Trade Finance TV:  Distributing trade finance assets – the new era

With around 80% of global trade financed by some form of trade credit, the ability to distribute trade finance assets is key to liquidity. In this episode of Trade Finance TV we talk to experts from two banks and two non-bank liquidity providers about how the “originate-to-distribute” model has evolved; not only between banks, but also originators and investors, and how it has been shaped by regulation and technology.

As Santander’s Jonathan Lonsdale puts it, “We need to tap into that pot of institutional capital. There is a limited amount of bank capital and no matter who syndicates what to whom it is a zero-sum game.”

Continuing the theme of the previous episode, technology plays a huge part in making this happen and, explains Lloyds’ Cláudia Dos Santos, “needs to speak to our systems and allow our systems to communicate with other systems and it can’t be a one size fits all”. We hear more about the “standardised dashboard that can exist between the participant and distributor” from Liquidx’s Dominic Capolongo, and Christoph Gugelmann from Tradeteq closes by observing that just as containerisation simplified ocean-borne trade three decades ago, trade finance instruments need to be standardised “and put into boxes to make them available to the capital markets.”

Participants

Cláudia Dos Santos, Director, Trade and Working Capital Sales, Lloyds Banking Group

Jonathan Lonsdale, Global Head of Trade & Working Capital Solutions, Private Debt Mobilisation, Santander Corporate and Investment Banking  

Dominic Capolongo Chief Revenue Officer LiquidX (by video link)

Christoph Gugelmann, Founder and CEO, Tradeteq

Presenters

  • Clarissa Dann, Editorial Director, Deutsche Bank AG
  • Deepesh Patel, Editorial Director Trade Finance Global

Transcript of interview:

Clarissa Dann: Welcome to Trade Finance TV – I’m your host, Clarissa Dann.

Joining me today are my co-presenter Deepesh Patel from TFG, Claudia Dos Santos from Lloyds Banking Group, Christoph Gugelmann for Tradeteq, Jonathan Lonsdale from Santander and Dominic Capolongo Longo from LiquidX.

Deepesh Patel: Thank you for the opportunity, Clarissa, and it’s great to be joined by our wonderful guest to review the ‘Originates’ distribute model, how it’s evolved not only between banks but between originators and investors and how it’s been shaped by regulation and technology.

Clarissa Dann: With around 80% of global trade financed by some form of trade credit, the ability to distribute trade finance assets is key to liquidity. We’re going to look at how this is reshaping the trade finance landscape. It’s not just originated distribute anymore, is it? How has the process changed?

Deepesh Patel: Well, it’s certainly a changing dynamic. Claudia, let’s go back to the basics and a bit of history. Why do banks distribute trade finance assets?

Claudia dos Santos: Since the end of the Second World War there’s been a significant growth in the number of companies operating globally with global integrated supply chains. Added to that global trade has grown tremendously over the years, and even Covid couldn’t stop that trend. And as a result of that growth in financial markets since the early 1980s, balance sheets have become increasingly larger. And as banks, we have to provide for that increasing balance sheet requirement.

So it’s no longer just about a single bank having the ability to cater for the entire requirement of the client. We need to bring other parties into the system. And now we see two major factors at play, right? One, the regulatory environment that is forcing banks to share their balance sheet more broadly in order to originate that ancillary income, combined with the pressure from the clients as well, for us to make that balance sheet more diversified. So I think those are the two key trends that are driving trade distribution at the moment.

Jonathan Lonsdale: I would agree with that. I think also there’s that traditional reason of just having a limited credit appetite for each name. To that, though, I would probably add that some of our clients want us to distribute. They want us to share trade finance assets with other of their relationship banking groups because obviously it’s a good asset class, it’s got good relative value, good risk return profile. So the clients want us to share with their banks as well. And then I suppose the final thing is, from a banks perspective, we want to test our pricing and test our structures. We want to make sure that there is a market out there for them should it ever be needed.

Clarissa Dann: So it’s to share, isn’t it Claudia?

Claudia dos Santos: It’s very much so, Clarissa. And the pressures coming from the client specifically trying to make sure that we are delivering sort of like the entire financing requirement in a sustainable manner.

Clarissa Dann: So who are the buyers of these trade finance assets?

