‘bread and butter business’. What we have seen in the last couple of years is that everyone saw a big drop in business during crisis.
Since the last quarter of 2009, the economy is picking up and people are realising that the financial crisis was not a doomsday scenario. This year is also showing a big increase in business, in terms of new insurance commitments and implemented commitments.
We did US$2.1bn in 2009, and in 2010 we expect to do US$3.5bn – this is an increase of almost 50%. Even during the crisis, where other major European insurers were suffering big losses, our loss ratio was very small. From our experience, certain sectors are performing the best.
This includes petrochemicals, pharmaceuticals, electricity and food. Suffering sectors in the region include real estate, building materials and the financial sector. We cover some deals in Iran but cost is a factor there and the sanctions have greatly limited the kind of transactions we can cover. We are also seeing a huge increase in demand for political risk insurance in Yemen and Sudan.
Raza: With such increase in volumes in insurance cover – does that reflect any shift towards more open account business?
Taha: We don’t tend to work on an open account. Within the Mena region, we mainly work via a local bank, and in certain cases with OECD countries we do open account.
Patel: Given that most of the losses are coming from OECD countries where trade business is predominantly conducted on an open account basis, does this not show that trading via documentary credits, a method preferred by traders in Mena, is a more secure way to do business?
Nizardeen: We are seeing a lot of interest from Syria, we are receiving many requests to open LCs for Syria, especially in the field of petrochemicals. Dr Taha, what do you see happening in this region? What kind of market is there?
Taha: We are mostly providing cover for infrastructure projects on a medium or long-term basis in Syria. We see some Turkish companies looking at opportunities in Syria. And there is a lot of Gulf investment going into the country, but we are not getting requests for political risk insurance from these investors. We see it as a very stable country.
Kochanthony: The petrochemicals imported by Syria are going into Iraq. Syria and Jordan are strong re-export markets and much of this goes into Iraq.
“The situation is improving for local banks to raise dollar financing.”
Laxman: Iraq is becoming an interesting country for all of us.
Taha: We are looking at developments in Iraq. It is not a member of ICIEC yet, but we believe it will eventually be a good market for the PRI product. As the political situation stabilises, business will come.
Raza: Looking at commodity finance, do you see large companies looking for new structures?
Mogrelia: Within ECT (energy, commodities and transportation) at ABN Amro, we serve clients that are active in various parts of the value chain; specifically within commodities. This means helping our clients originate, transport, trade, process and distribute various commodities. We do this through a wide range of financial structures, from straightforward inventory financing, letters of credit and guarantees, and ownership-based financing to highly structured cash and carry and pre-export financing transactions.
Our diverse product offering is often the result of deeper knowledge and understanding of the client’s business. To take an example relevant to Mena; after the crisis, senior lending in the transportation sector was scarce, thereby exposing clients to liquidity constraints.
We set up a JV with Qatar’s QInvest to open up an unconventional investor base through a shariah-compliant fund focused on the shipping industry. It was a great success and was recently named shariah fund of the year.
Raza: Besides other value-adds, is bringing the cost down not also key to making semi-secure transactions appealing?
Mogrelia: In the current economic climate, costs remain relevant. However, knowledge of the business, speed of credit decision and a diverse product offering will often score as high on the client’s agenda.
Raza: Looking at the market from the perspective of the customer, what are their priorities when they look at trade finance or structured trade finance facilities? What conversation are you having with your clients?
Mogrelia: About 18 months ago when liquidity dropped, access to finance was the immediate need. This meant clients saw larger diversity in the costs of funding. Such diversity has now significantly narrowed down. If you look at the syndicated loan market in the last few years you will notice that both the amounts and costs have moved closer to pre-crisis levels.
The key difference being that with US dollar funding costs being so low, the overall costs do remain manageable and tenors have crept up.
Patel: Going back to the market intelligence we have via HSBC’s trade confidence index surveys, lack of finance was being mentioned by traders as the biggest barrier to growth in this region until early this year, but now it is insufficient margins.
With improving liquidity in the banking sector, and with banks preferring to lend via well-structured trade based facilities rather than clean loans, availability of financing for trade has gone up substantially in the region, and as a result pressure on margins has been strongly felt by banks too.
Given a scenario where margins for both traders and banks are under pressure, commodity finance and other structures involving direct control of goods, and therefore potential additional costs, may not be as attractive an option now as they were when corporate balance sheets were stretched and banks needed credit enhancers to support higher lending.
Mogrelia: As I mentioned before, the pricing in the syndicated loan market in the commodities sphere has come off quite a bit. I wonder how much further it can go down.
