TRADE FINANCE: Into the void

Global trade is slowing – fast. After expanding 5% in 2011, growth in global trading volumes will slow to 3.7% this year on World Trade Organization estimates.

At the same time, concerns are mounting over how trade flows will be financed, in particular for those looking to develop natural resources and related infrastructure. The risks remain particularly acute for many Asian economies that are still heavily reliant on exports to the European Union and the United States.

Asia managed to ride out the 2008/9 global financial crisis, boosting intra-regional trade in the process. But many see today’s global economic slump as more insidious than before, threatening the solvency of developed nations and their financial sectors – a fact that makes the scarcity of funds for trade all the more alarming.

Although the funding gap for trade has been a steady feature of the market for some years amid soaring trade volumes, experts note that the dearth of funding in today’s environment is especially severe. “There is a persistent market gap in trade financing, one that is exacerbated at the moment,” says Steven Beck, head of trade finance at the ADB.

The funding shortage is partly a function of financial deleveraging and tighter regulation in the West, says Beck. “We see deleveraging taking place in much of the world. Compounding this are tighter regulatory requirements – lower permitted leverage ratios – on banks and, finally, there is need for banks to shore up their capital bases by raising more capital and/or shedding assets.”

The combination of these factors “is sucking a lot of capital out of the economy that could otherwise be used to support trade and other economic activity,” Beck says.

This financing gap is unlikely to diminish soon: it’s “the new normal”, he says. “This is scary, because it could mean anaemic economic growth and low job creation into the medium term.”

Mark Evans, global head of trade and supply chain at ANZ in Melbourne, says it’s difficult to estimate the extent of the funding shortfall: “By virtue of this deleveraging, repatriation of western banks’ assets to home markets and with Basel III on the horizon, there will be a financing gap – the size of which is currently unknown.”

Some now argue that Asia is ill-equipped to cope with a pull-back of European and US banks from the region, says Evans.

However, the banks that pulled back from emerging Asia – French, Spanish and Italian banks in particular – were primarily focused on big structured trade and project finance transactions, rather than financing the large volumes of day-to-day vanilla trade finance in the region.

Large global banks, including HSBC and Standard Chartered, continue to have among the largest trade finance share in Asia, taking into account their range of clients from small- and medium-sized companies (SMEs) to multinational corporations.

Shivkumar Seerapu, regional trade finance head for Asia-Pacific at Deutsche Bank, based in Singapore, acknowledges that “the availability of finance has become tighter all round.”

Finance is still available “for the bigger and well-rated clients”, says Seerapu – “but at a higher price”.

Ravi Saxena, regional head Asia-Pacific trade at Citi, says, “Demand has gone up with our core clients, and this is particularly so with tenors. Terms of trade have increased as buyers are negotiating for longer tenors.”

Nevertheless, the bank’s balance sheet for trade in Asia “has tripled in the last three years” as companies’ trade finance needs have soared, he adds.

STEPPING IN

Local and regional financial institutions are now starting to do more business following the retreat of European banks.

“On the ground we are seeing both local and some regional banks expanding to fill the gap,” says Evans. “Companies are able to source trade finance and, in fact, the market remains very competitive.”

There has been a “renewed push” by US and Canadian banks into Asia, while Chinese state-owned banks – among the biggest and most profitable in the world – have been “rapidly spreading their footprint” across the region.

Australian bank are also making some of the biggest inroads in Asian trade, albeit largely in bilateral trade with China. Although wholesale funding costs for Australian banks have increased, the sector remains well capitalized and has minimal direct exposure to European sovereign debt.

But Beck is quick to dismiss the notion that Asia-Pacific banks are picking up the slack left by departing western lenders. “This idea that the Japanese and Australian banks are filling all of the gaps left by European banks is mostly a myth,” he says. “For local Asian banks, they are not filling most of the gaps. There is a credit culture which does not change overnight. I don’t see the gaps being filled.

“When capital is tight, banks focus on core markets, not the more challenging emerging markets, and on core large clients, not SMEs. So to the extent we see Japanese and Australian banks picking up business, filling bits of the gap left by less active European banks, it’s mostly confined to supporting large corporates in relatively developed markets.”

Others take issue with the suggestion that China’s banks will somehow make up for the trade financing shortfall. “I don’t see [Chinese state banks] filling any gaps,” say one banker in the region. “But I do see them becoming more experienced, learning more about the trade business and getting more comfortable with the business. The increased contact with western banks will pay off for them.”

MEETING THE CHALLENGE

Nevertheless, some regional institutions are beginning to step up to the challenge. The Development Bank of Singapore (DBS) is one example of an institution that has been more visible in a number of high-profile trade deals this year.

Meanwhile the ADB launched its Trade Finance Program (TFP) to help trade. In the region in 2011, the initiative supported $3.5 billion in trade deals, covering 1,803 transactions, where the average duration of the finance was 180 days. The most active countries were Bangladesh, Nepal, Pakistan, Sri Lanka and Vietnam.

Says Beck: “The TFP works to fill market gaps. We’ve had over 50% growth in TFP volumes in Q1 2012 compared to the same period last year. The programme focuses on supporting trade where the gaps are proportionally largest, in the more challenging Asian markets, so it doesn’t assume risk in relatively developed markets like China, India and Thailand.”

Since the global crisis, the pace of intra-Asian trade has picked up, partly to offset diminished demand from traditional export markets in Europe and the US and partly as a result of rising demand for a growing middle class in China and India.

Although the supply chain has strengthened to help accommodate this change, rising labour costs in China have also meant a shift in manufacturing industries to Bangladesh, Vietnam and other lower wage Asian countries.

The net result has meant a boost for trade finance. Says Beck: “This is a big component of our TFP portfolio. Over half of our transactions in 2011 supported intra-Asian trade, and the trend continues.”

Seerapu says Indonesia, Vietnam and Sri Lanka are among a number of emerging new locations for manufacturing and sourcing alternatives to China, while the Philippines is now also seen as an alternative to India for call-centre operations. “This trend of diversification is good for the multinationals and good for Asia,” he says. “Looking ahead, I see more upside than downside. Trade volumes will increase in the near to medium term in Asia.”

New pools of liquidity will help finance trade, not least the emergence of China’s currency, the renminbi, as a major trading currency. China’s trade volumes are roughly $3 trillion per year, 10% of which is already RMB-denominated, says Citi’s Saxena.

“The use of the renminbi is changing the way some trade finance is transacted, and this has been a rapid change,” he says.

The impact of Basel III regulations, which come into force in 2016, is an unknown that many are still grappling with. Seerapu says that “the ability and willingness of the banks to finance the growing trade flows will depend much on how the Basel III regulations get implemented.

“In its current shape and form, it would mean increased cost and less availability of trade finance, which would not be welcome news for banks and companies.”

But regulatory concerns notwithstanding, there are still reasons to be cheerful: global trade is expected to accelerate from 2014, according to a recent HSBC study. Over the next 15 years, trade in Asia and globally is expected to grow 120% and 86%, respectively.

Asia-Pacific’s annual trade growth will consistently outperform the global average, with the gap widening further over the next 15 years, the forecast says, while China is expected to overtake the US as the world’s largest trading nation by 2016.

For Simon Constantinides, HSBC’s regional head of global trade & receivables finance for Asia-Pacific, this is ample cause for “optimism for the region’s trade prospects” in an otherwise challenging environment.