Trade Finance as an Investment vBK 2017 - Kimura Capital · economies, then Trade Finance is the fuel the engine needs to keep running. And yet, for all its longevity, Trade Finance

TradeFinanceasanInvestment

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February2017

TradeFinanceasanInvestment 2

TABLEOFCONTENTS

INTRODUCTION......................................................................................................................................3

1. WHATIS“TRADEFINANCE”?..........................................................................................................4

Whatarethenuances?...................................................................................................................5

Who’sinvolved?.............................................................................................................................6

2. WHATISTHEINVESTMENTOPPORTUNITY?...................................................................................7

BridgingtheTradeFinancegap......................................................................................................8

Identifiableflowsgeneratingtransparentreturns.........................................................................9

CapturingtheTransactionChain..................................................................................................10

3. WHATARETHERISKS?..................................................................................................................11

ThedatareinforcesTradeFinance’slowdefaultprofile..............................................................11

Puttingnumbersinperspective....................................................................................................15

ValueaddedTradeFinanceexpertise...........................................................................................16

4. HOWCANINVESTORSPARTICIPATE?...........................................................................................17

CONCLUSION........................................................................................................................................19

APPENDIX……………………………………………………………………………………………………………………………………20

BANKINGWISELIMITED KIMURACAPITALLLPOXFORD LONDONUNITEDKINGDOM UNITEDKINGDOM

TEL.+44(0)7769507944 TEL.+44(0)2078872231E-MAIL:[email protected] [email protected]

©BankingwiseLimited/KimuraCapitalLLP,February2017.Allrightsreserved


INTRODUCTION

‘Trade Finance’ is essentially the provision of dedicated funding in support of the movement of physical goods being traded along a supply chain.

As an established discipline, Trade Finance has been around almost since trade itself, from providing working capital loans to merchants venturing to far flung lands in search of local produce to intermediating in the exchange of transactional documents and the resultant payments flow. If trade is the engine that keeps goods and services flowing to support economies, then Trade Finance is the fuel the engine needs to keep running.

And yet, for all its longevity, Trade Finance has been little understood beyond its core of practitioners: often absorbed within such umbrellas as Global Transaction Banking or general Corporate Banking, Trade Finance has been under the radar from an asset class perspective. But things are changing. In the face of diminished liquidity as a consequence of burdening regulation, banks have been opening the door to institutional investors and specialist funds to participate in trade deals that were previously shared amongst themselves. In tandem, the International Chamber of Commerce (ICC) has been gathering dedicated market data for its Trade Register, which provides previously unavailable but meaningful statistics for banks, regulators and other stakeholders to present a view of the risk profile of the Trade Finance industry globally, with particular focus on credit-related default and loss experience - all of which is reinforcing Trade Finance’s claim to be a low default proposition compared to the general corporate banking world it is lumped within.

The natural evolution of these developments is to view Trade Finance as an investment opportunity.

This paper therefore explores the rationale for accepting Trade Finance as an investable asset class, from an understanding of what Trade Finance actually is to a suggestion of what opportunities may exist.

It seeks to answer the questions:

- What is Trade Finance

- What is the Investment Opportunity

- What are the Risks

- How can Investors participate

This paper is the first in a series to explain Trade Finance as an asset class for investment. Further features will delve more deeply into the type of transactions being financed, into commodity trade finance in particular, and into how risks are being managed. These will be supplemented by topical articles and FAQs from time to time.


1. WHAT IS “TRADE FINANCE”?

“WhoareYOU?”saidtheCaterpillar.Thiswasnotanencouragingopeningforaconversation.Alicereplied,rathershyly,“I--Ihardlyknow,sir,justatpresent—atleastIknowwhoIWASwhenIgotupthismorning,butIthinkImusthavebeenchangedseveraltimessincethen”.–LewisCarroll’s‘AliceinWonderland’

TRADEFINANCEappearstobeundergoingsomethingofatransformation.AsitprogressesthroughitsownWonderland,ittoohasbeenchangedseveraltimestothepointwhere‘TradeFinance’todaymeansdifferentthingstodifferentpractitioners.Tosomeit’sassimpleasissuingacashcoveredLetterofCredit,whilsttoothersitinvolvesprovidingfinanceinanyofseveralwaysasabridgebetweenanexporter’soutlayandreceiptofhissalesproceeds.Sojustwhatis‘TradeFinance’?

Simplyput,TradeFinanceistheprovisionofdedicatedfundingtosupportthemovementofphysicalgoods(merchandise)tradedalongasupplychain.

