Tim Evershed examines what insurers can do to help keep Asian economies thriving, and how they can help ease the lending gap.
Trade credit insurance (TRI) and political risk insurance (PRI) have increasingly vital parts to play in oiling the wheels of Asian trade.
Asian economies continue to flourish as shown by the increasing size of the Asian Development Bank (ADB’s) regional trade finance programme, which is something of a bellwether for the region. In 2010, the programme supported 783 trade transactions worth US$2.8bn and by 2012, it had grown to support 2,032 trade transactions to the value of US$4bn involving 1,577 SMEs.
In the long-term the outlook is promising too. PricewaterhouseCoopers (PwC) economists say they expect China to overtake the US as the dominating force of global trade by 2030. And out of the 25 top bilateral sea and air freight routes, 17 are expected to be connected to China, many of them linking the country to other Asian economies.
Between 80% and 90% of world trade relies on bank finance in the form of trade credit and short-term guarantees and it is Asia that uses more trade financing instruments than anywhere else. To illustrate this, more than 80% of trade letters of credit are issued in Asia, according to figures from Standard Chartered.
This was not always the case as Richard Burton, Asia Pacific CEO at Coface, points out: “Until the Asian crisis of the 1990s a lot of trade was done on trust and a handshake, on the basis that if you knew someone you didn’t need to ask for any security or a letter of credit or anything.
“We’ve seen trade grow phenomenally over the last few years: a lot of that has been driven by Asian countries exporting. That has brought a need for and a strong growth in trade credit insurance.”
However, a survey conducted last year by the ADB found that banks were rejecting a substantial percentage of requests to finance imports and exports. According to the survey, this meant that US$1.6tn-worth of demand for global trade finance was not met, with US$425bn-worth not fulfilled in developing Asia alone.
The credit crisis and eurozone crisis have both had negative impacts on bank lending. Due to balance sheet constraints and refinancing challenges, several European trade finance banks have become more selective and have reduced their activities in Asia.
“Insurance acts as an alternative distribution channel for banks, which use insurance as a risk management tool – managing internal limits to support extending trade credit – and from a capital management perspective,” says Albert Lim, director, head of credit origination, Asia Pacific at Swiss Re Corporate Solutions. “Insurance, being non-competitor to the bank syndication market, is therefore a very useful alternative distribution channel for banks to support trade in Asia.”
There are also regulatory issues. According to the ADB’s survey, banks indicated that they would reduce support to trade finance by about 13% if Basel III is fully implemented. Although the liquidity requirements for banks laid out by the Basel committee have become more lenient, this is expected to ease, but not eradicate, the perceived negative impact that Basel III may unintentionally bring to trade finance.
Lim explains: “In this regard, the insurance sector can add meaningful value. This is in particular of interest in longer-term financing such as infrastructure debt where Basel III capital gets most punitive.
“Also, mainly driven by higher regulatory capital requirements and cost of funding, we have observed some [mainly European] trade finance banks switching their business models from ‘buy-and-hold’ towards ‘originate-and-distribute’.
“This also benefits business production in PRI and TCI markets and is positive as long as meaningful risk retention by banks is warranted to ensure alignment of interests.”
According to some observers, there has never been a greater convergence of bank and insurance as a result of the additional capital requirements under the Basel regimes. Devpriya Misra, vice-president, senior credit originator at Swiss Re Corporate Solutions, says: “Increasingly, we note that banks now realise that using insurance as form of ‘contingent capital’, may be more efficient as it offers a lower cost of capital than its own bank capital. “By leveraging on insurance, banks can now do more trade business with the same amount of bank capital.”
One of the ways to do this, Misra clarifies, is by implementing a shift towards better deal structure and using insurance to mitigate the credit or country risk as well as to take capital relief. As such it provides a better return to the bank for an otherwise uneconomical deal.
Burton at Coface adds: “There is a direct link between trade credit insurance and financing. If you have a finite trade credit policy you can go to your to bank ask for finance on your receivables and banks are quite open to that now. It provides the basis for the additional security for them to be able to lend to companies.
“We are seeing a lot more financing and investment emanating from Asia to other parts of the world, which has meant banks, traders and companies operating in new areas and territories where they may not be so familiar or comfortable, as well as having increasing volumes to manage from a risk distribution perspective,” says Matthew Strong, partner of credit, political and security risk at JLT Specialty.
New players, new game
Asia has witnessed continued growth in the TCI market from existing underwriters increasing their capabilities and new entrants coming into the market. There are now over 45 global players in the commercial market and 21 of those operate within Asia.
JLT’s Strong says: “There are huge levels of capacity both on a global basis and from an Asian perspective. There are, however pockets of constraint, whether that be for certain territories or certain names. On the medium to long-term credit there’s a lack of sufficient of capacity for anything beyond five years, with only a limited number of underwriters playing in this space.”
Burton at Coface adds: “We could still do more and grow faster. The risks in Asia are good so the issue is not capacity but distribution. We are seeing a resurgence in the export credit agencies because governments are trying to support their export sectors to get more SMEs exporting as a way back to growth.”