Laxman: I still believe that banks have not started lending actively, especially to the SME sector. Liquidity has come back, but banks are sitting on it and risk aversion is still there.
Raza: What does the rest of the group see as major barriers to growing trade business in the UAE?
Kochanthony: A typical trader’s balance sheet creates limitations for procuring finance. Bankers are also being constrained by the need to maintain minimum return on risk-weighted assets.
This in turn necessitates the need for innovation. Balance sheet efficient financing, both for the customer and the bank is needed, and few of the prominent players in the industry are well advanced into this area. Financing cost is a key component that impacts the bottom line of the trader, and as such there is an eagerness to move from secured trade terms to open account terms.
For the discerning customer, open account financing and credit risk cover are currently available with selected financial institutions.
Raza: Specifically in the Mena region, over the past three to six months – have the banks lent more? Or is the level the same as last year?
Patel: HSBC’s trade business, both funded and non-funded, is substantially higher now than it was at the beginning of this year, and considering our dominant market share in key trading markets across Mena, this growth translates into a substantial increase in dollar terms too.
Taha: They are definitely lending more, but they are looking for quality business and customers, they want security.
Raza: So it is not a complete return to unsecured lending. Liquidity is there, but it is still for the higher end of the corporate spectrum.
Laxman: Yes, this trend is definitely recognisable among banks. There are many concerns about the effects of Basel II and III, and risk management is playing a bigger role among banks.
Taha: Today four of our 10 largest customers are banks, yet just a few years ago there wasn’t one bank in our programme.
Raza: Since the conclusion of the Dubai World restructuring, are UAE banks ready to lend more?
Laxman: The Dubai World restructuring came as a great relief, but you can’t and I don’t expect an immediate resumption in lending. It will be conditional lending and the banks will be much more careful.
Raza: How much of the new liquidity is going into real structured trade assets and how much is funding syndications or working capital facilities?
Laxman: Trade finance used to be 30% of our average proportion of our lending volumes.
Most of the banks active in trade have actively stayed in this market. Trade finance will receive more and more attention – although subject to Basel II and III regulations.
Nizardeen: We were Initially doing cash business, but now we are doing more LCs and murabaha transactions.
Cook: Two years ago, when I first arrived in Dubai, I asked the same question raised by Asif earlier, regarding real trade versus working capital facilities. When I came here there was very little real structured trade finance (STF) going on, and there still is very little STF.
When you are talking about an increase in trade business, it needs to be clear whether this is in terms of pure trade finance or STF. What is it that banks mean by the term STF?
In my experience, what banks here would very often term STF is secured syndicated lending where the security happens to relate to trade cashflows or trade assets.
It is not actually structured in terms of the commercial processes being an inherent part of the financing structure and documentation from a legal perspective and from a bank’s risk analysis perspective. still don’t see that happening here on a great scale – one or two banks here and there – but not many and it’s not increasing dramatically.
Patel: There’s a good reason for that. If you look at STF globally, it is a way for financial institutions to provide financing to producers of commodities in a structured way so that they better control the supply chain and secure repayment.
In Mena, where the key exports are oil and gas, and the exporters are generally government-owned companies, most of the exports happen under letters of credit and standby credits, and some on open account terms. These large, well-capitalised and liquid corporates are generally not looking for STF solutions to support their production/pre-sales financing requirements.
Cook: One reason people give me as to why STF is not used that much here is the relatively high upfront costs of putting in place STF solutions. A high upfront cost can be absorbed over time on deals of two, three or four years, but most money here is still six or 12-month money. In the long-run, though, I think structured trade products provide better value for money.
Raza: Under structured trade finance we could create a trade asset that could be granted better capital treatment and an additional secondary market investor base, but that requires more work and structuring.
Laxman: There is a lack of expertise on structured trade finance.
Nizardeen: Often we see traditional trade finance specialists doubling up as commodity structured trade finance experts. The dividing line is very thin.
Raza: Are clients still looking to obtain more secure payment terms using LCs, or is there a shift towards open account?
Laxman: Globally open account is still growing, but in this region, we are returning to traditional instruments such as letters of credit. In long-term, open account will continue to flourish.
Raza: So corporates are still trying to get better and more secure payment terms, but will this change in future?
Mogrelia: Not in commodities, the transactions are too large, so I don’t envisage huge growth in open account trade.
Taha: The driver in this is not the bank but the exporter. Exporters know if they insist on secured methods of payment they can’t compete with other exporting firms. They have to do open account.
Raza: Companies are for the time being still looking for more security around payment terms. But this will change, and we need to look at how best to support the supply chain and other financial instruments so we are there for the customers.