Thesupplychainistypicallyinternational(cross-border)butaslendersengagefurtheralongachain,elementsofdomestictrademayfeature.WTOstatisticsputtheglobaltradeinmerchandiseatUS$16trillion(seechartbelow)ofwhich90%iswidelyacceptedtobesubjecttosomeformoffinance,equatingtotheUS$14trillionestimatedbytheICCtobethevolumeofinternationaltradefinanceprovidedglobally.

Source: World Trade Statistical Review 2016


TradeFinancethoughcomesindifferentguisesandit’sarguablytheHOWofdeliveringTradeFinancewhichmakesthedifferencebetweenitbeinganinvestableassetclassornot:sometradefinance‘products’or–intheirownright–‘propositions’havecharacteristicsthatlendthemselvesmoreappropriatelytobeinganinvestableassetclassthanothers(assetbacked,transparent,self-liquidating,time-boundflexibility,identifiablecashflowandreturns).

For‘TradeFinance’isafamilyofrelatedofferingsthatindividuallyorcollectivelydeliveronthestatedobjective…butwhereeachbringsitsownuniquecharacteristicstoprovideasolutionwhichwillhaveinfluenceonintendedoutcomesandrisk.

Forinvestors,it’simportanttounderstandwhichsideofthefamilyyou’reinvestingin.

What are the nuances?

VanillaTradeFinance(VTF)istherootwhichoffersthemorebasictradeproductsofLettersofCredit,Guarantees/StandbyLCs,BidandPerformancebonds,Acceptance&DiscountingofBillsofExchange,andImportorExportLoans.Typically,intheeventofadefaultalenderlookstothebalancesheetofitscustomer(asobligor)andhasnoimmediaterecoursetotheunderlyinggoods,beingtypicallygeneralmerchandise.ExpectedLossthoughinvanillaTradeFinanceaveragesonly0.02%acrossallproducts(source:ICCTradeRegisterReport)duelargelytothecontingencyofthetradeinstrumentsi,whichareonlypayableifcertainstatedconditionshavebeenmet.WithinVTF,onlyImport/ExportLoans,BillsDiscountingorConfirmationsofExportLCsreallylendthemselvesasaviableinvestment,particularlywhenpooled.Atanobligorlevel,thedefaultratefortheloansis0.80%whilstit’sonly0.05%fortheExportLCs,astheyrepresentriskonaFinancialInstitution.

CommodityTradeFinance(CTF)hasbeendefinedtodifferentiatethetransactionalcommoditytradelendingtoSMEsiiandgeneralcorporatesfrombalancesheetlendingtoinvestmentgradecommodityfirms:commoditiesincontextbeingrawmaterialinputsforfood,energyormanufacturing.CommoditytradersaremajorusersofVTFinstruments,whichareblendedwithoverdraftortermloanstoprovidebespoke,oftenself-liquidating,transactionallending.CTFtendstobetransparent,isfrequentlyassetbacked,isshort-termwithoftenrepetitivedealsandtypicallyforstrategicoressentialcommercialinputs.Assuchitlendsitselfverywelltobeinginvestable.ThesizeoftheCTFmarketdependssomewhatoncommoditypricesbutisestimatedtoequatetoaround30%-35%oftheglobalTradeFinancemarket,ie.c.US$4-5trillion.Recourseistypicallytoabankissuedreceivableonbehalfofathird-partyortothecommodityitselfratherthantothebalancesheetofthedefactoborrower.


A2015reviewofthehistoriccreditloss/defaultexperiencebyacoreofcommoditytradefinancebankspointstoa0.20%averagelossrateagainsta0.81%averageobligordefaultrate,whichcomparesfavourablytoStandard&Poor’sUScorporatedefaultratewhichstoodat2.8%inDecember2015.Moody’sglobalspeculative-gradedefaultrateroseto3.4%attheendof2015.

ReceivablesFinance(RF)maytaketheformofdiscountingwithorwithoutrecoursetotheselleraspecificorapoolofthird-partyinvoicesorbookdebts.Becauseunderlyinggoodswillhavealreadypassedhands,lenderstypicallytakeoutcreditinsurancetoprovideabackstopforbothwithandwithoutrecoursefinancings.Specificdefaultdataisnotavailable,althoughtheICChasstateditsambitiontobridgethegapinfuturereviews.ExpectationswouldbeforanaveragedefaultratethatfallssomewhereinthemiddlebetweenthatofcommoditytradefinanceandS&P’s/Moody’scorporatedefaultrates–ie.c.1to1.5%.Whereallconditionalityhasbeenmet(includingforinsurance)andareceivableisdueandpayable,anRFportfolioofferscharacteristicsthatmakeiteminentlyinvestable.

