Fund Manager, Trade Finance
Trade Finance helps support and facilitate an estimated US$ 18 trillion of global merchandise exports annually, of which 80% is either financed or risk insured according to the World Trade Organization (WTO). Growth in the volume of world trade is expected to remain at 2.8% in 2016 rising to 3.6% in 2017.
Danny Jones highlights recent trends in Trade Finance.
Trade finance appears to be in the spotlight for a number of institutional investors. What is driving this trend?
Following the global economic crisis, the changing regulatory landscape in the financial sector with the introduction to Basel III has led to the trade finance business line becoming more challenging for banks/traditional lenders. The regulatory changes dictate that financiers allocate increased regulatory capital towards trade finance exposures which makes this business line less attractive from a return on regulatory capital perspective. Banks/traditional lenders will have to increase pricing between 18% and 40% under the Basel III rules and some have rather chosen to rather scale back or even close their trade finance operations. This has created an opportunity for alternative financiers like the Rasmala Trade Finance Fund to play a critical role in bridging the funding gap and delivering customized structured trade finance solutions to established mid-sized corporates that require growth liquidity. A growing pool of alternative liquidity providers have entered the trade finance market and established investment vehicles which has made trade finance more accessible than ever before to institutional investors.
There is a well-documented funding gap in the global trade finance market. Is the GCC also experiencing this funding gap?
The region remains overbanked and therefore large regional corporates continue to enjoy access to relatively cheap bilateral funding from both international and local banks.
In the last year, credit lines to regional mid-sized corporates and traders have been capped or are being trimmed by traditional trade financiers. This has resulted a liquidity squeeze in this segment of the market. Therefore, there is significant local interest from mid-sized entities to engage with alternate financiers to further diversify their funding sources and grow their businesses. Corporates recognize that alternate financiers have higher cost of funds relative to traditional banks therefore core trade finance facilities continue to be provided by relationship banks with more expensive finance from alternate financiers typically used to cover temporary shortfalls and incremental high margin orders.
In the SME sector there has in recent months, been a sharp tightening in lending standards on the back of an uptick in non-performing assets from this segment of the market due to the challenging economic environment. The funding gap in the regional SME sector therefore remains acute and this is unlikely to improve in the near term.
How does traditional trade finance differ from structured trade finance?
Traditional trade finance is based on balance sheet lending whilst structured trade finance seeks to shift the risk from a corporate borrower into an isolated asset or structure such that repayment is achieved irrespective of the financial health of the corporate borrower. Structured trade finance enables the financier to mitigate various risks including sovereign risk, corporate risk, asset price risk, payment risk, supply and/or demand risks by isolating an asset and the predictable cash flows associated with that asset. This is achieved in a manner that ensures repayment of the obligation from the cash flows generated by the underlying assets.
How does structured trade finance provide diversification to those who want to achieve higher yields in a challenging economic environment?
Short term self-liquidating trade finance exposures have historically generated attractive low volatility returns for investors that are uncorrelated to the performance of most other investment strategies including equity, fixed income and the leveraged loan market/corporate lending market. The heightened volatility witnessed in global and regional equity and fixed income markets in recent years has resulted in a search by institutional investors for investment strategies that generate above average returns with low volatility. Well managed structured trade finance funds and portfolios are designed to meet these investment objectives and contribute positively to the risk adjusted returns of an investor’s diversified portfolio. In addition, the short duration floating rate characteristics of structured trade finance obligations will protect investors in a rising interest rate environment.
Will alternate financiers replace traditional banks?
It is important to recognize that alternate financing will not replace the traditional trade finance banks who provide predictable liquidity and products critical to the seamless functioning of global trade. By way of example, the ability of alternate financiers to meet the liquidity needs of their clients is less certain as they are dependent on available cash, subscriptions, redemptions and standby liquidity facilities. Alternate financiers cannot issue letters of credit or payment guarantees and therefore we see traditional and alternate financiers co-existing within the industry. A number of trade finance professionals operating in the structured trade areas of traditional banks have recognize that the regulatory challenges facing the banking industry will not dissipate in the near future and have therefore chosen to “switch ships”. We expect the steady migration of experience and expertise from the traditional trade finance banks into the alternate financing sector to continue for the foreseeable future.
ABOUT RASMALA TRADE FINANCE FUND
The Rasmala Trade Finance Fund was recognized for its outstanding performance and innovation by MENA Fund Manager.
- Asset Type: Alternative
- Fund Currency: USD
- Fund Size: USD 85 million (As of 31 March 2016)
- Domicile: Cayman Islands
- Inception Date: 14 September 2014
- Structure: Open-Ended
- Performance Hurdle: 3 Month USD LIBOR+350 bp
- Geographic Allocation: Global
- Subscription Frequency: Monthly
- Redemption Frequency: Monthly
- Redemption Notice Period: 30 Days