George Wilson, head of institutional trade finance, and Derryn Faure, institutional trade finance, at Investec Bank Limited, call for a greater understanding of the mechanics of trade finance in the context of African trade, and outline why it should be considered sustainable by definition.


Every day, micro, small and medium-sized enterprises in the emerging world continue producing, buying and selling the goods and services their markets need, employing people but still barely keeping their economies ticking over. If only there was an efficient, low-risk way to assist this sector to unleash its potential? There is… through financial institution (FI) trade finance.

The excellent credit profile of trade finance products has been publicised annually in the ICC Trade Register – it just hasn’t been broadcast much outside of transactional banking. Despite all the empirical data, global regulators appear to ignore this evidence and treat emerging market Main Street trade finance as if it were Wall Street investment banking, and in so doing have created the commercial ingredients for the trade finance gap and all its suffering.

Without a radical shift in mindset, the coming global recession, rising interest rates and inflation could easily push African frontier economies further into collapse. Perhaps all that is needed is greater understanding of the mechanics of trade finance and African economies, and recognition of the environmental, social and governance (ESG) beneficence of the FI trade asset class that can shape it into a manageably investable product.

Even before Covid-19, the depredations of war in Ukraine and high global inflation, at least US$120bn of the global trade finance gap could be attributed to Africa alone. The well-understood, primary cause of this has been the inability of SMEs to obtain

trade credit and foreign exchange from their financial institutions. In turn, the root cause of their African banks’ forsaken trade facilities is the imposition of global banking regulation, making it deeply unprofitable for them to provide these trade facilities to their SME clients. Bankers could either use their precious capital and liquidity, at a loss, to finance SME trade, or they could take the same capital and liquidity to buy government bonds and lock in double-digit returns, risk-free – hence the missing SME trade facilities and the resultant trade finance gap.

The development finance institutions (DFIs) and multilaterals have long understood the problem and are desperate to do something about it. They just can’t reach the SMEs or their lower-tier banks, they have a crippling substantiation problem, and western ESG perspectives increasingly disqualify investment in African trade finance. These institutions have become fixated on supplier finance facilities in their flagship SME trade programmes because the global corporate buyer fits the western ESG stipulations and does the due diligence and reporting on all the SME suppliers for them. Unfortunately, that approach doesn’t work for the overwhelming majority of SME trade on the continent.

The US Federal Reserve’s rate hikes have spelt the end of the emerging market (EM) carry trade, with the biggest risk-off from EM bonds for 18 years, forcing fragile economies to import inflation.

The flood of global investors’ dollars from African bonds and some unfortunately timed elections has seen some z-spreads blow out to more than 25%. African currencies have devalued substantially, and their foreign import cover is under increasing pressure as the US dollar prices of cargoes have tripled. This has started a spiral of economic decline and, unless the International Monetary Fund steps in, this could lead to devaluation, default, essential shortages, suffering, ‘Spring’ uprisings, and regime collapse.

It doesn’t have to be like this. If global investors could only appreciate:

  • the truly astounding empirical default characteristics of FI trade finance;
  • that traditional Basel credit analysis is harmfully wrong for trade product risk assessment;
  • how valuable and rewarding African trade is as an asset class;
  • and that their investment mandates need to be updated to unlock the intrinsic ESG value of such sustainable African trade finance assets.


Inappropriate regulation

Since 2007, the ICC Trade Register has curated the data of over 38 million global trade transactions amounting to over US$19tn. It examines all the credit dimensions of the different products, supplying extensive analytical commentary that clearly demonstrates the incredibly low-risk true nature of FI trade finance through the cycle of global financial crises, recessions and pandemics.

The 2021 ICC Trade Register records a 0.01% default rate for export letters of credit (LCs), which maps to better than AAA rating. Unfortunately, under Basel, banks must use theoretical obligor ratings which are capped at the sovereign grade. So, although the actual product’s risk of default is better than AAA, a US$10mn LC issued by, for example, a Ghanaian bank will be deemed CCC with a probability of default of 14.48%, and a confirming bank would need to hold more than US$26mn of capital costs under Basel rules.

The pricing of this type of EM FI trade finance completes the picture: the market price discovery of the assets reflects the true nature of the product’s risk characteristics. ‘Markets are never wrong’, and when African banks’ and government bonds blew out over a thousand basis points recently, the market-clearing price for African FI trade actually tightened in the same jurisdictions that government bonds quadrupled.

This inappropriate Basel regulation and low trade pricing are the reasons why banks that originate trade assets cannot hold them on their balance sheets. Increasingly, banks are abandoning the very lifeblood of fragile African economies due to the enormous capital costs required against low-risk revenues, making them unprofitable. This is also one of the reasons why international investors aren’t interested when they really should be: because everyone abandoned rational empiricism where the assets were originated, so their investment mandates forbid buying them. Even the EM and alternative funds don’t want them because they ‘need’ much higher returns for such perceived ‘risky’ assets – they naturally pay between 2% to 4% over SOFR and asset managers want 6% plus, while hedge funds won’t get out of bed for less than 10%.

What’s crazy is that EM FI trade finance could form an ideal alternative asset class for those very investors as their performance is diversified away from herd market reactions in equities, bonds and commodities. EM institutional trade finance continues to perform beautifully when other asset classes cycle through ups and downs. The ICC Trade Register proves that African trade finance doesn’t default, performing counter-cyclically even when the world economy goes to hell in a handbasket. This is enlightened self-interest: trade dollars are prioritised because emerging market central banks won’t allow their trade payments to default since they know it will lead to their collapse into failed states. It is underwritten by DFIs and multilaterals for the same reason.


Sustainable by definition

What’s even crazier is that such an obviously sustainable asset class is not top of the list for ESG investors and is in danger of being disqualified by developed market taxonomies because of the evidence required to prove environmental benefits, regardless of its social and sustainable impact on African economies. Western policy makers either don’t understand or simply choose to ignore how trade finance as a product set is different from debt, and that developing economies are the precise target of the 12 non-environmental UN Sustainable Development Goals (SDGs). Their reductive interpretations of the UN SDGs over-emphasise proof of environmental goals because they are the most relevant to western economies. This solipsism is big business: in June we were treated to the unprepossessing but revealing spectacle of the audit firms scrabbling to protect their US$8bn sustainability audit pot from EU lawmakers who think it may lead to conflicts of interest.

To the uninitiated, FI trade may seem to be an abstruse, technical classification. But it must be understood that:

  • the only entities that can touch, understand and grant credit to African SMEs are African FIs;
  • only these African FIs can be used as aggregators for international investors and DFIs of otherwise impossibly granular portfolios of real SME trade;
  • and these banks’ treasuries are the engine room of their countries’ foreign exchange and liquidity functioning, as is the case with Nigeria’s Form M, NAFX and RT200 trade mechanisms.

It then becomes clear that, unlike ESG bonds, African trade finance has its own independent, regulated and audited governance naturally embedded in the form of the African FIs, which can crucially deliver the ‘G’ without recourse to expensive western ESG ‘experts’.

In the original spirit of ‘trade not aid’, we can cut the Gordian Knot and understand directly from the UN SDGs that African trade finance should be sustainable by its definition, unlock the asset class’s true investor value, and promote it to its proper place as the best alternative asset class in the world.