SupplyChainFinance(SCF)isperhapsthemostmisunderstood,largelybecauselenderswouldarguethatwhattheyalreadydoisfinancesupplychains…however,thenuancehereisthatinsteadoffinancingabilateraltradebetweentwopartiesalongasupplychain,thelenderslooktotheultimatereceivableattheendofachaintofinancethevarioussuppliersdowntheline.ItisineffectanexpandedformofReceivablesFinance.

StructuredTradeorStructuredCommodityFinance(STCF)tendstoinvolvemoremediumtolong-termfinancingsforeithercommoditiesorcapitalgoods,whichmaybebackedbyanExportCreditAgency(ECA)iiiorsecuredbyanassetbackedborrowingbase(usuallyofcommoditiesortheirreceivables).InsuchcasesSTCFlendsitselfwellasaninvestableTradeFinanceoffering,thoughtherearecaveats:wheretheuseoffundscannotbedirectlycorrelatedtotradeflowsorrecourseisdeemedtobesquarelytoacustomer’sbalancesheet,theloanwillbeconstruedascorporatelendingwhichwouldthenfallwithinacorporateassetclassratherthanTradeFinance.Seethecautionarytale,page14.

Who’s involved?

• AtradeinitssimplestformexistsbetweenBuyer(Importer)andSeller(Exporter)

• OftentheBuyerofonetrademaybetheSellerofanother,ashepurchasesinputstoproduceoutputs(thesupplychainview).

• Theremaybemiddlemen(traders),whobuyfromonepartytosellthesameproducttoanotherpartyaddingvaluethroughjust-in-timedeliveryorperhapssemi-processing.

• FinancingmaybeprovideddirectlybytheSellerextendingtradecredittotheBuyer,orbyanintermediaryextendingloanstoeitherBuyerorSellerorboth.


• Counterpartiestoindividualtradesmayincludecorporates,financialinstitutions,sovereignsorspecialisedentities(set-upforthesolepurposeofatransaction)

• Alsoindirectlypartytoatradeislikelytobeanarrayoffacilitators/serviceproviderssuchasFreightForwarders,Shippers,InspectionCompanies,Warehouses,Insurers,PortAuthoritiesandvariousGovernmentLicensingAgencies.

Tradecanthenbesimple(bilateralbetweenBuyerandSeller)oritcanhavevaryingdegreesofcomplexity(anadditionalormultiplepartiesbuyingandsellingalongaspecifictransactionsupplychain).TradeFinancecanthenbesimilarlysimpleorcomplex,andinvestorsshouldthereforeunderstandsomethingoftheriskprofiletheyarebuyinginto(see‘WhataretheRisks’below).

2. WHAT IS THE INVESTMENT OPPORTUNITY?

Theopportunityisforinvestorstoparticipatedirectlyorindirectlyinprovidingtradefinancefunding(tradeloans)toborrowersengagedinthephysicaltradeflowsofmerchandise,whomaybeproducers,semi-processors,tradersorconsumersalongthetradesupplychain.(Pleasesee‘HowcanInvestorsparticipate’below)

Worldtradehasbeengrowingyearonyearalmostconsistentlythispastdecade,witnessinganotableblipin2009(post-bankingcrisis)whichwasfollowedbyarecoveringgrowthin2010and2011,beforeanotherblipin2015ascommoditypricestumbledinthewakeofaChinaslowdown.TheWorldBank,however,projectsworldtradegrowthat3%.

Page 3

The Transaction Chain

Exporter(Seller)

Trader/Distributor(Buyer / Seller)

Importer(Buyer)

Lender / Intermediary


Principaltradegrowthwillbeintheemerginganddevelopingeconomies(c.4-5%)withthemoreadvancedeconomiesbeingrelativelyflat(<2%).


Bridging the Trade Finance gap Asthefinancialservicesindustryadaptstothechangingregulatorylandscape,banksalonecannolongerfulfillthedemandforTradeFinancefunding,particularlytoSMEs:alreadytheAsianDevelopmentBankhasidentifiedatradefinancegapof$1.6trillioncausingtheindustrytomakearenewedchallengetowardstheregulators.Meanwhile,newspecialistfundsandboutiquesareemergingtobridgethegap,whilstthebanksthatpreviouslykeptbusinessbetweenthemselveshaveopenedtheirdoorstonon-bankfinancialinsititutionsandspecialistinvestors.GivenTradeFinance’slowrisk:highrecoveryrate(see‘WhataretheRisks’)andayieldlinkedtypicallytoaspreadoverfloating1,3or6monthsLIBORiv,it’slittlewonderTradeFinanceiscatchingtheeyeofinvestors–asyieldsfallontheirtraditionaltargets,TradeFinanceoffersacounterbalance,deservingtobeconsideredwithinadiversifiedinvestmentportfolio.



