Summary
International trade is the driver of growth in today's globalised economy, which is based on the division of labour. And inextricably connected with thriving trade relations is the use of trade credit to finance such exchanges. It is no accident that, beginning in the mid-1800s, industrialisation not only boosted global trade, but also led to the establishment of many banks – such as Commerzbank and Deutsche Bank here in Germany, which both celebrated their 150th anniversaries early this year.
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Update Magazine I/2021 |
1 Global Trade Continues to Evolve
For a long time, providing trade credit was a service banks provided – by financing the gap in timing between the delivery of goods and payment. However, there has been some movement in this respect over the past twelve years. Due to the Great Financial Crisis and the higher risk-based capital requirements set by regulators, banks have increasingly exhausted their credit limits. In addition, stricter capital requirements under Basel III make such a business more expensive – something that companies that do not have investment-grade ratings, and cannot or do not want to turn to the capital markets, are currently discovering.
Just in the international trade finance segment alone, we are talking about huge sums of money. For example, global exports have risen almost without interruption over the past 40 years, now totalling around USD 20 trillion per year. According to estimates by the Asian Development Bank, global demand for trade finance now exceeds supply by some USD 1.5 trillion.1 So, even if trade tensions, protectionist tendencies and adjustments to supply chains negatively impact the international exchange of goods in the years to come, there will still be huge demand for trade finance for the foreseeable future.
2 Take advantage of new investment opportunities
Asset managers can help to bridge that gap by tapping into capital from institutional investors. In the current low-interest-rate environment, many institutional investors are desperately looking for new investment opportunities that offer a spread over government bonds – particularly in the fixedincome segment, for regulatory reasons. And there are some features of the trade finance segment that are attractive to the aforementioned group of investors.
For example, the expected return is comparable to that of high-yield bonds. But at the same time, the duration is significantly shorter because trade finance on average has a maturity of three to six months. Since commercial invoices are selfliquidating over this period, dependence on the trend in the capital markets and/or long-term interest rates is fairly low. There is also a low correlation with other asset classes, and comparatively low volatility. For investors, this in turn means that the trade finance investment segment adds positive diversification characteristics to an existing investment portfolio
The latter feature was again demonstrated quite impressively only recently: when many investment segments experienced heavy price losses in March due to the COVID-19 crisis, trade finance once again turned out to be a haven of stability. Short maturities mean that trade finance is almost immune to increases in risk premiums. In light of the economic crisis caused by COVID-19, many capital market investors are currently wondering whether the economic trend will be V-shaped, U-shaped or even L-shaped, i.e., whether the economy will recover immediately, or only after a long period in the doldrums, or not at all. Trade finance investors do not have to answer that question, since they have a time horizon of only a few months – a big advantage in times of heightened economic uncertainty.
3 Excellent prospects – investing now and in the future
Another attractive feature for institutional investors: default rates are normally relatively low compared to traditional bank loans. Although trade payables do not have priority over other liabilities, companies often keep paying their suppliers so that their business operations can continue as long as possible, even during hard times. Given the counterparty risk, this is something else that is attractive.
Getting asset managers and their investors to help close the trade finance gap is becoming easier thanks to technological innovations. For example, the emergence of fintechs has brought a series of innovations to the market, including automating the processes for attracting new customers, handling payments and managing collateral, as well as electronic invoicing. Such innovations reduce operating costs, and make it possible to award even smaller volumes of financing economically. An additional regulatory boost came from a European directive which since 2018 has required electronic invoicing for payment of government contracts in many countries.
The following example shows specifically what a cooperation between banks and asset managers in the area of trade finance can look like. The Allianz Working Capital Fund (ALWOCA) is a strategy that invests in trade liabilities of small and medium-sized enterprises (SMEs), but also in those of global companies. Such investments include invoice receivables, receivables-backed loans, factoring loans, letters of credit, structured notes and other trade finance instruments. Even though the legal format may vary widely, the one thing these liabilities have in common is that they are very short-term, and are related to working capital or trade finance.
Since there is no public market for these instruments, ALWOCA is currently working with fourteen sourcing partners to originate potential investments. Naturally, they include banks with customer contacts, but also non-banks such as fintechs, factoring companies and alternative lenders. In addition, ALWOCA can rely on AllianzGI’s affiliate Euler Hermes – the global leader in credit insurance, with access to credit analyses of more than 40 million companies – to provide credit ratings. Leveraging its own in-house research, AllianzGI itself brings to the table information on more than 800 bond issuers and more than 1,000 listed companies, as well as proven risk management expertise. All of this is vitally important, since the debtors’ creditworthiness – i.e., the likelihood that the trade credit will be repaid on time and in full – is the main driver behind the performance and risk of the trade finance strategy.
4 A win-win-win strategy
The main advantage to partner banks lies in a strengthening of customer relationships in the SME and institutional lending business. By selling trade finance on to an asset manager and its institutional clients, they can relax the regulatory corset that is constricting their lending to companies with lower ratings, enabling them to provide trade finance to more customers. In addition, under this model, AllianzGI serves as a silent syndication partner, eliminating any concern that clients could be poached. At the same time, investors in turn benefit from the fact that AllianzGI will select the companies best suited for them from the pool of available trade finance, making it possible to invest in their loans in a diversified portfolio. This ensures that the equally high regulatory requirements covering investments by institutional investors are satisfied, and that no shortcuts are taken regarding the stability of the financial system with this kind of investment.
Overall, cooperation between banks and asset managers on trade finance issues is a Pareto-optimal solution, as economists would put it. Or stated more simply, there are lots of winners, but no losers. Partner banks and their clients benefit from an expansion of the trade credit business, especially with SMEs. And for investors, it opens up a largely uncorrelated investment segment that offers attractive spreads on underlying assets with short maturities. For investors regulated by Solvency II, this investment segment also carries a low solvency capital requirement because of the short-term maturities. So in summary, there are very good reasons for banks, asset managers and institutional investors to work together in the area of trade finance.
There are lots of winners, but no losers. Partner banks and their clients benefit from an expansion of the trade credit business, especially with SMEs.
1https://www.adb.org/news/15-trillion-global-trade-finance-gap-frustrating-efforts-deliver-crucial-jobs-and-growth-adb
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