With corporates looking for safe places to put their pockets of liquidity, trade finance assets seem an ideal solution with potential to balance yield and liquidity thanks to the short-term nature of trade finance lending.

Other attractions include historically low default rates and the diversity and granularity of trade finance loans that are grounded in the real economy. By investing in trade finance assets investors can gain exposure to the asset class without needing to be lenders themselves.

As helpfully summarised by the law firm Mayer Brown,¹ traditionally trade finance can include:

• Investments, typically in the form of factoring or other purchases of individual receivables (or other financial assets created from or otherwise supporting those receivables), whether to provide financing to buyers or suppliers (or other intermediaries) in the supply chain (“obligor-specific transactions”);
• Asset-based lending (ABL) typically constituting loans, provided to a supplier of goods or services and secured by a revolving portfolio of short-term receivables and inventory; and
• Securitisation of trade receivables (structured finance) which may be financed by banks or more widely in capital markets but always utilising a bankruptcy remote structure.

While some of the larger securitisation structures are well-known in the trade finance community which package baskets of assets such as supply chain finance and letters of credit (LCs) with an average life of 180 days, such structures are few and far between because of the constant need to replenish the basket. Deutsche Bank has issued four transactions under its TRAFIN series, taking an underlying portfolio of US$3.5bn in flow business, short-term trade finance, LCs, supply chain finance and documentary credit business, dividing it into different risk segments and placing the first loss tranche of US$216.13m (6.5% of the total portfolio) with institutional investors.²

Jonathan Lonsdale, Head of Trade & Working Capital Solutions, Private Debt Mobilization, Santander Corporate & Investment Banking (and formerly at Deutsche Bank) explains in the Guide to Receivables Finance (published September 2021³) how such structures found traction in the marketplace:

“Basel reforms and the Capital Requirements Directive IV (CRD IV) have made trade finance increasingly expensive from a regulatory capital perspective, despite representations made by the industry that the asset class should not be treated the same as riskier asset classes. This has prompted banks to turn to securitisation as a way to obtain balance sheet and capital relief, and trade finance has naturally emerged as an asset class for which there is healthy demand from investors in securitised format.”

He continues, “Changes to the Basel framework that came into force in January 2019 have reduced the efficiency of synthetic securitisation as a tool for capital relief alone, though given the record issuance levels in 2019, there appears to be sufficient supply, indicating that this is still an economic and necessary tool for banks’ management of their capital position.”

Although some institutional investors and corporate treasurers are familiar with and have participated in such securitisations, for many companies, pension funds, corporate treasurers, this is a new asset class and alternative bridges to securitisation between investor and originator have been emerging.

This shifting landscape of investor access to trade finance assets was the backdrop to two panel sessions organised by the International Trade & Forfaiting Association (ITFA) at the end of 2021 in a welcome return to physical conference sessions after a pandemic-induced hiatus.

As a ratings agency that rates trade finance funds, Fitch, said Alastair Sewell, “has a professional interest in the structures and wrappers for the asset class”. He works with corporates that invest in mutual funds and for many of those investors, he said, “particularly in EUR, a return of nothing is aspirational – in this world where getting your money back is an aspiration, there is clearly an incentive to search for yield”, he reflected. This, he continued, “leads some of the more adventurous investors to look further afield into instruments that are familiar such as trade finance as part of an overall segmentation strategy”.

Asset managers, he added, have an opportunity to deliver trade finance assets to investors in such a way that gives confidence after the fall-out of the Greensill scandal⁴.

“Most of our investors ask for…the right risk return and transparency”
Bart Ras, Managing Director, Working Capital Origination, Pemberton Asset Management

Former banker Bart Ras of Pemberton AM confirmed that “asset managers and private debt is moving into this space”, with opportunities for attractive returns from non-investment grade assets. “Most of our investors are asking for two things: the right risk return and transparency. They want to understand what they are buying and be transparent in which areas they could lose money. They just want to understand the scenarios of how they are protected, what are the things that could go wrong and how they get their money back.” He added that more needs to be done on educating investors as for many of them payables and receivables assets are new.