OneoftheattractionsofTradeFinanceasaninvestmentisitsflexibility:

- Dealscanbepackagedtomeetaninvestor’sriskprofileintermsoftenors,valueand,ifappropriate,goodsorgeography.

- Yieldswillbetransparentacrossthedifferentriskprofilesandinvestmentcanbetailoredtooffercapitalorincomegrowth

- Monitoringidentifiablecashflowsmakesiteasiertospotanypotentialpitfallsandtakeproactiveorreactivemeasurestomitigate

- Shorttermtenorsofdealsfacilitateinvestorsmovinginorout

Identifiable flows generating transparent returns Returns vary according to the type of fund and the risks it assumes, but in general Trade Finance returns are said to compare favourably to investing in bonds or leveraged loans: indeed, it has been argued that investors in trade finance loans would have enjoyed positive returns in any 12 month period since 2007, whilst even bond investors may have suffered negative returns during some holding periods. For Trade finance as an asset class is uncorrelated to stocks or bonds, taking as it does its roots in tangible ‘kick the tyres’ trade flows. Money is lent against identifiable transactions and repaid from their proceeds.

Investors should be careful though to understand exactly what each fund means by its offered rates of return, as a “net 20% pa” target might be achievable in higher risk markets (eg. Africa) but only if earned interest is being capitalised and rolled into further successful deals throughout the year. Investments in Asia might achieve 4% to 5%* pa. (reduced due to there being a more established and liquid market), whilst a more geographically diversified fund might achieve somewhere in the region of 7% - 10% *pa.. *Figures extracted from established funds


For investors seeking to take regular income (eg. quarterly or semi-annually), the achievable return will be rather less, being more aligned to the margin being received at each short-term maturity, which is subject to a number of influences: the range of spreads is therefore broad, from 50 basis points per annum (bppa), ie. 0.5% pa, up to 500 bppa, ie. 5.0% pa or more.

Funds may target markets where local currency borrowing costs are relatively high in order to offer cheaper US$ funding which nonetheless affords an attractive spread (eg. local costs 10% but US$ 3mth LIBOR 1% + spread 5% = 6% overall borrowing cost – subject to local market restrictions).

Due to the nature of returns being tied to an agreed transaction margin or funding spread, Trade Finance loans offer relatively low volatility of income and, assuming funds invested can regularly be deployed, there is also a consistent flow.

Capturing the Transaction Chain ThekeytoanyinvestmentinTradeFinanceisthentheabilityofthefundmanagertodeployfunds,forwhichtherearevariousopportunitiesalongthetransactionchain.

Forfundmanagersit’sthenaquestionofwhichTradeFinancefundingopportunitybestmeetstheriskandrewardprofileofthefund.

CapturingtheAtoZofthetransactionchainpresentsseveralopportunitiesforalendertointerposeandaddvalueforreward.Italsoaffordsgreaterleverageoflimitedresources(peopleandcapital)andactuallyimprovestransparencyandthereforeriskprofile.


3. WHAT ARE THE RISKS?

TradeFinancehasnothithertobeenrecognisedasanindependentassetclassbuthasratherbeenconsideredasub-setoftheFinancialInstitutionandCorporateassetclasses.ThedownsideofsuchanapproachisthatTradeFinanceistypicallyviewedfromariskperspectiveasbeingonaparwithcorporateloansandotherlendingproducts,whereastherealityismuchmorefavourable:

AccordingtotheICCTradeRegisterReport,TradeFinancehasanaveragedefaultrateof0.02%acrossallvanillatradefinanceproductsandtradefinancelendingis5timeslessriskythangeneralcorporatelending.DefaultinTradeFinancedoesnotalwaysmeanloss,duetocontingentinstrumentsandhighrecoveryrates.

TheICCTradeRegisteranditsresultingannualReportareproducedbytheICCBankingCommissionandremaintheonlycomprehensive,authoritativeandwidelyreferencedsourceofdefaultandcreditriskdataforTradeandExportFinanceintheworldtoday.Whenseencollectively,the2015and2016ReportspresentaconsistentlylowcomparativeriskforTradeFinanceversusotherassetclasses,notwithstandingaworseningobligordefaultrateforTradeinthemorerecentfindings–up0.08%onLoans(seewww.iccwbo.org).

