Trade: adjusting to a new direction of travel

The inexorable search for new markets and lower costs is contributing to a dramatic shift in trade flows. For example, 35 per cent of all the cut flowers bought in Western Europe are grown in Kenya’s Rift Valley and air-freighted in daily. Components manufactured in multiple countries are transported thousands of miles for assembly into finished goods, which are then shipped again. According to the International Chamber of Commerce’s 2013 report, Rethinking Trade & Finance, developing countries’ share of global trade has increased 10 per cent since 2000; exports rose 8.5 per cent in 2012 alone.

Much of this trade growth is bypassing Western Europe and the US, with Asia, in particular, playing an increasing role (see diagram, below). Trade experts point to south-south and intra-regional trade (trade between countries in the same region) as significant trends: “The shift in trade from West to East has occurred gradually over the past two decades, but it has accelerated since the financial crisis of 2008/9,” says Madhavan Ramaswamy, global head of products for banks, transaction banking at Standard Chartered Bank. “As consumption dropped in the developed world, developing countries looked to their home markets for growth – with growing, young populations, urbanisation and fast-emerging middle classes. Demography will have a huge influence on trade flows in the future. Seventy per cent of the world’s population lives in emerging markets.”

Martin Knott, head of trade, global transaction services Emea, Bank of America Merrill Lynch (BAML), agrees: “Intra-regional growth is impressive,” he says. “Between 2000 and 2012, intra-regional trade in the Middle East grew 486 per cent. Within Africa, growth was 454 per cent and in Eastern Europe, it was 453 per cent. This compares with a growth rate for trade within Western Europe of 123 per cent in the same period.”

Trade banks are following the flows, either by setting up operations in new markets, or establishing the banking partnerships necessary to ensure coverage. There is every evidence that traditional correspondent banking is still valid and here to stay: “Banks in developing markets need to look after their home market customers. But it is very expensive to open and operate overseas branches without the efficiencies of scale in the local markets,” says Standard Chartered’s Ramaswamy. Standard Chartered has trade desks in 45 countries and a strong presence in Africa, Asia and the Middle East.

Société Générale has a strategy of building a strong network presence itself (the bank has trade desks in 55 countries worldwide) and also maintains traditional correspondents. “We have about 800 correspondent banking relationships and close trade relationships with around 300 of those,” says Thierry Roehm, head of trade services at Société Générale. “This means we share local information about risks. There’s a cost to this, you have to do credit analysis and due diligence, but these long-term relationships with correspondent banks really help us to assess risk and ultimately to serve our corporate customers well.”

But new trade scenarios and changing market fundamentals are bringing challenges. Companies are reducing their use of documentary trade services, which offer risk mitigation but are relatively expensive for customers and increasing open account business. Today some 80 per cent of world trade is conducted on open account terms, with intra-Asian trade accounting for the majority of letter of credit  (LC) issuance. Roehm points out that this long-term trend is against a background of increasing geopolitical risks and “despite a more risky global trading environment than we have seen for some time”.

One aspect of changing trade flows that has not been reviewed thoroughly is their impact on the processing side of trade finance, says Vince Galloni,  global trade processing product group manager, BNY Mellon.

“For banks, shifts in global trade flows can mean higher levels of client demand for trade-related services. This increase in demand can translate into new revenue opportunities if banks can provide additional trade-related services. “

Value-added service delivery capability is key and for many banks, the lack of trade-related processing capabilities can be a formidable obstacle. For many such banks, reliance on a wholesale provider of processing services can allow them to focus on client-facing aspects of their relationships while also providing world-class levels of processing support.

An overnight document examination service is a good example of how this principle plays out in practice.

Banks engaged in trade finance need to provide letter of credit document examination service. Carrying out these examinations requires an extensive set of capabilities:  discrepancies must be quickly identified and corrected; a high level of security must be provided for data transmission and payments; documents have to be efficiently and reliably uploaded to a secure platform; LC status updates must be available 24/7; and data retention for at least seven years must be provided.

“Acquiring these capabilities can be a costly and technologically daunting prospect for small- to medium-size banks. But shifts in trade flows may make the delivery of trade finance services indispensable to maintaining relationships with importer or exporter clients,” says Galloni. “To maintain the vitality and strength of the global transactional ecosystem, it’s imperative that banks have access to wholesale providers with three service delivery hallmarks: the necessary expertise and experience; a strategic focus on addressing the processing needs of local banks; and a commitment to business plans that preclude competing with local banks for trade finance accounts.”