A key thing to remember noted both de Comminges and Sewell was that one size does not fit all and the importance of distinguishing between the different types of trade finance assets. Sewell pointed out how an insurance company will have different requirements from a pension fund, while de Comminges noted that, “not all assets provide the right return to investors – trade finance comprises multiple asset classes and these assets need to be defined and segmented”. He explained, “You have traditional trade finance assets, LCs, etc all working well in the secondary market that distributes that risk. Then you have open account, receivables finance and supply chain. Then there is the higher yield business: pre-export finance and commodity trade finance. Trade finance funds need to reflect their different sectors or else investors will not know what they are getting into.”

In particular, de Comminges said, it was important that investors could easily understand that trade finance assets are funded with the balance sheets of the best financial institutions in the world. Hegde added, “It is our responsibility as asset managers to provide the transparency and understanding – investors must be able to understand what is in the fund. Receivables finance and structured commodity trade finance, for example, while both sitting under the broad umbrella of trade finance, will deliver quite different risk/return opportunities, and may also have significantly different operational or regulatory capital implications for investors.”

Mike McGill confirmed that Allianz Global Investors does have investors that are more familiar with investing in private markets and that over the past 18 months, there had been much discussion around what the inherent dependencies of the funds are, how the assets are sourced, and what access there is to liquidity. “This suggests there is a baseline understanding established around instruments, the markets and portfolio construction,” he said.

Turning to the issue of liquidity, for investors to feel comfortable with trade finance funds, they need the reassurance that the liquidity they inject will come back to them with a positive yield – and that all depends on what timescale the investor is looking at. As de Comminges observed, “You position the funds and not the transaction and you are competing with other funds. You need the right portfolio with the right diversity that the investor understands that fits their liquidity requirements.”

The other issue, everyone agreed, was at what point the investor is using trade finance funds to provide a working capital solution rather than an actual investment. Ras (who has previously worked for a large Dutch MNC) reflected on how working capital is a moving target. “I like deals that do mature and where facilities are repaid.”

“Investors need to understand that investing in trade finance is investing in the real economy”
Bertrand de Comminges, Global Head of Trade Finance Investments, Santander Asset Management

In addition, one should remember that a trade finance fund is scrutinised alongside other investment funds. “We care competing against money market funds,” said de Comminges. These provide daily liquidity that trade finance funds cannot provide, and they focus on financial institution risk as well as governments. Trade finance, he added, provides diversity across industries “but investors need to understand that investing in trade finance is investing in the real economy. They are investing in the biggest an more solid commercial relationships in every industry”. Keeping investors is critical – when an asset manager buys, for example, EUR300m of trade finance assets from a bank and one of the investors pulls out of the fund, this creates problems. “We build our funds slowly as education and confidence takes time to build,” he added.

While banks were historically the main source of trade finance assets, the panel agreed that the inflow of assets from this channel had reduced and asset managers are turning to other sources (such as corporates and fintechs). In another session delegates heard how trade finance assets are transformed using blockchain technology into non fungible tokens (NFTs) which institutional investors can then buy and sell.⁵

Speaking away from the panel session, André Casterman, Chair of ITFA’s Fintech Committee confirmed the initial tokenisation transactions: “The new tokenisation option delivered as part of the TFD Initiative completes the chain from investor right through to the recipient of funding with complete transparency, accountability and liquidity. This is an important step as it lays the groundwork for the distribution of tokenised bank-owned assets in a standardised and secure manner and offers the potential to involve the retail space.”

Should the banks be worried? Boris Jaquet, Global Head of Trade Finance Distribution Deutsche Bank (who was among the delegates at the ITFA event) thinks it is too early to tell although, he says, “I have seen certain types of assets moving from banks to platforms noting some banks are active players on those platforms – so perhaps this is just a change in the market landscape.”

Sources

¹ See https://bit.ly/33Bn9nk at mayerbrown.com
² See https://bit.ly/3qHlntA at gtreview.com
³ See Guide to Receivables Finance at corporates.db.com
⁴ See https://bit.ly/3qN4bTG at tradefinancetv.net
⁵ See https://bit.ly/3fFNKSr at treasury-management.com