The2015Reportcites:

• “Lowoveralltransaction-levellossrate…theaveragetotalcustomerlevelExpectedLossforTradeFinanceproductsislessthanone-tenthoftheexpectedlossoftheMoody’srateduniverseoverthe2008–2014periodforLCsandGuaranteesandapproximatelyonefifthofthesameforLoansforImport/Export”

ThislowcomparativerateisexplainedbyTradeFinance’seventdrivencontingencywherethedefaulteventdependsontheoutcomeofotherprecedingevents,orthelackthereof.

The2016Reportreinforcesearlierpatterns:

• “The2016ReportcorroboratesfindingsfrompreviousyearsthatTradeFinancepresentsbankswithlowaveragematuritiesandlittlecreditrisk,withlowdefaultrates,lossgivendefault(LGD)andexpectedloss(EL)rates…Short-TermTradeFinanceremainslow-riskwhencomparedtootherassetclasses,includingcorporateandSMElending

The data reinforces Trade Finance’s low default profile

WepresentbelowsomeselecteddataextractsfromtheICCTradeRegisterReport2016which,forthepurposeofthisguide,focusesondatarelevanttotheinvestableExportL/CsandLoansforImport/Export,whicharedefinedthus:


Short-term data

AdaptedfromICCTradeRegisterReport2016

Intheprevious(2015)TradeRegisterReportwhichcarriedcomparabledata,itcites:-“ComparingthesedefaultrateswithMoody’scorporatedefaultratesoverthesametimeperiodallowsforarepresentationofdefaultratesinawidelyknownframework.WhilstExportL/CscomparetosomewherebetweenaAaaandAaMoody’srating,eventherelativelyhigherdefaultratesofPerformanceGuaranteesorLoansforImport/ExportcanberepresentedbyaBaaandBaMoody’srating,respectively,andcompareveryfavourablywiththeMoody’sratingofanaveragecorporatecreditportfoliocoveringallratingclassesof~2.1%”.

Analysisofshort-termtradefinancedataintheTradeRegister2008-2015

ProductTransactiondefaultrate

Exposureweighteddefaultrate

Obligordefaultrate

Moody'sratingforcomparabledefaultrate

ExportL/C 0.01% 0.04% 0.05% Aaa-AaLoansforImport/Export 0.24% 0.21% 0.80% Ba

Totalcustomersanddefaultratebyproduct,2008-2015

ProductTotal#Obligors

Total#defaultedobligors

Obligordefaultrate

Moody'sratingforcomparabledefaultrate

ExportL/C 116,646 55 0.05% Aaa-AaLoansforImport/Export 203,811 1,623 0.80% Ba


Furtherdatawithinthe2016reportrevealsthefollowing,evidencingtherelativelyshort-termnatureofTradeFinancewheretypicaltradecyclesfallwithin120–180days.

AdaptedfromICCTradeRegisterReport2016

ContributingtotheunderstandingofTradeFinanceisthebreakdownbelowofcustomerdefaultratebyassetcategory,whichshowstherelativeweightingofFIs,SovereignsandSpecialisedentitiestoCorporates.Notedisthatthedatatimeframecapturesthe2008-2009‘bankingcrisis’post-LehmanBrothers,whichmayaccountforthehigherdefaultrateandlowerrecoveryrateamongFIs(ExportL/Cs)thanamongcorporates(Loans).

Totaltransactionsanddefaultratebyproduct,2008-2015

ProductTotal#transactions

Total#defaultedtransactions

Defaultrate

Weightedaveragematurity(days)

ExportL/C 2,098,540 198 0.01% 133.8LoansforImport/Export 8,692,811 20,519 0.24% 160

Exposure-weightedtransactiondefaultratebyproduct,2008-2015

Product

Totalexposure($000)

Totaldefaultedexposure($000)

Exposureweighteddefaultrate

Transactiondefaultrate

ExportL/C 1,201,351 461 0.04% 0.01%LoansforImport/Export 3,919,215 8,072 0.21% 0.24%

Recoverydata

ProductAveragetimetorecovery(days)

Averagetimetorecoveryinyears

Averagerecoveryrate

ExportL/C 114 0.31 64%LoansforImport/Export 145 0.40 69%


The Medium-term view Short-termTradeFinanceisemphasisedandwhilstMedium-LongtermTradeFinanceloansarepossibleforECAorasset-backedborrowingbases,thereisacautionarytaleforthesehighlightedbythefollowingchartandcommentarypresentedintheICCTradeRegisterReport2015:

“ThesefindingshighlightthatidiosyncraticshockscanhavesignificanteffectsondefaultratesforMLTproducts.Assuch,careshouldbetakentounderstandingthecompositionofagivenportfoliowithregardstounderlyingassetclassesandgeographicaldistribution”.


