Financing trade’s recovery
While Covid-19 has shaken trade and trade finance, the industry has the continued activity, support and fundamentals to ride out the storm. The key now is to build on the momentum gathered following the outbreak and build out the framework for the industry’s long-term digital evolution, explains Deutsche Bank’s Russell Brown
The year 2020 has not panned out quite as we might have expected. With trade wars, commodity price volatility and a worldwide health pandemic, the global economy has suffered a triple whammy – with consequences that will likely be felt for years to come.
This turbulence has taken its toll on international trade, with World Trade Organisation figures pointing towards a precipitous drop in global trade flows this year, ranging anywhere between 13% and 32%.1 To get trade – and ultimately the global economy – back on its feet, trade finance is more pivotal than ever.
Encouragingly, there is widespread industry optimism regarding trade finance. The International Chamber of Commerce (ICC)’s 2020 Global Survey, which takes in views from 346 respondents in 85 countries, highlights that 61% of respondents are planning to expand their product offering, while 54% are looking to build their market participation.2
For the relative outsider, it’s perhaps a puzzling result. Trade flows are down; risks are up. Where’s the room for optimism? It’s a question of perspective. The risks might be higher for banks, but trade finance remains a uniquely low-risk business, backed by its self-liquidating structure. Trade proceeds directly refinance trade finance debt, which has long meant default rates are way ahead of even triple-A rated corporate debt. So an uptick in risk does not necessarily translate into a worrying risk profile for trade finance assets. Trade finance remains, and always has been, good business for banks.
On the corporate side, long-term trade flows suggest the dip will ultimately register as a temporary blip on an otherwise upward curve. For context, global trade flows reached US$18.1trn in 2019 –despite worries relating to geopolitical tensions and growing protectionism.3 In fact, we have already seen a rebound effect from Covid-19 following the initial shock in March and April and, with counterparty risk heightened by ongoing uncertainty, the value of trade finance as a risk mitigation tool is helping bolster demand. The conclusion? Corporate appetite for trade finance is not going anywhere either.
For all the headwinds, then, the stage is set for trade finance to push on and help kickstart the global economy’s revival. It’s not quite a case of “as you were”, however. For this to happen, the trade finance industry will have to evolve, in terms of industry standards and, in particular, in terms of digitalisation.
Digitalisation: from nice-to-have to necessity
Nationwide lockdowns and border closures quickly brought to light the dependence of trade finance on paper documentation and in-person processes. While the move to paperless trade has been an objective for some time already – over 80% of respondents to the ICC Global Survey cited emerging technology, digital trade and online trade platforms as either an immediate or near-future priority over the next three years – Covid-19 has triggered a renewed push for it to become a reality.
The shift was almost instant. In a matter of hours last March, tens of thousands of Deutsche Bank employees across the world began working remotely from their homes, in step with the majority of industry participants. Paper operations were struck from the menu at a stroke. There was no time for committees, working groups or industry-wide rumination: transactions needed funding immediately and pragmatism was the only path forward.
This sheer necessity brought about what innovation alone could only make possible. Banks found ways to make their processes work digitally and they put them into action. Shortly after the coronavirus epicentre moved from China, the ICC issued rapid response guidelines in the wake of the pandemic, which called for governments to void legal requirements for paper trade documentation and adopt the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Electronic Transferrable Records as an alternative legal framework.4 This helped bring vital clarity to the situation – particularly in emerging markets, which are, after all, at the heart of trade finance.
It is difficult to over-state the importance of this for the future of the industry. These are big, important steps. But we’re only at the start: the next step will be to build on the momentum, standardise the processes and establish a new, better way of working via digital channels.
"It will require more than just a change in market practices for a return to normal trading levels"
All hands to the pump
It will require more than just a change in market practices for a return to normal trading levels. With as much as US$5trn in trade credit needed to mitigate the impact of the virus on trade, governmental and regulatory support has proven essential in supporting businesses in their recovery from the economic downturn.5
Final implementation of Basel III – the latest instalment of the Basel Accords – has been postponed by a year, to allow banks and other financial institutions the additional operating capacity to respond to the crisis and ensure the stability and resilience of the global banking system.6 New rules under the framework would have increased the cost of capital for trade finance. Its deferral has therefore been welcomed by the industry as it seeks to provide critical support for the real economy during this time.
Meanwhile, multilateral development banks, such as the European Bank for Reconstruction and Development (EBRD), have increased their existing support programmes to reflect the unprecedented impact of Covid-19. In April alone, EBRD financing under its Trade Facilitation Programme (TFP) – specifically targeting emerging markets – exceeded €500m.7 Other measures include a US$20bn Covid-19 response package from the Asian Development Bank (ADB).8
In July, the World Trade Organization (WTO), along with the EBRD, ADB, International Finance Corporation (IFC), African Development Bank Group (AfDB), Islamic Trade Finance Corporation (ITFC), and the Inter-American Development Corporation (IDB Invest), also announced their intent to increase support for the trade finance market in the coming months.9 Initiatives such as these help banks mitigate the risks of lending and ensure they can continue to fund important trade flows in these times of heightened economic uncertainty.
Here to stay
These welcome injections of liquidity into the market speak to the robust nature of trade finance and the strong upward trajectory of trade flows over the long term. The numbers might be dipping temporarily, but on the back of strong growth over the past two decades (which have posed major issues of their own), trade finance industry practitioners are rightly optimistic about the future.
The list of challenges to be tackled will never subside, but these same challenges will often enable the transformation and ultimate improvement of the industry. The next steps are clear. We must build on this momentum for digital transformation and tackle the tasks head-on, building a sector that is resilient and fit-for-purpose in the new world that is taking shape.
Russell Brown is Global Head of Trade Finance, Financial Institutions at Deutsche Bank
1 See https://bit.ly/352oe4k at wto.org
2 See https://bit.ly/3lPL2uR at iccwbo.org
3 See https://bit.ly/3nTc5Y2 at iccwbo.org
4 See https://bit.ly/37b5vGu at iccwbo.org
5 See https://bit.ly/2HcaE5V at iccwbo.org
6 See https://bit.ly/2SUUQHl at bis.org
7 See https://bit.ly/2SXXLPK at ebrd.com
8 See https://bit.ly/2HcBTxa at adb.org
9 See https://bit.ly/31rhJHp at gtreview.com
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