Jonathan Lonsdale: So I think if we look at the bank originated space, the vast majority is being syndicated to other banks, whether it’s relationship banks or smaller, more opportunistic banks who like the risk return and want to get in the space. Then you have private credit insurance, which isn’t universal, but it does work for a lot of banks and allows us to de-risk our balance sheet in quite an efficient manner and has traditionally been a big part of this market. And then we have institutional investors, which I’m sure Christoph and Dominic will talk about, but I think there’s specialist trade finance funds who are quite surgical. And then there’s the broader untapped institutional capital that the sooner we can bring into this asset class, the better.

Claudia dos Santos: I think there’s been an increasing growth in the specialist space, right, where you see the specialist asset finance groups and private credit as well coming into the market. But what I would also add is the role of ECAs and development funding institutions that are actually looking at supply chain finance and receivables purchase as an actual asset class to support their various investment mandates.

Deepesh Patel: So that was the bank fee. Dominic, what are your thoughts?

Dominic Capolongo: As Jonathan said, there’s been a material increase in all buyers. Banks still dominate the market, as you mentioned, but what we’re seeing more of is smaller banks enter the market as originators now more than just participants. In the institutional space, as was mentioned, the asset class is extraordinarily attractive. The funds have a strong desire to be in it, particularly in a volatile interest rate environment. It’s a great investment for any of the debt funds.

What all folks lack is the ability to manage the information that has grown exponentially as the market has grown. So being a distributor is easier said than done and at the end of the day, to continue to expand the market and bring in more institutional investors, information distribution and information management is going to be key.

Deepesh Patel: Christoph, do you agree?

Christoph Gugelmann: Yeah, I think if you speak about institutional investors, we are really kind of talking about a handful of large, dedicated institutions. But I think the reality is we need to bring capital markets into the picture. Just want to give you an example. In the US mortgage market, about 60% of all mortgages that banks originate is getting distributed. Only about 1% gets kind of like allocated to specialist funds. So if we can achieve the same thing for trade finance, I think we fundamentally change the world.

Deepesh Patel: And I think we need to standardize trade assets and make them more distributable, right?

Clarissa Dann: Yeah, we’ve seen packaging notes. So how do we accommodate increasing pools of assets and the numbers of participants?

Jonathan Lonsdale: So I think when you look at the trade finance asset class, it’s actually a series of asset classes, really. And I think that we have to live with. So there’s always going to be some heterogeneity between the different asset classes. But then I think what is unique to this market or is a unique issue this market faces is that a lot of banks have their sub asset classes classified differently and use different terminology. And on top of that, you also have a tendency to bespoke things for individual corporate clients, which when you come to distribute, means you’re never picking up the phone saying, ‘this is the same as the one we did last week.’ They are broadly the issues that we need to solve.

Claudia dos Santos: I agree. I think BAFT and ITFA have done a really good job in terms of helping us standardize the language when it comes to legal documentation and streamline the negotiation process, but trade finance distribution remains very much a manual process. From the offer and acceptance and the pricing negotiations to the daily management of the assets itself all the way into reporting. So I think bringing in technology can take us a long way in terms of streamlining the origination, streamlining the negotiation. Artificial intelligence, machine learning, A.I., blockchain can help us digitize the assets as well as streamline the distribution. And at Lloyd’s, we’ve invested a lot. We digitized as much as we can to minimize the manual handling of these assets.

Dominic Capolongo: I think both Jonathan and Claudia are absolutely correct. As the market expands and more people participate, whether they be new banks to the market or expansion of existing banks. The key is taking what everybody’s doing manually with lots of fat finger issues and potential compliance challenges and turn it into an automated, streamlined and efficient process. So we shouldn’t look at the asset class and try to standardize across the board. We have to recognize the differences. What we need to do is just put in place a framework of information management, and this is where the technology that Claudia has mentioned comes in that can help manage the flow of information among the banks and increase the transparency of both the assets and the transactions that occur between the parties.

Deepesh Patel: Thank you, Dominic. So standardized, streamlined and efficient. Christoph, what technology is adoptable to support this evolving ecosystem, and we saw a lot of that at the TFDI conference.