Inessence,tradefinanceloanswouldnormallybeprioritizedintheeventofamoratoriumofacountry’sdebtsbutwhereanMLTtradefinanceloanhascharacteristicsmoreakintoabalancesheetdrivencorporateloan,the‘tradefinance’relevancehasbeenchallengedinthecourtsandrelateddebthasbeenreclassifiedtofallamonggeneralcreditors.Kazakhstanprovidedadefiningprecedent.Thechallengessucceededbecausethefinancewastooremovedfromthecycleoftradeflowsactuallybenefittingthecountry.Cautionisthereforeneededtoavoidinvestingintradefinanceassetswhichdonotfullymeetthetradefinancedefinitionthatacourtmaydetermineinaparticularjurisdictionwhereredressisrequired–wherethatcourtisitselfrepresentingtheinterestsofitscountry.

Afurtherchallengeisofcoursepredictingeventswhichmaybe3to5yearsaway.

Putting numbers in perspective

AlthoughtheICCTradeRegisterReportisthedefinitivesourceofTradeFinancedefaultdata,itdoeshaveitslimitations.Itgathersdataonthe‘vanilla’tradefinanceproducts(LettersofCredit,Performancebondsandguarantees,ImportorExportLoans)buttodatedoesnotyetspecificallyaddressthemoreelaborateofferingsofreceivablesfinance,borrowingbasefinanceandownership-basedfinance,allofwhicharehowevercomponentsofacommoditytradefinanceproposition.

More specifically for commodity trade finance, a working group of the most active banks in commodity finance contributed to a dedicated review of the sector, benefitting from the anonymized pooling of data by the Global Credit Data Consortium: over the 2008 – 1H2015 review period, implied LGD (loss rate/default rate) was 20% or less consistently, reflecting the high recoveries from structure and collateral. Indeed, average default rate over the period was 0.81% notwithstanding the downturn years of 2008 and 2009 which saw 1.32% and a peak default rate of 1.85% respectively. All other years recorded < 1.0%.

Toputthesenumbersinperspective,S&P’svUScorporatedefaultratejumpedto3.3%inFebruary2016,withexpectationsthatthedefaultratewouldriseto3.9%byDecember2016.Thiscomparesto2.8%inDecember2015and1.6%inDecember2014. Moody’sglobalspeculative-gradedefaultrateroseto3.4%attheendof2015.

ThereareindeedrisksinTradeFinancelendingandinCommodityTradeFinancelendingbutthelowdefaultexperiencecompareswelltoothercorporatelendingandisduetotwofundamentaldifferences:

1. TradeFinanceandCommodityTradeFinanceuseforwardlookingriskassessments

2. CommodityTradeFinancebenefitsfromadedicatedriskcentricoperatingmodel


Traditionalcorporateriskassessmentslookathistoricbalancesheetstoestablishcreditworthinessandtheirriskmodelsputemphasisonturnover,EBITDAandinterestcover.TradeFinanceontheotherhand,especiallycommoditytradefinance,lookstosuchbalancesheetsnotsomuchforcreditworthinessbutratherforvulnerabilityandplacesmoreonusontheforwardviewofthevariousfactorsthatwillinfluenceandimpactontheoperationalisationofthetransactiontobefinanced.Whererecourseisself-liquidatingratherthantothecorporatebalancesheet,acorporateriskmodelisirrelevant.

TradeFinancethenisnottypicalcorporatebankingandshouldnotbeconstrainedbytypicalcorporatebankingtechniques.Itisspecialisedbankingandthemarketrecognisesapremiumforthepractitionerswhobringtheirvalue-addedexpertisetoanalyse,manageandmitigaterisksdynamicallyevolvingalongthetransactionchain.

Value added Trade Finance expertise Riskmanagementisadifferentiator.Thevalue-addedofanexperiencedanddedicatedteamofspecialistsset-uptomeetthedemandsoftheTradeFinancebusinessshouldnotbeunderestimated:whenthisexpertiseisharnessedwithinariskcentricframeworkit’sthereasonthatsomelendersavoidthepitfallsthatothershaveapenchantforfallinginto.

Knowingwhattolookfor,butmoreimportantlyhowtomanageandmitigatetherisksarisingalongatransactionchainistheskilloftheexperiencedTradeFinancepractitioner.Itbringsanaddedvalueinnotonlystructuringdealsforprotectionbutalsoinensuringthatoncefundshavebeenlentthereisanongoingmonitoringand,wherepossible,controlovertheensuingtransitiontowardseventualsettlement.Thisoftenmakesthedifferencebetweensuccessandfailureandisthechiefreasonwhythereistypicallyariskpremiumtobepaidtofundmanagers.

