A greater supply of capital and a dip in demand are strangling the trade finance business.

Author: Susan Kelly
Constantinides, HSBC: [Pricing] has been driven down quite significantly.

For many corporations, a rising supply of capital and a plunge in commodity prices is an ideal scenario. That’s not the case for companies in the trade finance business, which is currently in the throes of a major shake-up. Supply is outstripping demand, putting pressure on margins. If margins get any thinner, some banks may have little choice but to retrench. Some may be forced out. “It’s a highly competitive market,” says Simon Constantinides, regional head of global trade and receivables finance, Asia-Pacific, for HSBC. “[Pricing] has been driven down quite significantly.”

That may not change anytime soon—not as long as the cost of commodities sags. The sinking prices have taken the value of commodity shipments down with it. Oil is the perfect example. “If you’re financing oil shipments and it’s $100 a barrel, the demand for financing is going to be a lot higher than at $50 [a barrel],” explains Dan Scanlan, regional head of transaction banking for the Americas at Standard Chartered. “The same amount of oil is getting shipped, but the amount of financing needed is being reduced.”

To compete, some banks are easing up on credit standards. “Not only does pricing decline, but people start giving up covenants,” says John Ahearn, global head of trade at Citi. “You’re starting to see credit standards slip. A deal that would have been structured much tighter a year ago is structured much looser.”

Indeed, if margins erode even more, Constantinides believes some banks will exit the business. Selling their trade finance operations seems the likely way out. “The only way you survive this is to go for scale,” Ahearn notes.


Cheap money and a decline in prices aren’t the only things buffeting the trade finance industry. Profits are also being zapped by a raft of new regulations, including a greater focus by regulators on money laundering. “We’re constantly putting in more and more and more controls,” Ahearn says. Compliance tasks that are now required in trade transactions can include a sanctions screening or a negative news search on the names included in a trade document or a vessel check to ensure a ship hasn’t stopped at a sanctioned country. As banks perform those checks, “the wheels of commerce are turning much slower,” Scanlan says.

Ultimately, the changing market dynamics and increasing costs for banks will mean higher costs for corporates, notes Scanlan. While that hasn’t happened yet, “it’s only a matter of time, particularly for what banks consider to be high-risk transactions ... including transactions emanating from high-risk countries,” Scanlan predicts.

Citi’s Ahearn notes that banks are doing the compliance work manually. “So far, it’s been a ‘put bodies against it’ strategy,” he says. “One of the things we need to do is automate these processes.”

Electronic alternatives have not yet gained much traction. The SWIFT bank payment obligation offering—which uses an electronic exchange of information about trade transactions—has not been swiftly embraced. Jim Wills, senior business manager at SWIFT, notes that 40 large corporations and 16 large banks are now using BPOs, with annual transactions in the low thousands. “Primarily in Asia is where we’re seeing the activity take place,” he says. Jon Richman, head of trade finance in the Americas at Deutsche Bank, says that while BPOs offer “a strong value proposition,” the many parties, rules and technologies involved means “it takes a long time to generate the critical mass you need for large-scale success.”

The lion’s share of trade transactions are no longer being backed by trade finance instruments but are on an open-account basis. Nancy Atkinson, a senior analyst at Aite Group, notes that trade transactions often involve large corporates buying from small suppliers. The shift away from trade finance can leave those suppliers in need of financing. “We’re seeing increased interest from large companies to support their strategic vendors, those small business suppliers,” Atkinson says. “Supply-chain finance is starting to come into its own.”

Given the current volatility in the foreign exchange markets, receivables discounting can also serve as a risk management measure, says Richman. “If you have a receivable in a foreign currency, if you discount it early, you will reduce the risk.” He notes that Deutsche Bank is building forex solutions into its products, allowing a client to pay in dollars or some other currency while the purchaser is paid in local money.

As the banking industry changes and client demand for large supply-chain finance grows, trade finance will become increasingly connected to the capital markets, Richman believes. In some cases, big supply-chain finance programs are already bringing alternative investors into the fold, he notes. “We are increasingly seeing new types of investors play in these programs, given the attractiveness from a risk/return perspective.”


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