The anti-trade environment
The essential purpose of trade finance is to facilitate commerce, particularly across borders. But that task is getting harder than ever.
The 2017 economic reality looks to be one of a backlash against trade on a global scale, as governments around the world institute protectionist economic policies and tear down trade agreements.
We have seen signs of more and more countries erecting barriers to free trade … a potential wave of deglobalisation will hurt small, open economies such as the Nordic countries where the trade-to-GDP ratios range between 70% and 100%.
Helge Pedersen, Group Chief Economist at Nordea, in the January 2018 Economic Outlook
Pedersen notes that trade barriers will hit emerging markets, such as those in Asia and Africa — markets that in the past few years many Nordic businesses have counted on as an export growth opportunity. These markets have already been hit by depressed commodity prices, FX fluctuations post-Brexit, a shortage of liquidity, and tumult in the global shipping industry.
So far, few protectionist measures have hit the EU, the main trading partner for the Nordics. But with elections in several European countries due during 2017 and protectionist policies on the agenda, there’s a risk that trade will become more difficult there, too.
What can we do about it? It will be important to lobby governments to promote the value of international commerce and keep trade flowing, but start planning for the worst: model the effect on your business if international trading partners close their doors or impose punitive tariffs, and be creative about new opportunities to maintain growth.
Risk and compliance
Trade finance has been proven to be a consistently low-risk proposition, with minimal default rates (albeit growing, according to latest ICC reports). But, like all financial transactions, trade finance is subject to a range of compliance restrictions, including AML, sanctions, KYC and KYCC.
There’s no prospect of the compliance landscape suddenly changing in 2017 — financial crime is here to stay, sanctions against key markets like Russia have been extended, and KYC is likely to broaden out into new areas, such as know your goods (KYG). And unfortunately, in the light of antiglobalisation trends, we can expect little further harmonisation.
What does this mean for you? The burden of risk and compliance has known implications — it affects the pricing of insurance and guarantees, closes access to trade finance services in at-risk markets, and cuts SMEs out — creating the so-called trade finance gap.
For those businesses that do have access to trade finance, the emphasis will be on managing cost, ensuring that all the right processes and checks are followed — and appreciating the impact that compliance has on establishing new commercial relationships in particular.
Alternatives to traditional trade finance
Wherever there are obstacles, the market will find a way. So, as access to traditional trade finance tightens, it’s driving the development of alternative financing solutions.
Many businesses are taking out credit insurance-backed trade finance, covering risk and opening up access to bank financing where there otherwise was none. And now businesses can also choose from entirely new working capital finance products, such as supply chain finance, which helps bridge the trade finance gap by leveraging a buyer’s strong credit rating to open up access to trade finance for smaller suppliers. Even well-known categories of products like factoring are seeing a resurgence.
The ICC reports that SWIFT’s trade finance traffic fell 5% in 2016, to the lowest levels since 2008, while non-TF financing solutions like cross-border factoring grew 22% since 2014.
Of course, when access to trade finance is constricted, the simplest alternative is to go ahead without trade finance at all. And indeed we’ve seen a growth in open account transactions, not backed by traditional trade finance instruments, which already make up around 90% of transactions.
To substitute for the cash flow benefits that trade finance normally offers in these situations, corporates are using receivables financing, overdrafts and other credit facilities, and risk is often simply accepted as a cost of doing business or managed through tight internal controls. Alternatively, many corporates are working directly with private risk insurers (PRIs) to protect themselves during transactions, particularly in emerging markets.
Digitalisation, blockchain and smart contracts
But the real growth area for 2017 will be the use of digitalisation — which is the answer to many of the challenges we’ve discussed.
It’s impossible to write an article about anything fintech related now without mentioning blockchain, and indeed blockchain is poised to have an effect on trade finance, too. In 2016, the first letter of credit transaction was conducted using blockchain; and IBM predicts that by the end of 2017, 15% of top global banks will be running blockchain-based solutions.
Because the majority of the costs associated with trade finance are actually in document handling, both within banks and corporates, digitalising the exchange of documentation promises to slash the cost of trade finance and make it economical for banks to open up trade finance at lower prices — as well as cutting the time it takes to process a trade finance transaction from days to hours.
By combining blockchain and the internet of things, corporates can create smart contracts — automated, self-executing digital contracts that trigger payments and receipts in real time as goods move through the supply chain. IoT tracking of goods eliminates uncertainty about where physical goods are; blockchain helps verify identity and ownership and could conceivably simplify compliance and governance, as well as cutting manual workload and human error.
Digitalisation is far from being mainstream. Providers have been promising digital letters of credit and bills of lading for years, yet most corporates and banks still routinely exchange paper documents. In the latest ICC report, just 7% of respondents said that digitalisation was “widespread”. But that will change: you don’t need a crystal ball to see that digital trade solutions will see a huge amount of development in the year ahead.
Standards and industry collaboration
There’s one last trend — perhaps the most important of all. If digitalisation is to deliver on its full potential, and if challenges around the trade backlash, compliance and adoption of new types of financing are to be addressed, we’ll all need to work together.
2016 saw some steps backward in this regard. For example, while R3 open-sourced Corda, we saw several prominent members leave the Consortium. And there are a multitude of alternative, competing blockchain platforms out there, all claiming success.
While diversity is the natural outcome of innovation (and not just in blockchain), we’ll need to move beyond that into a period of consolidation and harmonisation in order to simplify interoperability. This will have to happen in blockchain, as well as in IoT, artificial intelligence, big data analytics, and in cybersecurity. There’s a lot of work to do!
But there’s plenty of opportunity to drive harmonisation in more familiar areas, too — in fact, this is where we should all focus for immediate results. Look at the positive effects of SEPA and ISO 20022 payments, the popularity of SWIFT’s KYC registry, which has hit 3,000 members, or the use of the SWIFT MT798 “trade envelope” to simplify the digital exchange of trade documents.
Participate and drive the future
2017 will no doubt bring challenges of many kinds. But risk is nothing new, and as an industry we can solve these challenges: with sound business planning, with technology innovation, and perhaps most importantly, with effective collaboration. Trade finance as a concept is more relevant than ever, and with modernised tools and products, it will serve corporates well for many years to come.
To find out more about Nordea trade finance products, and our expanding range of working capital finance solutions, get in touch with your relationship manager or visit nordea.com/en/our-services/tradefinance/.
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