Thisbecomesallthemorerelevantwhenfundsarelendingtosupportcross-bordertradeflowswhereonepartymaybeinanunregulatedmarketoramarketwherepubliclyavailableinformationisnotreadilyavailable.TradeFinancepractitionerswillrelyontheirownnetworksandshouldbemakingfrequentvisitsandenquirytoprotecttheirloans.


FraudisthemaincauseoflossinTradeFinanceandfraudisfacilitatedwherethelenderdoesn’thavesufficientmarketknowledgeorexpertisetospotitortotakestepstopreventit.That’sfrequentlywherelendershaveinvestedinthelast5years,beefingupriskandcomplianceteamstoensureappropriateduediligenceiscarriedoutpriortoanyengagementandthenmonitoringexposuresonanongoingbasistoavoidanysurprises.Thestrongerthefund’sriskmanagementpractices,thelesslikelyisthepotentialforfraud.

4. HOW CAN INVESTORS PARTICIPATE?

AccesstoinvestinginTradeFinanceloansmaytakeanumberofforms:

- Directlending(bilaterally)orco-lendingwithoneormorepartners.Thisisadvisableonlyforthosewithaprofessionalexperienceintradefinanceandwithasizeableamountofcapitalattheirdisposal.Directlendingwouldmeanoriginatingadealoneselfwhereasco-lendingcouldbesharinginadealsourcedbyanotherparty,usuallyacommercialbank.

- InvestinginaregulatedTradeFinancefund,eitherdirectly(asshareholder)orindirectlyviasubscriptiontothefund’sassets(ie.Buyingintotheindividualfundsbeingmanagedtoparticipateintheirgrowth).Specialisttradefundshavebeenaroundsincetheturnofthecenturybutmorehaveevolvedinrecentyearsledbyformerbankersandtraderswithvaryingdegreesofpedigreewho


offermostlynicheopportunitiesinsectorsorgeographiestheyarefamiliarwith.Whenreviewingsuchfundsit’simportanttoknowtheexpertiseoftheowners/managersandtounderstandhowthefundengages:

o Isitafundoffunds(sourcingfromotherfundsandlendingdirectly)orafundlendingtoafundoffunds?

o whatisitsmodusoperandi–directloans,‘repos’viorstep-inasprincipal?

o Whatsectorsorgeographiesdoesitcoverand/oravoid?

- Agrowingtrendforinstitutionalinvestorsandthelargerfamilyofficesorhighnetworthindividualsistoplacefundswitharegulatedspecialistfundmanagertoapplyintoatailoredriskprofileoftradefinanceassets.Investorsbenefitfromtheexpertiseofthefundmanagerinsourcingtransactionswhichmeettheirspecificgoalsfordiversificationofsector/geographyetc.

Inthepast,attemptstopackageandsecuritisetradefinanceassetsmetwithanumberofdifficulties:

- thedynamicsofmanydealsalterstheriskprofilefromonestagetoanothermakingformalratingsofportfoliosachallenge,eg.Whenfundsaredisbursedriskmaybetoarecourseonthegoodsthemselves,butasthetransactionevolvesanexportletterofcreditmaybeconfirmedbyabank,transferringtherisktotheratingofthatbank.

- thiscreatesachallengeforfundmanagerstoretainthefundwithinasetrating,asassetsmoveinandoutofscope.

Amoreappropriatesolutionbeingappliedtodayistoconsidertheriskprofileofportfoliosasaseriesof‘buckets’,affordinggreaterflexibilitytofundmanagerswhilstenablinginvestorstodetermineabucketprofilewhichsuitsthem:eg.AnemergingmarketsfundversusanOECDfund,orafundinvestinginbankexportLCconfirmationsversusaninvestmentincorporatereceivables.Fundsmaybesegmentedbycommodityorbygeographyorbyobligortype(FI,sovereign,corporate,specialised).

Thereispresentlyno‘go-to’registerofTradeFinancefunds,althoughthismayberemediedasthemarketevolves.


CONCLUSION

TradeFinancelendsitselfwelltobeingrecognisedasanassetclassforinvestment,wheresomeelementsofitaremoreinvestablethanothers.Whilstcomparativeriskislow,it’stheexperienceandprofessionalismofpractitionersinsourcingqualitycounterparts,carryingoutappropriateduediligenceandapplyingandmonitoringmitigantsthatmakesTradeFinancewhatitis-sobackingtherightfundmanagersbecomespivotal.

