By Christoph Gugelmann, CEO at Tradeteq
Ask an investor which asset class they see as the most attractive and trade finance may not necessarily feature in the mix. This little understood asset class is one of the oldest and most profitable forms of institutionalised credit, yet remains an untapped investment opportunity.
There is currently a $1.5 trillion trade finance gap, but without efficient access to the asset class for non-bank financial institutions such as pension funds, insurance companies and credit funds. If we are to close the gap and seize the treasure that is trade finance, we need to address the current market processes. As with most modern-day solutions, the key lies in technological innovation and automation.
A guide to the treasure
Trade finance oils the wheels of global trade to drive economic growth. The model is organised around providing working capital for buyers and sellers along the supply chain. As such, it is closely tied to and reflective of the growth of the global economy. This makes the asset class better placed to stay neutral during periods of volatility seen in financial markets.
Trade finance has attractive investment characteristics. In a world where half of global bonds yield less than 1% and a material portion which is subject to negative yields, trade finance offers positively yielding, typically low-risk, short-dated cash-flows that are uncorrelated to traditional asset classes such as stocks and bonds. Trade finance is also self-liquidating, meaning the instruments will be repaid from cash flows generated through the underlying trade.
Investments in trade finance requires an infrastructure allowing funders to process and monitor large amounts of instruments. Ongoing effective due diligence has to be conducted in order to mitigate transactional risks. To date only banks managed to build and operate required operational infrastructures at scale.
“If we are to close the gap and seize the treasure that is trade finance, we need to address the current market processes.”
Build the bridge to access the treasure
While trade finance has some clear value, it remains a largely underserved market. Banks provide about $10 trillion in trade finance to corporates in support of the $16 trillion global market for international trade. The demand for these funding products currently exceeds the available funding and banks can’t serve all their customers as well as they would like to.
The phase-in of the transitional Basel III arrangements until 2027 will require increasingly higher capital for banks to hold trade finance on their balance sheet. Banks therefore need to move to an originate and distribute model and are keen to bring institutional investors into the picture.
The Trade Finance Distribution Initiative (TFDI) is one example of the industry working together to build a market where trade finance assets can be bought and sold efficiently. A crucial step in this process is to create a blueprint of the common standards for global trade finance asset distribution. The TFDI is targeting institutional investors that seek alternative exposure to either large investment-grade multinationals, or to SME sellers of lower, medium-grade credit quality.
However, for collaboration to be truly effective, common data standards and definitions to address operational inefficiencies, transparency issues, and risks are required.
“Building the bridge of knowledge between banks and institutional investors is the key”
The keys to the kingdom
Having one common infrastructure in place will greatly enhance the finance industry’s demand for democratisation and enhanced efficiency in trade finance distribution. Tradeteq is the platform that seeks to achieve this, by allowing banks to connect, interact and transact with institutional investors and share trade finance exposure. To make trade finance assets both transparent and scalable, Tradeteq automates processes end-to-end and makes advanced credit analytics and reporting tools available.
Trade finance instruments per se are mostly unrated by traditional rating agencies. By providing investors with an AI-driven risk score, trade finance can be made accessible for regulated institutional investors which can now use internal assessment approaches under their respective regulatory solvency frameworks.
Trade finance will continue to grow in status and be seen as a truly investable asset class in its own right. What is most clear in the roadmap to executing this vision is that market participants must consolidate their approach around standardisation. Building the bridge of knowledge between banks and institutional investors is the key to unlocking the treasure chest that is trade finance.