Nicolas Langlois Managing Director, Head of Trade Distribution at Standard Chartered, provides his views on the crucial value of trade distribution as a capital and liquidity instrument.
Global trade is undergoing challenging times: the value of goods that crossed international borders in 2015 fell 13.8% in dollar terms (the first contraction since 2009) according to the Netherland Bureau of Economic Policy Analysis’s World Trade Monitor; the demand for and pricing of commodities has also been impacted: at just under US$50 a barrel, brent crude has more than halved in value from a high of US$107 two years ago; and regulatory developments are adding pressure on the optimum usage of capital, for instance via the BCBS’ ongoing consultations (CD362) to reduce the reliance of internal capital models in banks’ RWA computations.
Most financial institutions are gearing up to deal with these challenges through the diversification of their portfolios, increased emphasis on digitisation and innovation in product ideas, but the critical differentiator for the more successful players will be the ability to distribute trade assets efficiently, in a scalable and sustainable way.
Many financial institutions aspire to run a well-oiled distribution engine to support their balance sheet and to enable efficient asset origination. But only very few are in that position, as it requires the development of a diversified investor base, and a wide range of distribution solutions, requiring the allocation of significant investment dollars in systems and people in order to handle the complexity of optimising granular trade finance portfolios.
With the most recent capital requirements set out by the Basel Committee and local regulators, pressure is mounting on the core book of corporate and institutional banks and their ability to meet their clients’ trade finance needs.
Trade distribution has proven to be a vital lifeline to trade finance during the financial crisis, supported by a number of developmental organisations which have developed programmes with banks to ensure the continuity of financing, in particular to emerging markets where access to liquidity has been particularly challenged.
As with every challenge, opportunities arise for those who can push the boundaries. The way we cope with the regulatory landscape, the way we partner with investors, the way we influence internal mindset, the way we design innovative solutions and market changing ideas – each of those needs to be challenged.
Regulatory landscape – from overload to competitive advantage
Distribution is taking a significant steer towards balance sheet efficiency. What started as a risk mitigation tool is turning into a critical capital and liquidity optimisation instrument.
The Basel Committee, in its intention to strengthen the stability of the financial sector, has also provided some differentiated treatment for trade finance, which is the reflection of the special nature of this asset class, its lower risk profile and what should therefore be an asset of choice for participants in the trade finance market, from originators to investors.
The initial expectation of Basel II guidance by BCBS in 2004 to create harmonisation and a level playing field amongst financial institutions didn’t effectively translate into results after its implementation. The choice between three different approaches known as Standardised approach, Foundation IRB (Internal Rating-Based) and Advanced IRB – and the need for translation into local regulatory frameworks led to a situation where banks participating in the same business ended up carrying significantly different amounts of capital depending on their lead regulator, the country where they book that business, etc.
Now Basel III is adding a new spin to the equation, both in term of harmonisation, with consultation seeking to restrict the use of internal models for credit RWA calculations, but also several capital add-ons known as capital conservation and countercyclical buffers with various calibrations that are again changing the rules of the game.
And the difference between participants in the trade distribution market only amplifies when looking beyond banks. Solvency II for insurers introduces Solvency Capital Requirement (SCR) and Minimal Capital Requirement (MCR), while pension funds, mutual funds, fintechs all have a very distinct and heterogeneous set of regulation and supervision which require different level of capital requirement for the same underlying risk.
Those who understand the nuances will be able to develop solutions that maximise benefits for both parties.
Trade assets – a special asset class for investors of choice
There is no distribution without buyers. Access to the right set of investors has always been a differentiating factor. However, as the distribution needs for corporate trade assets continue to increase, the challenge lies with expanding and finding the right set of investors who can cover a wide spectrum of risks. This means finding new investors who may not have existing relationship with banks, thereby forcing banks to re-evaluate their on-boarding approaches and the management of those alternative investor relationships.
Another important factor is the change of mindset of some of the traditional investors, be they banks, development organisations, credit insurers, etc. These players are very comfortable with taking the risk of other financial institutions, or participating in the traditional documentary trade solutions-linked risk, but have limited natural appetite on the corporate side due to lower level of experience, understanding of open account trade finance structures, as well as their current underwriting processes which are more onerous for corporate risk vis-a-vis financial institutions.
Trade finance is a special asset class with unique characteristics. It is self liquidating, but typically may have frequent payments. The majority of the transactions’ deal size is small, but some will be significantly big and strategic. The tenor is usually short, but can also be long dated depending on industries and clients’ working capital needs. This wide spectrum of trade assets drives the need to develop a distinct range of solutions.
Banks will need to develop an efficient programmatic approach for simple recurrent transactions, bespoke solutions for structured transactions with a wide range of investors and a complex mix of distribution channels, syndication capability for large deals to win the leadership position with clients, and securitisation capabilities to monetise trade finance assets for capital and liquidity optimisation for the greater benefit of the bank.
The trust between banks and investors is a predicament to successfully pushing the boundaries. Transparent sharing of information and partnership approaches will define the willingness of investors to increasingly rely on the banks’ underwriting capabilities and take the extra leap of faith to jointly support clients’ businesses.
Pushing the boundaries on systems and digitisation – the path to a fluid market place
While trade finance solutions have seen innovation in recent years through the BPO, and digitisation through ePresentation solutions and supply chain platforms, trade distribution is predominantly following the age-old ways of interacting via phone and email with very limited integration or digitisation in place as of now. Banks are now investing, or are in need of investment, in electronic distribution solutions. There is significant scope to transform the operating model through internal efficiencies as well as through influencing the market.
The market is undergoing a significant shift in terms of technology solutions threatening to change the way the distribution business has been run in the past. A digital market place which can bring together the sellers and buyers of the risk would have the potential to disrupt the current business model, subject to solving challenges around legal, compliance and operational efficiencies. For distribution players, it’s not about whether to invest or not, but, rather about when to invest and which great idea to sign up to.
Culture – the syndrome of “my asset”
Alignment within the organisation is critical for successful distribution strategy and execution. Given the capital pressure, almost all global banks need to push the boundaries with their origination teams to use distribution as an enabler to creating more capacity for clients’ business. The challenges reside mainly on changing the culture of sales forces who consider distribution as a last resort option in a quest to protect “their assets” and related revenue, as opposed to leveraging investors’ support to create larger business opportunities with clients.
This has several ramifications, from latitude in waiving standard documentation clauses which impairs the ability to share risk with investors, to performance management and rewards.
This may, for instance, mean influencing the organisation through scorecards with a selection of the right metrics. Subtle changes in performance metrics can have a material impact on behaviours, in particular in transition phases. But do banks have flexible enough systems and management structures to deliver on what seems like a simple idea?
Also to avoid sitting on a dusty shelf, capabilities need to be smartly commercialised within the banks. This needs to go beyond pure functionalities and expand to distribution market insights, where investor appetite and pricing are dynamically shared with originators.
Embedding distribution within origination is a choice with a commitment to invest in systems, in the relationship with investors, and in people and organisation frameworks.
Bringing it all together – pushing the boundaries for sustainable economic growth
Trade distribution is an absolute must-have capability today for banks. Benefits from distribution are multi-fold as it helps optimise scarce resources by enabling the efficient churn of capital, an increase in the availability of credit and liquidity, and fuels corporate business needs.
By pushing the boundaries across the ecosystem of trade distribution, banks will create new opportunities to support commercial transactions for their clients, thereby greasing the wheels of world trade and ultimately growing GDP.