New Basel III bank capital requirements are poised to increase pricing on trade finance, an essential component of international trade. A new report from Greenwich Associates concludes that such an effect could accelerate the development of alternative sources of credit — including trade finance funded by non-bank investors.
In the new report entitled, Global Trade Finance: Basel III Capital Rules Open Doors For Alternative Sources Of Funding, Greenwich Associates documents mounting concerns among companies around the world about the possible impact of Basel III. An increase in trade finance costs would have a particularly large and negative impact in Asia, where companies’ reliance on trade finance as a critical source of funding is higher than in developed markets. Already, European banks that have been major suppliers of trade finance in Asia are pulling back, largely as a result of the new capital rules. Although local Asian banks and Japanese banks are stepping in to fill that void, conditions appear to be in place for the emergence of alternative sources.
One of those sources will likely be trade finance funded by non-bank investors, with participation facilitated via institutional funds or structured products. “In the current era of historically low interest rates, investors hungry for sources of attractive returns could be enticed by the incremental yield, low volatility, low duration and diversification benefits of trade finance,” says Greenwich Associates consultant Markus Ohlig.
Banks and investment management firms have already successfully come to market with a limited number of trade finance vehicles for investors, including structured trade finance vehicles designed to provide the banks with capital relief and investors with attractive returns. Another source of trade finance may be the burgeoning class of institutional trade finance funds.
Obstacles and Solutions
Despite favorable conditions, opportunities for investor-driven trade finance are materializing at a very slow pace. The reason: The industry has yet to tackle some significant barriers that need to be overcome before trade finance can emerge as a viable asset class for investors, including a lack of easily accessible data on pricing and other transaction information, the lack of standardized documentation on transactions, and a settlement process that one market participant calls “fiendishly difficult.”
The easiest way to overcome the hurdle of trade finance’s “invisibility” to financial investors: Get the 20 largest trade finance banks to commit to posting at least some data for all transactions on Bloomberg. Although banks will likely resist disclosing certain proprietary aspects of deal structures, many observers believe that the public disclosure of even rudimentary deal details would begin to provide a necessary level of transparency and data for investors.
Among the additional steps that industry participants and others believe would promote the development of trade finance as a viable institutional asset class would be the creation of a trade finance index — even one based on the current handful of deals that trade regularly — and the assembly of a trade finance primer that established some standard terminology and definitions for the business.
Only A Matter of Time
Given the high levels of demand for trade finance among companies around the world, the new capital pressures on banks and the potential benefits to investors, it is certain that this market will continue to develop at a steady, albeit slow, pace. “Historically, when demand for a product exists, the industry has shown the ability to overcome logistical obstacles and make it happen,” says Greenwich Associates consultant Dr. Tobias Miarka.
Despite some real obstacles to growth, Greenwich Associates believes it is only a matter of time before trade finance becomes a viable asset class for investors, and non-bank investor capital becomes an important source of funding for trade finance around the world. With Basel III capital rules providing banks with an incentive to make investments in the development of new vehicles and investors eager for yield opportunities, the stage is set for an eventual boom in non-bank funded trade finance.