A note on available information concerning trade finance

Transcription

1 1 GCF2011.TFdataARMACv2rev A note on available information concerning trade finance by Andrew Cornford, Observatoire de la Finance and Alexander R. Malaket, CITP, President,OPUS Advisory Services International Inc. January 2011

2 2 Trade finance and the downturn in global trade The downturn in global trade since 2008 has been greater than would have been expected on the basis of trade s historical relation with economic activity. Many observers have attributed this difference partly to particularly marked increases in the cost of trade finance and declines in its availability. 1 Surveys conducted by the Bankers Association for Finance and Trade (BAFT) 2 and the IMF and by the International Chamber of Commerce have confirmed that banks, particularly at the height of the crisis, had been reducing lending in support of international trade and making it available on more restrictive terms and at higher prices. The cost of trade finance increased by a factor of four or five in some markets, but has since begun to return to more normal levels. Anecdotal evidence suggested that there was also a shift in trade financing towards more traditional, secured but higher cost instruments, although one which did not apply across the board. The surveys and market analyses motivated by the adverse conditions in the markets for trade finance contributed to enhancing knowledge concerning recent trends in trade financing. Moreover observations drawing on this material have enriched the global discussion concerning trade finance and its role in international trade. But at the same time, these studies and surveys have highlighted gaps in current data on trade finance and are acting as a spur to overdue international initiatives to remedy this situation. The structure of this note is as follows. The first section explains problems regarding the definition and coverage of the concept, trade finance, which complicate collection of quantitative data concerning such finance from private sources on a regular and systematic basis. This is followed by an overview of the principal categories of available data. The overview serves to introduce a more detailed discussion of the major categories of data by the principal private and official sources. The note concludes with observations concerning ongoing initiatives to improve the coverage of data on trade finance and likely future directions. The coverage of trade finance from private sources Trade finance is available not only from private sources such as banks and more specialised firms but also from public-sector sources such as official export credit agencies and various international financial institutions Market shares among private-sector sources are highly concentrated among the top-tier global providers of trade finance. Trade finance from private sources may be in the form of unsecured or secured credit. It is the latter which is associated with traditional instruments of trade finance such as letters of credit 1 Other changes cited as contributing to the exceptionally large decline in global trade include the greater reliance of trade on production-sharing networks and the proliferation of global supply chains (ICC, 2010: 19) 2 Since the date of its 2009 survey BAFT has been merged with the International Financial Services Association, the resulting institution now having the name BAFT-IFSA.

3 3 which are designed to secure payment for trade transactions and can serve as the basis for loan financing. Much international trade is financed through unsecured credit lines available to companies of good standing from their banks, such facilities frequently being extended without collateral. The purpose for which such lines are used is not necessarily specified in the documentation covering short-term unsecured borrowing, which may be classified under general corporate purposes or working capital. The borrowing firm may not be required to distinguish between those raw materials or finished goods purchased at home and those purchased abroad. For medium-term unsecured credit (used, for example, for buying equipment or for carrying longer-term receivables) there is usually a written agreement specifying the purpose and terms of the loan but not necessarily whether it will be used partly or wholly to finance imports or exports. Identification of trade financing in the form of multi-purpose or unsecured credit can thus be difficult. Indeed, the use of such facilities is rarely linked by lenders to trade finance, and is most likely to be managed in the portfolios of commercial or corporate bankers as opposed to being recorded and managed as part of institutions trade finance portfolios. eneric facilities available to borrowers and used in support of their import and export activities are not, in the vast majority of cases, included in the specialized and more esoteric instruments referred to as trade finance. Moreover in industry parlance trade finance usually refers to financing which covers transactions with tenors up to 18 to 24 months. Transactions involving longer maturities are categorized as medium-term trade finance, and the financing of more complex transactions such as capital projects with time frames which may extend to many years are classified as project finance. The multi-purpose facilities and lines of credit which are also used by businesses to finance trade activity do not fall into such neatly distinguished categories. The nature of the security which applies in the context of a trade finance transaction depends, in part, on whether the party applying for finance is an importer or an exporter. The issuance of a documentary letter of credit (L/C) on behalf of an importer generally requires that the importer possess a line of credit with the financial institution issuing the L/C. Financing on the export side, however, relies on credit facilities linked to the country of the exporter or the financial institution which holds ultimate responsibility for settling the liability related to the trade transaction. When a borrower s financial position is not such as to qualify it for unsecured credit in trade transactions, the borrower will be required to put up collateral or use other methods for increasing the security of financing and payments. The collateral can take the form of easily saleable assets such as financial instruments or title to the goods or services traded. Examples of collateral in the latter form are negotiable bills of lading, which are documents representing

