TRADE FINANCE: FINANCING UNMET DEMAND IN EMERGING MARKETS

Although barriers to trade have declined, gaining access to trade finance is challenging in some markets.

Emerging markets’ firms are ever more central to world trade. In 2012, trade in developing countries accounted for 38% of global flows—up from 14% in 1990, according to the McKinsey Global Institute report, “Global Flows In A Digital Age,” published in April. But unmet demand for trade finance capacity in emerging markets is making it difficult for small and medium-size enterprises to meet their financing needs, which may stymie their ability to grow.

Trade finance backs global flows by offering importers and exporters the ability to obtain much-needed funding while mitigating counterparty risk. A report published by the Bank for International Settlements in January estimates that trade finance directly supports about a third of global trade and is “primarily used to finance trade involving emerging markets economies (EMEs), particularly in Asia.” The report states that in China, for example, trade finance backs 47% of merchandise trade.

The lack of clear regulation... is leading to unintended consequences and is increasing the market gap for trade finance—which ultimately results in less trade and less economic growth.

~ Steven Beck, Asian Development Bank

Sam Sehgal, EMEA head of trade finance and commodities at Citi, identifies several long-term trends that will affect the development of this area over the coming decade. “Without a doubt, the most important trend is globalization,” he says. “As companies’ trade activities become more international, banks are likewise having to make their products more global and scalable. On a related note, banks which are looking to service their clients holistically also need to provide solutions which go beyond US dollar-, renminbi- and euro-denominated trade and also focus on exotic currencies.”

“A few years ago, people were talking about the decoupling of the East and West—but this isn’t the reality,” observes Simon Constantinides, regional head of global trade and receivables finance in Asia Pacific for HSBC. “We live in a global economy: The world moves rapidly and daily, and so does trade. The barriers to trade have been reduced, and companies are a lot more comfortable setting up their manufacturing operations all around the world.”

Sehgal notes that there is increasing investment in infrastructure by some emerging markets economies, as well as growing demand for commodities as expanding populations become more affluent, thereby consuming more. Both of these trends are driving EM growth, which in turn is a key driver of global growth. A report published last year by Ernst & Young, “Hitting the Sweet Spot: The Growth of the Middle Class in Emerging Markets,” predicted that the global middle class will expand by three billion people in the next 20 years, with most of this growth coming from emerging markets.

WORKING CAPITAL NEEDS

But it is unclear whether banks will continue to be able to finance that growth through their balance sheets. “Clients are increasingly looking for off-balance-sheet solutions,” says Sehgal. “Basel III will force banks to make choices for the scarcer capital they have, which as a result will mean less lending to the corporate sector. Corporates will therefore have to find intelligent and indigenous ways to extract working capital requirements from their own operations, rather than relying on bank debt. Often this means having a robust, end-to-end supply chain finance solution, i.e. a robust mechanism to pay suppliers, leaner inventory management and market-leading receivables financing capabilities.”

Banks are increasing investment to these areas. Constantinides says HSBC is focusing on the shift from traditional trade products, such as letters of credit, to open account terms. “We’ve been building out to support open account with our receivables finance and payables finance structures and have been putting new technology and solutions into the market with that,” he says.