Compliance requirements are also increasingly demanding for trade banks. Know your customer obligations, for example, can be challenging to meet in newer markets and more volatile economies, adding to the costs and risks for providers of trade services and trade finance.

And then there is the expected impact of Basel III, which will set more demanding asset value correlations and liquidity credit ratios for collateral in respect of trade transactions, increasing the cost of providing trade finance and likely constraining liquidity.

These higher costs of doing business and increased geopolitical and regulatory risks are causing trade banks to re-examine their operating models and relationships.

“Traditionally, correspondent banking was a limitless network of correspondents for each currency,” says Peter Jameson, head of FI product and network strategy, global transaction services Emea at BAML. “Today though, with ongoing pressures around costs and operational risks, we see banks appointing a core group of strategic correspondents for the G20 currencies and below that line, often consolidating – perhaps down to one provider in a central location for the less strategic currencies.”

Lloyds Bank supports UK businesses and trade flows using correspondent relationships in overseas markets while offering sterling facilities and support for inbound trade. Lloyds looks for best-in-class providers and for reciprocity, explains Lionel Taylor, head of trade products, Lloyds Bank Commercial Banking, adding:  “We benefit from the flexibility and reach of our FI partners, without the increasing cost and restrictions of maintaining our own global footprint on the ground. However the increased costs of due diligence will lead banks to review marginal relationships and there will be consolidation to get a better return on effort.”

The fact is that a small number of large players continues to increase its share of the market. Over the five years to October 2011, the top five trade banks increased market share from 12 per cent to 22 per cent, according to a Citi Equity Research Report of October 2011, Trade Transformed. “This has occurred because of the high level of investment required to build the infrastructure needed for international trade – this investment demands scale,” says Sameer Sehgal, Emea trade head, trade and treasury solutions, Citi.

With costs of doing business only increasing, Seghal observes a growing trend towards outsourcing:

“Over the next couple of years we will see banks adjusting to the implications of Basel III. In this scenario, where capital and financing is going to become more expensive, outsourcing in the trade space will become critical as we see banks moving from an ‘origination’ role to an ‘originate to distribute’ role,” he says.

“During the past 12-18 months, we have been involved in many strategic discussions with banks about a spectrum of services they need to support their international trade customers. At one level, these are discussions about operating models. For example, a large commercial bank in a developing country might be looking for advice and experience transfer. Other discussions are about execution, for example, of a back-end solution. And then there are white-labelling discussions where banks offer branded services which are provided by and run on the infrastructure of a third party, usually a large trade bank. I expect we will see a number of these solutions over the next 24-36 months.”

Banks are also collaborating to meet evolving market needs with new services such as financing solutions for customers’ supply chains, including making pre-shipment financing available to their suppliers.

André Casterman, head of corporate and supply chain markets at Swift explains: “To capture a larger proportion of the open account trade business, banks need to be ready to provide pre-shipment financing. Banks can offer supply chain financing against approved invoices working on their own – but how can they extend these solutions to countries they are not in, where they would have to on-board the suppliers and, in the case of pre-shipment financing, take the performance risk of the suppliers?”

The solution is to use a correspondent bank in the relevant market, with the knowledge needed to manage compliance requirements and bring local suppliers into the programme. A new instrument – the Bank Payment Obligation – is providing the connectivity and the legal underpinnings to enable such new business.

Société Générale’s Roehm also sees opportunities to work with correspondents at a secondary level to structure solutions to syndicate risk on certain transactions. This is where he believes the Bank Payment Obligation will be valuable in the future, particularly for large corporations with high volumes of similar transactions. “It’s a long-term solution because both the banks and the corporates need to make a [systems integration] investment. But it will have value in the future.”

The in-built flexibility and resilience of correspondent banking networks is enabling them to adapt to meet new challenges in new markets. But liquidity constraints may cause trade banks to look beyond their traditional partners. “The impact of Basel III, combined with the fact that world trade is growing at twice the rate of world GDP, means we will see a funding challenge,” says Tod Burwell, chief executive of Baft-Ifsa, the banking trade association. “Banks are starting to look to non-traditional sources, including institutional investors, for new sources of funding for trade transactions.”