4 4 title to goods to be shipped, and warehouse receipts, which are documents corresponding to good stored in a warehouse. Alternatively other legal methods are available for increasing the security of trade transactions to the different parties exposed to credit risk related to payments and financing. These methods do not necessarily entail a credit risk for the financial institution involved. However, they may be linked to the extension of short-term financing for importers or facilitate access to such financing in advance of payment by importers. Security (or risk mitigation) may take the form of guarantees or insurance products related to a trade transaction and provided by private sector sources or by government or quasi-government entities such as export credit agencies. Trade finance in its purest form (i.e., excluding generic commercial facilities which may be used in support of trade discussed above) generally involves contingent liability for the issuing bank. Documentary Letters of Credit, for example, are recognized as contingent liabilities under which the issuing institution faces exposure only if the liability party fails to meet its financial obligation. In statistical data on trade finance the transactions have traditionally been classified under the heading of arrangements which may involve both payments and financing. Terms for typical payments and financing options are listed in Box 1. Box 1. Common terms in payments and financing for international trade 3 Cash in advance. Here the seller receives payment before shipping the goods. Such transactions may be covered by a loan to, or the credit line of, the importer. Open account. Goods are shipped to the buyer and title documents and the invoice calling for payment within a stipulated period of time are mailed separately. The lag between shipment and payment may require the extension of credit during the period involved. Such credit may be through a banker s acceptance under which the bank accepting draft assumes the obligation of making the payment at maturity on behalf of the buyer. Documentary Collections (which include Documents Against Payment and Documents Against Acceptance). The documents conferring title are released on payment, or on acceptance of a time draft which indicates a commitment pay at an agreed future date. The lag between the release of documents and payment by the importer may be covered by the extension of credit to the exporter by a bank that is party to the transaction In the case of Documents Against Payment, where funds are remitted almost immediately, financing can be extended to the importer, allowing a delay in the reimbursement of funds to the bank effecting payment. 3 This box is based on Venedikian and Warfield, 1996: chapter 6 and Part 3, and Deak and Celusak, 1984: chapters 3

5 5 Letter of credit (L/C). A documentary or commercial letter of credit is an instrument typically issued by a bank on behalf of an importer in favour of an exporter, and represents a payment undertaking by the issuing bank to the exporter. An L/C constitutes a promise to make payment or to accept drafts (representing payment at an agreed future date) upon receipt of documents conforming exactly to the conditions set out in the letter of credit. The documents submitted typically include drafts, commercial invoices, packing lists, transport documentation (which may be a negotiable instrument), certificates of inspection, a certificate of insurance and, in general, any document required to evidence the exporter s compliance with L/C terms. A bank s commitment to pay is enforceable only when the exporter fulfils all the conditions specified in the letter of credit. The letter of credit can serve as the basis for an application for financing by the exporter during the period before payment is received from the importer. Security of payment under a letter of credit can be increased through confirmation by a bank other than that which originally opened or issued the letter of credit. Confirmation will usually be by a bank in the exporter s jurisdiction, and since the obligation to pay of the confirming bank is added to that of the issuer, it relieves the exporter of the risk of non-payment by the issuing bank in the importer s country. In countries where there are restrictions on banks extension of guarantees stand-by letters of credit may be issued to serve much the same purpose. Here the demand for payment is usually based on a statement of default by the party from whom payment is due rather than the documents associated with the traditional commercial L/C. Information on the costs of trade financing from private sources is not available on a uniform, systematic basis. This is partly due to the nature of trade finance, which involves a wide variety of financing and payment structures, and addresses a wide range of risks. It is also true that there is no industry-wide impetus or effort regarding publication of trade financing costs in a systematic or organized fashion, as providers of mortgage financing do in many markets. Thus, while the trade-finance press does publish league tables and report in more detail on certain sectors or on the characteristics and costs of specific trade financing transactions, there is no central source of information about the cost of financing international trade. The costs of trade financing are determined partly by the general level of the cost of funding in the financial markets, domestically and internationally. As indicated by available but not systematic data, lending rates and other terms of trade finance for different categories of borrower are also affected by risk premia, the amount of banks capital allocated to trade finance, and the way in which the trade financing is structured. Surveys of trade finance from private sources Overviews of recent trends in trade finance have been in the form of surveys of international samples of banks containing information which is partly quantitative and partly qualitative. The information is indicative rather than comprehensive owing to limitations on the sample of banks covered by the surveys and to the fact that replies are based on data from the