Christoph Gugelmann: Yeah, so there’s a lot of providers, but let me kind of try to classify according to the use cases. So there’s the workflow automation for single instruments, like a letter of credit. We have workflow automation technology for pooled investments that obviously are required for capital markets and specialist investors. It’s a little bit more involved.

I think both these technologies start from the extraction of assets from a back office system, from a bank. It’s then kind of checking them against investor criteria so the whole documentation can be automated. The execution of transaction can be automated. Reconciliation, but also the reporting can be automated and then you can bounce off limit systems of an investor, for example, in the bank or credit insurer, and then it flows back. And once the asset is distributed at the same time it will be booked again in the limit system.

Then there are credit risk analytics tools. There’s fraud analytics that can be overlaid. Maybe one last word on blockchain. I think blockchain we have seen a lot of trials and errors, more errors recently in that space. However, I think the distribution and security token will actually have a future because here you can take out even more friction costs if you repackage instruments in regulated security tokens.

Clarissa Dann: Let’s have another look at interoperability. It all needs to join up, doesn’t it? Dominic, I think you have some thoughts on that.

Dominic Capolongo: You have to look at the distributor making their process more efficient in terms of the management of both the distribution of the asset and the interactions between the parties. The second thing is looking at the participant side of it. They’re getting information in from various sources and at the end of the day, they want to manage their portfolio. So one of the areas that we have focused on is a sort of standardized dashboard that can exist between the participant and the distributor, so that the information that flows in real time will present itself on an online dashboard to the distribution partner and they can see their entire portfolio and then the distributor can actually make the process more efficient by automating the flow of information out to the distribution partners through that same system. So connectivity right now is picking up the phone and talking to people to make this market more efficient and continue to expansion and make the distribution process more effective. We need to turn that into a flow of information among technology partners, not so much human beings.

Claudia dos Santos: It’s important that whatever technology we are thinking about speaks to our systems and allows our systems to communicate with other systems. And it can’t be a one size fits all. It needs to be something that can integrate within multiple systems. And I think that’s key to driving sort of the automation of trade distribution going forward and removing that manual handling of the origination as well as the distribution.

Clarissa Dann: It’s not just a space for the API, not just a space for the cloud? Maybe the blockchain? We’ll see, but now it’s time to turn to our crystal ball. How do we see this market actually expanding and developing? All jump in here. What are your thoughts?

Jonathan Lonsdale: Well, I think we need to tap into that pot of institutional capital. There’s a limited amount of bank capital, and no matter who syndicates what to whom, it’s a zero sum game, more or less. You know, cracking the nut to get that institutional capital in there is the key thing. And we’ll need all of the things that we’ve discussed today.

Deepesh Patel: Christoph, what are your thoughts?

Christoph Gugelmann: Well, I think we need to replicate what we have successfully done in trade with the continuing resolution a few decades ago. Now we just need to do the same thing with trade finance instruments. We need to standardize them, put them into boxes and make them available to capital markets.

Clarissa Dann: Love the shipping analogy. Claudia.

Claudia dos Santos: We need to build in flexible systems again that enable that interoperability. We need to invest in technology that delivers the standardization such that we can tokenize potentially trade products as a distributed asset class. And then we need technology that speaks to our risk governance and compliance requirements, right? We can’t just be innovating outside of that environment because it will not stick.

Dominic Capolongo: The key, in my opinion, for the expansion is information management systems that manage the information flow both between parties, but as Claudia said, down within a particular party through their back office. I think the banks are going to continue to be the dominant players here. The institutional markets, let’s not forget, are not client focused in their approach to the asset class. It’s attractive to them. When it becomes less attractive, they may exit the space with something better. So we have to have the network of banks and continue to draw on that primarily and look at the institutional parties as more backed up because we don’t know where they’re going to go as the economic environment changes.

Clarissa Dann: Thanks. I think we’ve got a better idea, Deepesh of what the new era might be looking like. What do you think?

Deepesh Patel: Yeah, I think so. And I think Dominique makes an important point around the importance of the banks in terms of how much capital there is. But it is a bit of a potential transition and we’ve got to look at the need for private credit for private investors and BFIs, etc., coming into the distribution space.

Clarissa Dann: I’d like to thank our expert panel and of course, all of you for watching. For all other episodes, do go to TRADEFINANCETV.NET.

Published on November 27, 2023

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