ThereisotherwiseadangerthatthedriveforTradeFinanceinvestmentswillbringaplethoraoffundsallclaimingtoofferinvestorsexactlywhattheyneedbutnotallbeingabletoeffectivelydeliver-anabsenceofgenuineexperienceandpedigreeintheindustrybeingtherootcause.Yes,TradeFinanceriskiscomparativelylow.No,thatdoesn’tmeanit’sriskfree.Fraudremainsthemajorconcern,butispreventablewithproventechniques.

ThetimeisrightforTradeFinancetobetreatedasaninvestableassetclass.Afundinggapmeansthere’sgreateropportunityforinvestmentfundstobeprofitablydeployed,whilstTradeFinanceinvestmentoffersaconsistentincome,isrelativelyliquidtomoveinorout,andhasdemonstratedlowvolatility.

TradeFinanceshouldaccordinglyearnitsplacewithinadiversifiedinvestmentportfolio.

iLettersofcredit,Guarantees/StandbyLCs,BidandPerformanceBondsiiSmallandMediumSizedEnterprises,usuallydefinedbyturnoveriiiExportCreditAgency,astatesponsoredentitytosupportexportsviaguaranteestolenderivLondonInterBankOfferedRate,thebenchmarkappliedtofundingininternationalmarketsvStandard&Poor’s,financialservicescompanyandratingagencyviSaleandrepurchaseobligationswherethefundbuysassetstakingownershipwithapre-arrangedforwardsaleusuallybacktotheoriginalseller


APPENDIX

TheICCTradeRegisterReport2016givesthefollowingstatisticsforTradeFinance.

Short-term Trade Finance Statistics

BelowisacomprehensivebreakdownofthedefaultratecompositionoftheLoansforImport/Exportbetweenbankandcorporaterisk,andofthetransactiondefaultratebyassetcategory:

Source:ICCTradeRegisterReport2016

Medium – Long term Trade Finance Statistics

TheMediumandLongTerm(MLT)productsin-scopeoftheICCTradeRegisterarethosewiththebackingofanOECDvimemberbasedECA,representingthefullfaithandcreditoftheirrespectivegovernment.Althoughthein-scopeMLTtransactionshavedifferent


productcharacteristicsthanthetransactionsincludedintheShort-termTradeRegister,theriskprofileoftheMLTproductsisalsoconsideredlow.

ThisisprimarilyduetoalowExpectedLossunlesstheECAitselfdefaults,whichistypicallyconsideredunlikelyasthein-scopeECAsaresponsoredbyhigh-incomeOECDgovernmentsandhaveinvestmentgraderatings.




AboutBankingwiseLimited

Bankingwiseisanichebusinessandmanagementconsultancydeliveringtailoredadvice,supportandtrainingtotheFinancialServicesandCorporatesectors.

AboutKimuraCapitalLLP

KimuraCapital,LLPisanassetmanagementfirmheadquarteredinLondonwithanadditionalrepresentativeofficeinNewYork.KimuraprovidesanalternativetobankfundingincommoditytradefinanceforSmall-MediumSizedEnterprises(SMEs).Kimura’ssectorfocusisEnergy,BaseMetals,SoftsandAgriculturewithsubsectorexposuretopetrochemicals,alloys,concentrates,polymersandfertilizersandwillconsidertransactionsglobally.Kimuraadoptsastringentclienton-boardingprocess.Duediligenceisatthecentreofthecompany’soperationalmandate;athoroughreviewprocessisconductedoneachnewcounterpartyandeverytransaction.

Disclaimer

ThispaperisintendedasgeneralinformationforanyoneconsideringTradeFinancefundsasaninvestment.ItdoesnotconstituteanofferorrecommendationtoapplyforanyparticularfundorfundsandneitherBankingwiseLimitednorKimuraCapitalLLPholdthemselvesoutassolicitingforanyspecificinvestments.TheinformationhereinistohelpinformopinionandtosuggesttopotentialinvestorswhattheyshouldbetakingintoaccountwhenconsideringTradeFinanceasaninvestment.CounterpartiestoTradeFinancetransactionsmaynotthemselvesbeofinvestmentgradeandthereisariskoflossofpartoralloftheinvestmentsthroughdefaultonrepaymentdespitebesteffortsinselectingcreditworthytransactions.Potentialinvestorsshouldnotethattheirfundsmaybeinvestedinunregulatedandmorevolatilemarketswherethereislikelytobe


lessinformationpubliclyavailable.PotentialinvestorsareencouragedtoreadthetermsandconditionscontainedinarelevantOfferingMemorandumbeforeanyinvestmentismadeandtoseekguidancefromaregulatedadviserwhenrequired..

Trade Finance as an Investment vBK 2017 - Kimura Capital · economies, then Trade Finance is the fuel the engine needs to keep running. And yet, for all its longevity, Trade Finance

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