6 6 departments of banks specialising in trade finance. Thus these surveys do not account for any financing for international trade from the multi-purpose credit facilities referred to earlier. There is no objective means for assessing the relative proportion of financing for international trade that originates from specialist lending units as opposed to such multi-purpose facilities. The character of the information from several of the most recent surveys is illustrated here by selected findings of the 2010 global survey of the International Chamber of Commerce (ICC, 2010). The survey is based on responses from 161 banks in 75 countries. Of these banks 44 per cent had global trade-finance operations, 14 per cent had operations in a number of countries in the same region, and 42 per cent had operations in a single country. Major findings (which refer to 2009, unless otherwise specified) included the following: (1) The supply of trade finance in terms of both volume and value remained constrained by the economic crisis. 60 per cent of respondents indicated that the value of trade finance had decreased in 2009 owing to lower commodity prices, the weaker United States dollar, and bank restructuring. Respondents also reported substantial decreases in numbers of letters of credit.large majorities of respondents reported either decreases or no change in the number of guarantees and import collections in (2) During the crisis there has been increased reliance on traditional instruments of trade finance offering greater security of payment. 73 per cent of respondents (as compared with 52 per cent of respondents the previous year) reported having experienced demand from exporters for this form of security. 73 per cent reported that requests for confirmation of letters of credit had increased, the remaining 27 per cent reporting that such requests had decreased. 84 per cent of respondents expected an increase in demand for traditional trade instruments in (The ICC, however, drew attention to the widely cited estimates that more than 80 per cent of trade transactions are settled on an open-account basis but are not reflected in respondents replies because a large part of such tractions are settled in departments not specialising in trade finance.) (3) The costs of trade finance remained substantially higher than they were before the crisis. 30 per cent of respondents, for example, indicated that there had been an increase in fees for letters of credit and guarantees, 25 per cent expected a further rise in 2010, and 45 per cent reported an increase in fees for confirming letters of credit (as against 7 per cent reporting a decrease). The higher costs reflected funding costs, lessened availability of capital for trade finance, and increased counterparty risk. Particularly hard hit by higher costs were SMEs and exporters from some emerging-market countries. (4) Respondents indicated that as 2009 progressed, their ability to provide trade credit was improving owing to improved capacity and liquidity within the banking sector as well as to official support in response to the decision of the G20 of April 2009 to provide additional financial support for trade finance. The important contributions of export credit agencies and international financial institutions have been widely acknowledged under this heading.

