Broadening the appeal of trade finance as an asset class

Getting liquidity into supply chains is critical for the post-Covid recovery of cross-border trade. With the global trade finance gap at its highest level yet, a market has developed for investors to step in and address unmet demand. Speaking at GTR Mena 2021, Viacheslav Oganezov, co-founder and CEO of supply chain finance (SCF) platform Finverity, outlined how fintech can bring capital into this attractive asset class.

Growing demand

Over the last decade, the progressive reorganisation of regulatory capital frameworks has reduced banks’ capacity to handle trade finance, particularly for small- and medium-sized enterprises (SMEs). However, these firms, which represent about 90% of businesses and more than 50% of employment worldwide, are the motors of the global economy – and they need more finance, not less.

“For some of the bigger traditional financial institutions, it is difficult to meet this demand because it is simply not economically viable to service smaller tickets – especially if you need to do everything manually,” says Oganezov.

Trade finance encompasses a wide spectrum of structures that support the production, transportation, and payment terms of global trade. One product in particular – SCF – saw a huge surge in demand during the worst of the Covid-19 slowdown, as buyers pushed out payment terms, squeezing suppliers’ liquidity.

As the global economy begins to recover, this upswing shows little sign of abating.

“We have seen a tremendous pickup in requests for supply chain finance from mid-caps and SMEs because there is pent-up demand and there are supply constraints,” says Oganezov. “A lot of these companies have good relationships with their suppliers and buyers. They can secure the stock, and they want to sell it onwards, but they don’t have the working capital available to facilitate the flow. That is where it is crucial to provide these types of facilities.”

Large potential supply

Low default rates, attractive yield pickup, and limited correlation to public market debt should mean that trade finance is an obvious investment opportunity. However, the scale of non-bank investment in this space has been limited – until now.

“There is a large inflow of alternative capital because of what has happened to traditional financial instruments: there is no yield available in traditional fixed income, so investors are more and more interested in this asset class,” says Oganezov. “However, they need the required operational infrastructure to be in place in order to participate because it is very difficult for them to do it themselves.”

Non-bank investors are eager to get involved with this low-risk asset class, but to do so at scale they need specialist solutions tailored to their needs, which are very different from those of large banks. At the same time, smaller local and regional banks see an opportunity to grab market share, but similarly to non-bank investors, they need enabling fintech partners to compete effectively.

Bridging the gap with technology

“From visibility to underwriting support, access to real-time data for monitoring, as well as segregated accounts and payment automation, technology plays a key role because it lowers the barriers to entry,” says Oganezov. “Investors often don’t have those capacities in house, and they don’t want to build a massive back-office team; they want a solution that will support them on that. The costs of onboarding can be mitigated via technology, which in turn opens up this asset class to a wider group of investor profiles.”

However, it’s important to remember that technology in and of itself is not a solution but rather an enabler. The ability to originate quality transactions, structure them and match with the right lenders is vital. This quality deal flow combined with a tech-enhanced process not only reduces the perceived risk of certain transactions but also bridges the gap between bank/investor collateral requirements and corporates’ willingness to work with the proposed structure.

“Technology plays a huge role in ongoing risk monitoring,” says Oganezov, adding that Finverity has developed a tool as part of its collaboration with Abu Dhabi Global Market that allows it to seamlessly integrate into obligors’ accounting packages to see financial data in real-time. “This minimises the burden in terms of ongoing documentation, and also addresses the biggest risk in SCF: not seeing the deterioration in financials quickly enough to be able to pull out in time.”

A low-risk opportunity

Since 2008, the International Chamber of Commerce (ICC) has been tracking global risk in trade finance through its Trade Register, which brings together data representing up to 30% of all global trade finance transactions. The most recent report, published last month, found that while default rates for most trade finance products experienced a modest spike during 2020, they did not reach unprecedented levels, reinforcing the view that trade finance as an asset class is inherently low risk.

This low default rate, coupled with potential high single-digit yields, means that it’s no surprise that the trade finance sector has become increasingly enticing.

By harnessing the power of technology platforms, a greater number of funds and banks will be able to allocate to this asset class, enabling the wheels of global trade to continue turning.

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Posted by Radek Vanis

Chief Marketing Officer at Finverity