Nizardeen: As an Islamic bank, we buy goods from the exporter and sell them to our customer. Exporters are happy to sell goods to us as the moment they sell goods to us, the draft or payment is secured. We have seen an increasing trend in this type of business, on collection and open account.
Raza: Times of stress may lead to an increase in contractual disputes, what are you seeing in the market these days?
Cook: We have seen an increase in commercial disputes and we have seen an increase in queries from commercial parties. They are coming in saying here’s a contract – how can we get out of it? We have not seen many cases go to the next level, though, with proceedings initiated. On trade transactions, I have only seen two in last six months.
Raza: Let’s look at the Islamic side of the trade market.
Nizadeen: About five years ago I had a corporate customer who told me that he was not interested in Islamic banking and didn’t want to go down that route. So when I moved to a new bank, I came across the same customer and he was using Islamic finance.
After the recession he realised that Islamic banking became something worth looking at. It had been previously very difficult to convince him, he was very negative, so I was surprised to see him enjoying such a huge limit. Islamic financing has a lot of potential with clients realising that payment is more secured when you deal with the bank rather than dealing with customers directly.
Ahmed: When people talk about Islamic finance, they are typically referring to the shariah-compliant sukuk issuances as a benchmark for the size of the market, rather than Islamic trade assets.
There is little research and data available on this aspect in particular, perhaps because this asset class is a much smaller portion of the total asset mix.
There is an increasing awareness of the underlying Islamic trade finance structures, but at the end of day it is a commercial decision for the customer. The challenge for Islamic banks is how best to do the documentation and structuring, so that it is not onerous for the customer and at the same time is competitive compared to the conventional market.
My final point is on risk participation. The challenge lies for Islamic banks with the master risk participation agreements (MRPAs) which tend to differ from bank to bank, depending on the view of their respective shariah boards, versus conventional banks where these MRPAs tend to be much more standardised and therefore easily adopted by multiple banks.
Nizardeen: I think the sukuk is a relatively new phenomenon. Before this, most Islamic finance was in fact trade finance-related.
Taha: Even conventional banks come to us with Islamic trade transactions. I’d like to add some comments about the ITFC [Islamic Trade Finance Corporation which is part of IDB], which by definition does Islamic trade finance.
As a multilateral it has a special advantage as it has the time and resources to dedicate to structured trade finance, something commercial financial institutions are lacking.
The ITFC has done a number of STF deals in the commodity space, for instance financing exports from Cote d’Ivoire.
Islamic finance has an additional appeal in that it enables you to control the entire process of the purchase of commodities.
The bank has to be involved more in the whole process, whereas the conventional banks just deal in documents.
Patel: I would agree that when we talk about large value transactions in Islamic finance, it is often with reference to sukuks.
Having said that, when priced in line with conventional trade solutions and with easy to use documentation, we have see a reasonable demand for shariah-compliant trade solutions. HSBC offers a wide range of shariah-compliant trade solutions under our Amanah brand and they make up a reasonable percentage of our total trade book.
Raza: As a banking community, we can work together to bring standardisation which will be a great benefit for Islamic banking especially for conventional banks with Islamic banking windows.
Laxman: Our bank is a conventional trade bank – but since last year we have an Islamic window offering Islamic trade finance, and we have seen increasing business via this window – traditional and Islamic finance can easily co-exist.
Taha: Many of the banks participate in the large syndicated murabaha transactions that the ITFC does. And these are sizable deals, usually around US$100mn.
Raza: What are peoples’ views on dollar financing versus local currency financing? There is a quite a bit of offshore US dollar financing being done, because the lower Libor rate, whereas the interbank rate in this region is much higher – so there is a cost saving for the customer.
Cook: Part of this will depend on the country involved. The UAE currency is pegged to the dollar, so it is less important what your repayment source is. A lot of trade revolves around oil and US dollar receivables and banks use these receivables to pay back debt.
Patel: For exporters and importers which have true US dollar receivables, financing in US dollars makes sense as the borrowing rates are lower than those for local currencies in Mena.
But if the client is selling in or has receivables in local currency and has raised trade finance in US dollars to support the transaction, it can be a potential risk.
Today I guess the cost of covering this risk is not equal the differential in the interest rate, so the dollar financing on a fully covered basis is still beneficial for customers. However, for customers where receivables are in local currency and foreign currency future payables are not hedged we need to exercise due caution.
Cook: Would the tenor of the financing matter to you since the risk of decoupling from a pegged currency is less on shorter tenor transactions?
This is another benefit for using more structured trade solutions. But the flipside is to what extent will local and international banks be able to work together? What might be sufficient in terms of a return for a bank on advanced IRB for structured products will not necessarily provide the same return for banks that aren’t using the same capital basis. GTR