7 7 (5) 96 per cent of respondents indicated that losses on traditional trade products were the same or lower than for general banking facilities, and 59 per cent that losses were significantly lower. The 2009 surveys of BAFT and IMF and of the ICC contain data in a form similar to that of the 2010 survey of the ICC but based on smaller samples of responding banks (ICC, 2009a; ICC, 2009b; and Bankers Association for Finance and Trade, 2009) SWIFT The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides the communications infrastructure through which the majority of documentary (commercial and stand-by) letters of credit and documentary collections instruments (and their related messaging and payment flows) are transmitted between financial institutions across the globe. SWIFT is a cooperative organisation owned by banks which is designed to facilitate the exchange of payments and certain other financial messages between financial institutions throughout the world. A SWIFT payment message is only an instruction to transfer funds. Actual transfers are carried out thorough payment systems or correspondent banks, though issuance of a message does entail a liability to the disbursing bank (Stigum and Crescenzi, 2007: 854). According to a SWIFT survey of the 20 top trade-finance banks, as of the end of per cent of the banks used SWIFT for messages associated with 90 per cent of their letter-ofcredit transactions, and the remaining 20 per cent for messages associated with 50 per cent of their trade transactions (ICC; 2010: 27). SWIFT 700-series messages are formatted messages used to transmit Documentary Letters of Credit and related amendments and messages, while 400-series messages relate to Documentary Collections. SWIFT data refer to volumes (numbers of messages). Data from SWIFT message traffic are used to identify trends in trade finance. These Recent SWIFT data are broadly in accord with trends in the surveys mentioned above. There was a slow recovery during 2009 from low levels in January and February in line with the overall recovery in international trade (SWIFT, 2009: 10). The recovery anticipated in the ICC survey above appears to be confirmed by SWIFT figures for 2010, which show a growth of 8.6 per cent in trade-related traffic during the first 11 months (SWIFT, 2010) Insurance and guarantees The principal source of aggregate data concerning export credit insurance is the International Union of Investment Insurers, better known as the Berne Union. Membership of this body includes the world s major private credit insurers and national export credit agencies. Short-term (ST) insurance for trade transactions with repayment terms of one year or less is provided by both private and public members of the Berne Union. Data for such insurance cover credit limits, i.e. the amounts which an insurer has committed itself to insure during a specified period, as well as covered exports, i.e. the value of trade covered by a credit

8 8 insurance policy. The data also include claims paid and loss ratios, i.e. claims paid in relation to premium income which credit insurers use to measure credit quality retrospectively. Mediumand long-term (MLT) credit insurance with repayment terms of more than one year is mostly provided by official export agencies and usually covers particular transactions rather than trade transactions collectively up to a specified limit. Berne Union data do not include the relatively small amount of MLT credit insurance from private sources. The data include the value of exports covered, claims paid and the loss ratio. (A source of recent Berne Union data is Morel, 2010). Berne Union data point to several features or conditions regarding international trade and credit insurance but should be interpreted with caution since they reflect influences from the demand and the supply sides (Morel, 2010: 7). For example, exports covered by ST insurance of BU members declined 13 per cent between 2008 and 2009, a period during which global trade contracted much more rapidly. On the demand side for credit insurance, the decline in sales for which exporters could potentially seek cover was accompanied and at least partially offset by exporters increased recourse to insurance. On the supply side, export credit insurers responded cautiously to this demand owing to heightened default risk. The share of private insurers in total ST credit limits fell from an average of 85 per cent during to 72 per cent in 2009, that of export credit agencies correspondingly increasing from 15 per cent to 28 per cent. The coverage of MLT insurance extended by export credit agencies actually rose during the crisis from USD 127 billion in 2007 to USD 191 billion. Until December 2003 the Joint External Debt Hub of the BIS, IMF, OECD, and World Bank (available at ) provided country-by-country data on outstanding official trade credit in a series currently discontinued apparently for reasons linked to the relationship between cost and quality (Auboin, 2009: 11). Official trade credit is defined to include official trade related credits (provided under official export credit programmes) and officially guaranteed or insured supplier credits extended by exporters to importers. The figures included arrears and officially rescheduled amounts on officially guaranteed or insured credits from the financial sector since these are taken over by export credit agencies from the original bank creditors. Separate data were provided for total outstanding debt and for the debt of nonbanks separately at all maturities and at ST maturities. The Joint External Debt Hub still shows the data for outstanding export credit exposures of institutions which are members of the BU. Terms and conditions associated with the extension of official credit insurance are available from the export credit agencies themselves and on a selective basis in specialist publications on trade finance. Future

