The Need, the Opportunity, and the Solution of Trade Finance as Asset Class, June 2022

By Alejandro Battistotti, Senior Portfolio Manager at NN Investment Partners and ITFA Emerging Leaders Committee member  

The emergence of trade finance as an investable asset class is a recurrent topic in most specialized literature and conferences. An increasing number of asset managers and institutional investors are attracted to this space, which was traditionally and preeminently dominated by banks. This is no surprise since the asset class has many appealing features for institutional investors, such as its attractive risk-adjusted returns; its short duration and low volatility nature; its defensive and countercyclical behavior compared with other asset classes, and its favorable return on Solvency capital.

Nevertheless, trade finance and trade finance as an asset class are not necessarily mutually interchangeable synonyms. Trade finance as an asset class is one of the many dimensions of trade finance, which encompasses trade finance’s main purpose, namely financing the international movement of goods and services, but also transcends it. It does so by also taking into account investors’ needs and asset allocation strategies, as well as capturing market and regulatory opportunities while offering different access channels through repackaging of trade finance assets. In that logic, the emergence of trade finance as an asset class responds to the interplay of a need, an opportunity, and a solution.

There is a first self-evident need most vividly represented by the trade finance gap. In the last few years, the Basel capital framework has raised further barriers for trade finance and working capital in particular. When focusing on short-term financing, the new regulation increases minimum capital requirements which might translate into increased funding costs and more rigorous collateral measures, especially for borrowers with below-average credit worthiness. These regulatory changes have increased funding costs and made banks less prone to extend credit to SMEs, which are the backbone of the real economy. This leaves a large portion of the players in the real economy with insufficient or inefficient financing opportunities and consequently impacts supply chains globally.

There is a second need, that although less obvious, is quite pervasive, nevertheless. Institutional investors, which represent the largest pool of assets globally, are striving for returns after years of negative yields in liquid markets and illiquidity premium compression in the alternative space due to overcrowding. That need also has substantial social repercussions since institutional investors are not abstract entities. They are, on the contrary, quite tangible. They are us. It is our insurance premia and our pension contributions that need to be invested to generate sufficient yield in order to fulfill their respective social roles.

Opportunity in this case comes by the hand of regulation. Some recent regulatory changes have created an opportunity to address the problem of financing the real economy while obtaining a yield pickup in the process. Particularly, Solvency II after the latest March 2019 amendment of its implementing rules has made it easier for insurers and other institutional investors to invest in private debt, including in the SME space, hence creating an incentive to increase their investments in the real economy.

A need and an opportunity do not create per se an asset class. There is a need for a solution that articulates the risks and rewards in a manner appropriate to investors’ appetites. An investment opportunity only becomes an asset class when methodically and systematically approached. When financing trade, the operational difficulties resulting from high volume low value assets, irregular cash flows, and the legal intricacies of cross-border portfolios, make a certain degree of structuring mandatory in order to make these assets digestible for institutional investors. On this front, structured finance can offer solutions to allow investors a broader access to trade assets, and flexibility to meet balance sheet requirements, with added agility and flexibility.

It is here where asset managers have a role to play in trade finance by communicating capital market standards to real economy players, with particular emphasis on diversification, risk sharing, enhancing compliance standards, and transparency, as well as pushing forward a responsible investment agenda. If done properly, asset managers can synthesize a complex set of supply chain needs and asset allocation opportunities in a globally integrated asset class with deep social ramifications and positive societal impact. 

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