The shifting sands of commerce
The historic gas deal signed between Russia and China in May this year was yet more evidence of the shifting patterns in world trade. The 30-year, $400 billion deal for Gazprom to deliver gas to China was a major step in Russia’s renewed focus on Asia.
A month later, the head of Gazprom, Andrei Kruglov, was reported as saying the deal between Gazprom and China National Petroleum Corporation could be undertaken in Chinese renminbi (RMB) or Russian rubles as the RMB would soon be fully convertible. Initially, Russian Energy Minister Alexander Novak said the payments for the contract would be in USD. However, Western nation-imposed sanctions on Russia over its alleged activities in Ukraine have apparently forced a rethink. Financial Times reported recently that Russian companies are switching export contracts from USD into RMB and other Asian currencies in order to reduce their dependence on Western financial markets.
“Countries as large and influential as Russia and the People’s Republic of China have their own currencies to trade with and it is sometimes more logical to use one of those where they are able to do so,” says Ray Zabarte, interim head of trade, global transaction services, Royal Bank of Scotland (RBS). “As a result, we may see many more currencies used to price trade transactions. It’s important that banks are ready to support the importers and exporters in both nations on these new trade deals with trade finance solutions denominated in one or both of the currencies. These solutions include standard letters of credit [LC] and importer or exporter loans.”
The USD remains the global reserve currency but concerns about the impact of the protracted quantitative easing program of the Federal Reserve Banks have opened the possibility of a more balanced trade finance world, no longer dominated by USD. In December last year Swift announced that the RMB had become the second most used currency in trade finance, overtaking the euro. Swift’s data showed that RMB use in LC and collections grew from an activity share of 1.89 per cent in January 2012 to 8.66 per cent in October 2013. This is dwarfed by the USD, which has an 81.08 per cent share (down from 84.96 per cent in January 2012). The top five countries using RMB for trade finance in October 2013 were China, Hong Kong, Singapore, Germany and Australia.
In the payments market, Swift Watch figures reveal that in August 2014 the USD had a 42 per cent share of the total value of customer initiated and institutional payments inbound and outbound traffic on the Swift network. The RMB was seventh, with 1.57 per cent; having jumped from thirteenth place and 0.63 per cent in January 2013. The numbers are modest and knocking the USD off its perch will take some time, but the growth path is clear.
Any traditional trade finance bank will emphasise that the business is all about client demand – services are based on where clients are doing business and with whom. As global trade changes and client demands change as well, so too will the services of the trade finance banks.
“Following shifts in global trade flows, Russian companies started strengthening their cooperation with a number of counterparties outside Europe and North America,” says Andrey Ivanov, head of trade finance and correspondence relations division at Russia’s Sberbank CIB. “Current macro-economic fluctuations made it necessary for both corporates and banks to broaden their horizons and build diversified relationship networks with partners from various geographies. Among others we are strengthening the ties with Asian, Latin American and Middle East banks in parallel with (and to some extent followed by) signing of sound clients’ transactions in these geographies. We believe this trend will continue, creating new developments in trade finance.”
Recently many Russian corporates have signed commercial contracts with their suppliers in the currencies of their trade partners (including RMB) and converted a big portion of liquidity into RMB and HKD, says Ivanov. Among these companies are teleco Megafon, mining company Norilsk Nickel, natural gas provider Novatek and some other key market players. “Also we have noticed a huge increase of RMB settlements (more than 20 times since May 2014) and LC flows in RMB. This reflects the intention of clients to shift from USD to payments in national currencies.” As China is the biggest trade partner of the Russian Federation and due to the strong position of the RMB as a trade currency it is an important trend that creates “excellent opportunities”, says Ivanov. “The Russian Central Bank and key commercial banks pay close attention to study the best market expertise and to implement direct RUB-RMB swaps to facilitate operations in national currencies. This is a mainstream of trade bypassing USD payments.”
Bank of America Merrill Lynch (BAML) is also recognising a change in client demand when it comes to trade finance. Two years ago, it held a joint forum with the Hong Kong Monetary Authority to provide information to its Brazilian clients doing business in China. Martin Knott, head of trade, global transaction services, Emea at the bank, says the forum was held to support these clients’ business flows and to promote the bank’s RMB platform in Hong Kong. “And in July 2014 we hosted our annual Taiwan Treasury Exchange Conference. The feedback from Taiwan-based treasurers and chief financial officers showed that 55 per cent of Taiwan-based treasurers see the RMB as the most relevant currency to the future of their businesses ahead of the USD at 29 per cent and the Taiwan dollar at 13 per cent.”