9 9 The current crisis has accelerated initiatives to improve the availability of data on trade finance. Part of this acceleration is due to the determination of providers of trade finance to demonstrate the low credit risk associated with the different instruments and thus to influence in a downward direction the minimum regulatory capital requirements for such instruments. One such initiative has been the establishment by the ICC and the Asian Development Bank of the ICC-ADB Trade Finance Default Register, which will collect and analyse data to demonstrate to regulators that capital requirements for trade finance should be lowered better to reflect its true risks (ICC, 2010: and 51). Initial results of this initiative have confirmed the expectations of the ICC concerning the low risks associated with the instruments of trade finance. Data concerning 5,223,357 trade finance transactions with a value of USD 2.5 trillion (summarised in Sénéchal, 2010) included the following: the transactions had a relatively low average maturity of 115 days; the transactions had a low incidence of default involving less than 1,400 or less than 0.02 per cent of the total; the off-balance sheet transactions had an even lower rate of default involving only 110 out of 2.4 million transactions; the average recovery rate for transactions in default was 60 per cent, implying an average loss given default of 40 per cent. Recent initiatives are also designed to improve knowledge of trends in trade finance more generally. These initiatives involve the BIS, the ICC and SWIFT (Auboin, 2009: 11 and 21). At the BIS efforts are focussed on the possibility of distinguishing within its data on short-term crossborder bank lending the exposures due to commercial credit, of which it is reasonable to assume that a significant proportion consists of trade. SWIFT is developing a system designed to collect information on the value as well as the volume of letters of credit. It has also started to develop a processing device to earmark transactions as open-account trade finance. This note indicates ways in which, with various motivations, the stakeholders of the tradefinance industry have recently taken steps in the direction of greater communication and transparency. Nevertheless, the challenges of identifying the full universe of trade finance activities (including those linked to general purpose facilities) and developing the corresponding data base will remain for the foreseeable future. The achievement of a reasonable degree of transparency concerning both the value of the activities of financing international trade and the associated risks will be a significant step forward, even if the transparency is limited to the narrow, specialist definition of trade finance covering traditional mechanisms and to open-account and supply-chain finance. The dialogue and collaboration observed since the outbreak of the financial crisis as well as the focus on developing a unified and effective voice for the trade-finance industry will serve all those who have an interest in a better understanding of the different dimensions of trade finance and of its essential contribution to global commerce. The consequences in the form of,

10 10 greater transparency, enhanced understanding, and the availability of credible objective data will facilitate long overdue improvements in the political, regulatory and commercial environment of trade finance. References Auboin M (2009), Restoring trade finance during a period of financial crisis: stock-taking of recent initiatives, Staff Working Paper ERSD , WTO, December. Bankers Association for Finance and Trade (2009), Global Trade Finance Markets The Road to Recovery, Washington, D.C., September. Deak NL and Celusak JC (1984), International Banking. New York, Prentice-Hall for the New York Institute of Finance. International Chamber of Commerce (ICC) (2009a), Rethinking Trade Finance 2009: An ICC Global Survey, an ICC Banking Commission Intelligence Report, Paris, March. ICC (2009b), ICC Trade Finance Survey: An Interim Report Summer 2009, An ICC Banking Commission Report, Paris, September. ICC (2010), Global Survey Rethinking Trade Finance 2010, An ICC Banking Commission Market Intelligence Report, Paris. Morel F (2010), Credit insurance in support of international trade Observations throughout the crisis, London, Berne Union. Stigum M and Crescenzi A (2007), Stigum s Money Market, fourth edition, New York, etc., McGraw-Hill. SWIFT (2009), Annual Review SWIFT (2010), SWIFT IN FIGURES, November. Venedikian HM and Warfield GA (1996), Export-Import Financing, fourth edition, New York, etc. John Wiley.