Monday, 21 September 2020

Safeguarding trade finance operations in times of crisis

By Olivier Paul

Olivier Paul, Director, Finance for Development at the International Chamber of Commerce (ICC), explains the implications of the pandemic for the trade finance industry and the measures needed to help backstop a trade recovery.

  • International trade faces great uncertainties from the COVID-19 pandemic
  • Effective government intervention will help fully mitigate the potential implications of coronavirus-related workplace restrictions on the financing of trade
  • The deferral of the full implementation of Basel III will help ease any potential capital constraints faced by banks in responding to the crisis

There is no question that the coronavirus outbreak has turned the world on its head by causing a widespread disruption to our lives, the way we do business, and the wider economy – in turn, threatening to reverse the growth that global trade has experienced over the past decade.

Despite the grave impact of the 2008 financial crisis, the changing regulatory landscape and the return of protectionist policies in many countries, international trade has seen continuous growth over the last decade. However, it now faces an even greater challenge from the COVID-19 pandemic, and the prospects for international trade have not witnessed such uncertainty since the Second World War.

Undoubtedly, global trade volumes are expected to fall in 2020 – and with them – the revenues of the trade finance industry. Yet the effect on volumes over the next few years will very much depend on the scale and duration of the pandemic, as well as the immediate government response to it. And even after the pandemic and emergency measures have passed, international trade may still be constrained by long-term challenges in commercial behaviour and public policy. What’s more, the economic outcome will also depend on the effects of potential changes in policy, some of which may rein in the globalisation that has characterised the last 40 years.

Indeed, ICC estimates that as much as $5 trillion in market capacity will be needed to return trade volumes close to 2019 levels in 2021. With the World Trade Organization (WTO) projecting that the effects of COVID-19 could cause merchandise trade to drop by over 30% this year, it has been advised that a rapid economic recovery will only be possible if sufficient credit is available to bring trade close to its pre-pandemic trend over the next 18 months.

Notwithstanding the unprecedented actions taken by commercial banks and public bodies in response to the initial phase of the crisis, policymakers need to contribute by proactively scaling support for trade finance transactions – to prime the market ahead of demand returning to the global economy. To this end, several priority interventions – if properly calibrated – could immediately bolster financing capacity, including large scale purchases of low-risk trade assets to free up banks’ balance sheets or providing targeted capital relief for trade transactions under global financial stability rules, known as Basel III.

Transition to paperless trading

Trade finance transactions rely almost exclusively on hard-copy paper documentation to process payments and, ultimately, clear the release of goods to buyers. What’s more, in many jurisdictions, the use of electronic trade documents is either prohibited or their legal status is unclear. Yet with banks unable to handle documents in-person as government authorities seek to limit COVID-19 transmission, there is a risk that the underlying trade in goods, including essential medical and food products, will be further disrupted.

As such, while ICC and banks are taking rapid steps to limit any disruption to the processing of trade transactions, only effective government intervention to enable an immediate transition to paperless trading will help fully mitigate the potential implications of COVID-19 related workplace restrictions on the financing of trade.

The specifics of voiding legislative requirements will depend on the constitutional arrangements of each country. Nevertheless, international legal standards – such as the UNCITRAL Model Law on Electronic Transferable Records – can be readily adopted in national laws to provide legal clarity for banks to accept e-documents in order to expedite the financing of trade transactions and the release of goods through this unrivalled crisis.

Deferral of the Basel III implementation

Some interventions have already helped stabilise market confidence. This includes the deferral of the full implementation of Basel III to ease any potential capital constraints faced by banks in responding to the crisis. Along with technical clarifications provided by the Basel Committee, this will ensure that banks reflect the risk-reducing effect of government guarantee programmes when calculating regulatory capital requirements. What’s more, this will help mitigate against any potential for capital constraints to hinder the deployment of essential trade finance – particularly to micro-, small- and medium-sized enterprises (MSMEs), which are among the hardest hit by the pandemic.

However, more can be done, and consideration must be given to adjusting risk calculations for key products, as appropriate, in line with the established low-risk profile of this asset class and benchmarked against existing performing data. In turn, an immediate next step for governments and central banks would be reducing the risk weights for exposures to MSMEs from 100% to a range between 75% and 85%, as proposed by Basel III.

Freeing up banks’ balance sheets

Furthermore, large-scale government and central bank purchases of trade finance assets and/or guaranteeing of trade exposures should be considered to free up banks’ balance sheets to service additional trade financing demand for MSMEs. This could be enabled at scale by making use of existing technologies and techniques, including securitisations, which are classified as Simple Transparent and Standardised (STS) under regulations applicable to securitisation transactions. The benefits of such interventions are evident as they carry a relatively low risk to public finances given the self-liquidating nature of trade finance transactions.

Meanwhile, other industry parties can, and must, play their role in supporting trade finance transactions – from export credit agencies’ provision of support for short-term trade transactions to further scaling development bank programmes to provide vital risk-mitigation and liquidity.

Working together

In the face of the unprecedented challenges posed by the outbreak of the coronavirus, every day matters in taking steps to secure the functioning of the global trading system. Given the scale of financing required to support a rapid rebound in global trade flows – potentially as much as $5 trillion – all stakeholders are encouraged to take proactive steps to ensure the trade finance market can play a central role in driving a post COVID-19 recovery.

Timely interventions will be especially vital to ensure that all companies – particularly MSMEs – have continued access to reliable, adequate and cost-effective sources of trade financing. Working together, the industry will not only equip itself to weather the crisis, but hopefully to emerge from it stronger than ever.

Olivier Paul is Director, Finance for Development at the International Chamber of Commerce.



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