Increasingly, clients require their trade finance banks to support them in multiple jurisdictions across the trade value chain, including payment processing, financing and risk mitigation as well as value-added services such as document preparation, order matching and reconciliation, says Venkatesh Somanathan, Asia Pacific head of trade finance product management, global transaction banking, Deutsche Bank. “In addition, corporates want these products and features to be delivered electronically, which means that not only corporates and banks need to be e-ready, but also their partners such as shipping companies, customs authorities or insurers.”
Given the large volumes of global trade going to Asia and other emerging markets, Deutsche Bank is seeing a growing need to settle trade transactions in currencies from emerging markets, he says, adding that the RMB is also poised for take-off and could become a key currency in global trade in the future.
“In order to use the RMB as a payment currency, corporates need to build the capabilities to contract, invoice, receive and settle in RMB, so partnering with the right bank that can advise them on how to do so is crucial. This evolving client requirement will drive banks to develop new products for transacting, hedging and investing in RMB,” says Somanathan.
According to Standard Chartered Research, emerging markets now account for 42 per cent of world exports or 52 per cent excluding intra-EU trade and according to the World Trade Organisation, south-south trade is expected to grow significantly to 43 per cent (it is currently 24 per cent) by 2035. “Asia is at the heart of trade, having firmly established itself as the centre of the ‘made in the world’ vertical global supply chain, with China emerging as a mega-trader,” says Michael Vrontamitis, the recently appointed head of trade, transaction banking at Standard Chartered. “We believe it is thus important to continue capturing trade corridors linked to China and further China domestic penetration, as well as assess credit appetite beyond China. We also remain committed to India, where share of trade is expected to double by 2035.”
The USD will remain important as the leading currency for world trade, says Vrontamitis, however, the RMB is rising continuously and is expected to become a prominent player and join the ranks of the G3 currencies to become G4. “This shift brings about a greater balance and companies now have a choice as to which currency they want to settle in. We have already seen an advent of currencies that have begun direct trading with CNY, for example, AUD, GBP, KRW, etc. With China being an important trading partner to most countries, direct trading between such nations and China is not surprising. This will also allow companies to manage their risks more efficiently and is thus a welcomed change.”
Zabarte says RBS has seen a high degree of momentum toward open account trade financing when it comes to flows between China and the US. As a result, clients are consolidating their LC and collections using their preferred banks. At the same time, however, there has been increasing demand for local, regional and global supply chain finance.
Africa is another region that has come into focus in global trade, particularly as Chinese companies do more deals on the continent. Neil Surgey, head of global transactional products and services at South Africa-based Standard Bank, says the increase of trade flows between Africa and China and also intra-Africa trade have required the bank to deploy resources in key countries in the region to match potential growth. “In order to support the trade growth, our partner bank agreements have become critical as an enabler to deliver on the growing need to take risk to meet demand.” In 2007, Industrial and Commercial Bank of China (ICBC) took a 20 per cent stake in Standard Bank as part of its investment strategy in Africa. The $5.6 billion investment was the largest single foreign investment by a Chinese firm to be made.
Over the past few years since the internationalisation of the RMB, Standard Bank has focused on ensuring that it has the capabilities to meet the expectations of its clients from transactional processing, trade financing and foreign exchange trading perspectives, says Surgey. “Whilst the mitigation of risk elements are through traditional trade products, which are still key to risk management, the change in traditional trade instruments to supply chain/open account finance is a focus.”
Standard Bank’s focus is Africa and facilitating trade for Africa, says Surgey, and this is still largely undertaken in USD, with interest in RMB from China.
The focus on trade flows can be over-emphasised, says John Ahearn, global head of trade, at Citi’s treasury and trade solutions division. “If you look at the high-level numbers, it is a bit like drinking from a fire hose – there’s a lot of data coming at you. Some of the flows can be financed, but some cannot. At Citi, we spend time working out the ecosystems under these flows and what can and cannot be financed. ” This has been a useful exercise, he adds, as it has uncovered unique flows and client pairings that may not otherwise have been revealed.
Citi’s global footprint means any shift in global trade flows does not have a significant impact on its trade finance activities, argues Ahearn. He believes that the changing trade flows will have an impact on banks without a presence in any of the new corridors opening up. “The global Swift trade finance numbers have been relatively flat for the past three to four years,” he says. “Combined with the Basel III rules this means that banks not active in one of the corridors of global flows may question whether they should remain in the trade finance business.”
Ahearn says a number of trends in trade finance are emerging and Citi is adapting its business to them. First, the bank is trying to become a consolidator of trade finance deals, focusing more on this than on smaller deals. Second, he believes too many banks focus on budgets and whether or not they have missed spreads. “I don’t want to be in a business where I am that exposed to external market spreads,” he says. “This doesn’t involve the injection of intellectual property, which is where I think we can make a difference. We are trying to move away from being just price takers.”
