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Trade finance

Trade Finance Comes of Age as an Asset Class

Trade finance is the backbone of the global economy yet the shortfall between what banks can supply and what the market demands has continued to rise. The trade finance gap now stands at $1.7tn, according to the Asian Development Bank, leaving many businesses without access to the funding they need.

Faced with increasing capital restrictions, banks are recognising that by distributing these assets to capital markets, they can free up their balance sheets and essentially do more with less. However, trade finance’s potential as an alternative investment prospect has historically been overlooked, leaving it largely untapped.

Part of the problem was banks distributed only a small percentage of their trade finance books to capital markets. Tighter control on lending in the form of Basel IV is creating a new impetus and with investors searching for alternative sources of yield, a viable multi-trillion-dollar opportunity is emerging.

Calculating the opportunity

From global trade volumes, it’s possible to determine the scale of investment on offer. Around $14tn requires financing – some 80% of the $17.5tn of global trade according to the World Trade Organisation and Statista. In line with reports of other commercial bank assets, about half of the $7.2tn that is bank intermediated could become available to investors.

Based on an average 90-day tenure for trade finance instruments, $900bn of investor financing would cover the estimated $3.6tn of bank assets available for distribution. Therefore, if the largest asset managers had the means to divert just a fraction of their assets into trade finance, it would not only solve the global trade finance gap but also enable banks to lend more while creating more servicing income themselves.

Enabling buy-side firms to capitalise on this, however, depends on two factors – understanding trade finance’s appeal and breaking down the barriers to entry.  

The hunt for yield

Previously reliable investment options have presented new challenges. 2021 was a difficult year for bonds, which have traditionally been an instrument of choice for those seeking safe, long-term returns, while FX and equities have been prone to bouts of volatility and remain unpredictable.

On paper, trade finance has all the components that investors look for. It is a multi-trillion-dollar asset class based on the tangible flow of physical goods, making is less susceptible to financial market volatility or indeed geopolitical factors. This means it is a safer product and has the potential to deliver stable returns.

It is also a low-risk asset class. Default rates for trade finance products are lower and the time to recover in case of default is much shorter than for other products and asset classes. So, why the slow uptake?

Tackling access and cost barriers

The problem is capital markets access for investors is limited due to the need for repackaging of portfolio risk and operationally intense reporting requirements.

For an investment bank to execute on behalf of an asset manager, the transaction costs for a low risk, low yielding product would regularly exceed the asset spread of short-term bank exposure. This limits access to a small portion of riskier assets.

Commercial banks distributing trade finance via investment banks face similar cost barriers due to the need to repackage instruments from a legal and regulatory standpoint.

All this calls for a more cost-effective approach to make trade finance a palatable investment proposition.

Opening the door to trade finance

The desire to add trade finance assets to investor portfolios is not new – originator banks have been packaging up and selling their assets for years. What is changing is the steady dismantling of old complex and convoluted processes with little transparency and standardisation.

The trade finance infrastructure now exists to enable end-to-end straight-through-processing of hundreds of thousands of instruments in a low-cost way. This is equipping asset managers and commercial banks with direct access to trade finance assets, enabling alternative investors to channel more capital into banks and onto corporates.

The result will be diverse portfolios that not only deliver the prospect of healthy returns but also hold the potential to advance global trade and, ultimately, economic prosperity.


Christoph Gugelmann is Co-Founder & CEO at Tradeteq


The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group

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