Finally, trade finance as an asset class is becoming increasingly attractive to many institutional investors. As non-bank financial institutions, these firms are not subject to the same regulatory regime as the traditional trade finance banks and their cost of capital is cheaper. “In the short-term, such firms will be good participants in trade finance, buying assets from us, but in the long-term they may evolve into major competitors,” says Ahearn.
To remain competitive in trade finance, banks will have to differentiate themselves. Standard Bank’s Surgey believes access to liquidity, capital constraints arising from Basel III, pricing, the regulatory environment and innovation and technology will all be areas in which banks can differentiate.
RBS’ Zabarte says a key differentiator will be client service and how banks bring together the different parts of their organisation for their customers in a co-ordinated way. “It’s not just about having the best channels, it’s about how well your client relationship managers, sales people and operations teams interact with those channels, while providing the very best products possible of course.”
At BAML price remains a critical factor in trade finance, says Knott, but service, operations, platform stability and a network to support clients remain just as critical and no single element can be looked at in isolation. “Banks’ ability to structure transactions appropriately and to ‘recycle’ capital to create capacity will continue to be important,” he says.
Trade is increasingly ‘unbundled’, with countries no longer trading in goods so much as in ‘tasks’, such as design or assembly, says Vrontamitis. Goods are now ‘made in the world’, with components and partial assemblies frequently traded several times across borders before the final product reaches consumers. “Following these trends, the ability to serve and connect clients from end to end, facilitate their trade across geographically spread supply chains and cover a vast network of buyers and suppliers across various segments – from SMEs to global corporates – will be a key differentiator.”
At Sberbank, apart from deeper exploration of new geographies and currencies the bank is playing a greater role in the strengthening of new trade finance products, says Ivanov. “We are adopting some regional-specific product features of Chinese banks and other regional partners. There is a huge increase of appetite for funding from Sberbank to other financial institutions under trade finance lines inside and outside of Russia, following changes of policies of some global banks. Commodity trade finance, which we started to develop in 2013, is escalating after many Russian exporters started to be more cautious with regards to cooperation with their international partners. Financing under coverage of the Russian Export Credit Agency and the Agency for Export Credit and Investment Insurance is another brilliant opportunity of portfolio growth, which we actively develop.”
New actors in trade finance are likely to emerge as global trade patterns shift. “We will absolutely see more trade finance providers on the scene as trade flows change,” says Zabarte. “Chinese banks are definitely making their move towards western markets and over the past couple of years Middle East banks have started setting up more trade-focused capabilities outside their region. South Asian and Indian banks also continue to grow internationally.”
Surgey says domestic banks in any country that is experiencing a growth in trade will emerge as players in trade finance because they hold the trade resources and expertise. Chinese banks, for example, will increasingly play a bigger role in trade finance. Echoing Ahearn’s comments about institutional investors, he believes new players, such as insurance companies, will also fast become trade finance providers as they are not subject to the same capital constraints as banks. Zabarte adds that the industry is not yet seeing any new, non-bank players having any real impact, although “it may be to come”.
Traditional local banks such as top tier Chinese and Indian banks have been expanding into regions or globally to serve their clients’ needs as they grow beyond home grounds, says Vrontamitis. Chinese banks are already playing a prominent role given China’s emerging role in global trade and will continue to have a stronger position as China continues to grow its trade corridors with Africa, Middle East and North Africa and other markets. International banks such as Standard Chartered, with a strong network presence in the emerging markets, deep understanding of these emerging corridors and strong risk management capabilities, are also well-positioned to support clients across the entire supply chain as they export to these regions, he says.
While a number of partnerships between emerging and traditional, East and West etc banks have emerged none has yet been as successful as those seen in the cash management world, says Zabarte. “I think, as an industry, we need to manage our own expectations on partnerships for trade finance.”
Vrontamitis says in an industry that is about volume and scale, more partnerships and consolidation between smaller, local banks and bigger trade finance partners is likely. This will not be restricted only to the emerging markets but will happen in order to achieve more efficient economies of scale and to absorb excess capacity. “
Ivanov says the changing trade flows are a good opportunity for Chinese banks to cover a wider range of trade deals. “According to usual practice, many trade flows between Russia and China were financed by global institutions – many of them focused on the Asian region. We have noticed an increasing percentage of Asian deals financed by Chinese institutions, taking advantage of the geopolitical environment and promoting RMB business. Similarly it is a great opportunity for Brazilian banks many of whom are attending Sibos. While some new players focus solely on the domestic geography of underlying deals, many others keep their eyes wide open and apply a broader policy. With the passage of time they have a good chance to become global trade finance actors.”