Global trade system comes under greater scrutiny
With widespread disruptions in the trade supply chain and a growing trade finance gap, particularly impacting smaller businesses, a recently released report calls for systemic modernisation of global trade finance and lays down a roadmap for radical change
The call to improve procedures within the global trade system, and in particular the financing mechanisms that are the engine of that, have been steadily ramped up for many years now. The global financial crisis of 2007-2008 was a harsh wake-up call, and now coming up to two years of the Covid-19 pandemic and the major disruptions that has had to global supply chains, there is intense scrutiny being placed on how the trade finance system can be fundamentally improved.
It is not as though nothing has been done this century to improve and modernise the system – plenty has. But it is blatantly obvious it is not enough. And advances in standardisation, transparency and digitalisation etc so far have not been fast enough to keep up with the growth in global trade and the technological advances available to help in the push for the greater efficiencies needed.
With continued sluggish and inefficient systems, the financing of global trade suffers. For years now we have talked about the global trade finance gap – where companies trying to access finance are unable to do so. That gap is simply getting bigger, and it is predominantly micro, small and medium-sized enterprises (MSMEs) that are losing out (see below).
The scrutiny that has been directed at the global trade system has led the International Chamber of Commerce (ICC) and the World Trade Organisation (WTO) to call on governments, development banks and multilateral banks to act. At the same time there is now real impetus with certain initiatives being put forward by these bodies. In addition, a recent research report suggests a fundamental overhaul of global trade finance.
Released by McKinsey, the ICC and Fung Business Intelligence in November, a 57-page report entitled: ‘Reconceiving the global trade finance ecosystem’ explores a way to reshape and modernise trade to make it not only more accessible to help smaller businesses, but also more sustainable in a variety of ways.
There is no question this is a landmark report, and that it will be discussed, considered and hopefully some of the measures ultimately taken up. I urge you to read the report. One thing that I continue to find odd though is how the use of the word ‘ecosystem’ has gradually crept into ‘trade talk’. I’ve heard it numerous times at conferences and obviously seen it in print too – but I still find its use weird! For me, ecosystem means a biological community of interacting organisms and their physical environment. Now, it also has the meaning of ‘a complex network or interconnected system’. Fair enough, but I won’t be using it!
Trade finance gap grows
Up until last year many reports on the global trade finance gap had quoted the figure of $1.5 trillion as the size of the global trade finance gap – a figure which had been released by the Asian Development Bank (ADB) in relation to its Trade Finance Gaps, Growth, and Jobs Survey of 2018. The gap represents the difference between requests and approvals for financing to support imports and exports. In October 2021, the ADB revised this figure to $1.7 trillion for 2020, following its latest survey.
ADB trade and supply chain finance head Steven Beck, commented: “To close the gap, we need to bring trade fully into the digital world through greater coordination with the private sector as well as global agreement on common standards, practices, and legislation.”
In a statement released by the WTO and ICC in July 2020 (also in a letter to the G20) it noted the following: “Trade finance is a critical element in re-igniting worldwide growth in imports and exports. Since the need for trade finance is estimated to be between $2 trillion and $5 trillion, meeting this demand and addressing the shortfall will be challenging. There is serious concern that the growing gap between demand and supply will particularly affect MSMEs and businesses in developing countries, with important implications for jobs and incomes.”
WTO and ICC urged the private and public sectors to work together to bring about a rapid transition to paperless trading, including e-documents in the processing of trade finance transactions. In addition, the statement called for an exchange of views on how regulatory authorities can help ease constraints on the provision of trade finance. It also proposed increased risk sharing to support trade finance and the extension of development bank schemes to provide risk mitigation.
The report - ‘Reconceiving the global trade finance ecosystem’
The McKinsey, ICC, Fung Business Intelligence report is based on a year-long effort by the ICC’s advisory group on trade finance to raise awareness and address the challenges facing MSMEs, particularly in the emerging markets, in accessing the trade finance needed to support their growth and the global recovery. It is based on over 150 interviews with end-users and subject matter experts in 12 countries, and an ideation and review process covering leaders from trade, finance and technology.
According to McKinsey’s Global Banking Pools, the global trade finance market covered a value of approximately $5.2 trillion in 2020, amounting to roughly 6% of global GDP. Of this $5.2 trillion, 55% is throughout Asia-Pacific, 30% EMEA and 15% Americas.
It ought to be noted here that in 2020 global merchandise trade volume stood at $17.5 trillion, down from $19 trillion in 2019, which was itself down 3% on 2018. It is generally accepted that approximately 80%-90% of global trade requires financing of one form or another. The bulk of global trade is financed on ‘open account’ financing terms.
Broadly, the scope of trade finance considered for the purpose of the report covered three types of products. First, documentary business including traditional on- and off-balance-sheet trade finance instruments. Documentary business accounts for roughly 85% of total trade finance volume the report notes. Second, buyer-led finance eg reverse factoring, and third, supplier-side finance eg factoring, forfaiting.
Within its introduction, the report stated: “Against a backdrop of increasing digitisation of financial and commercial services, trade finance has been relatively slow to modernise its decades-old processes. Multinational corporations have begun to leverage digital technologies that promise improved supply-chain efficiency and transparency, establishing new digital networks to facilitate trade and finance. But MSMEs, with their fragmented nature and limited scale, find it difficult to capitalise on such opportunities.
“Resolving this issue is critical for all participants in the global trade finance system. An improved global trade finance ecosystem could add many of the 600 million new jobs needed by 2030 to absorb the growing global workforce, as well as enable progress toward the goal of financial inclusion, which is particularly needed in developing economies.”
The report also stated that technological innovations to date within trade finance had led to ‘digital islands’ or closed systems of trading partners which unintentionally could create longer-term disconnects. It suggested bridging these islands with an ‘interoperability layer’, enabling “ubiquitous access across networks and platforms”.
This interoperability layer would have a three-part mission. First, to promote adoption at scale of existing trade finance standards for operational interaction. Second, to design and disseminate additional global trade finance standards and protocols to fill market gaps. And third, to develop blue books and identify guiding principles for improved collaboration among trade finance participants.
In a subsequent article by the report authors, it noted: “The interoperability layer would be a virtual construct that acts as an umbrella for existing and future standards, protocols, and guiding principles. To be clear, it is not a proposal for regulatory change, nor is it intended to be a hardware or software entity to which parties must connect. It would be a collaborative effort involving relevant organisations in the trade finance market. It would give all parties - particularly under-represented segments like MSMEs and businesses in emerging markets - a fair opportunity to participate. The goal is an architecture of common standards and best practices enabling trade finance to become more inclusive, collaborative, and digitised.”
The report lists a number of benefits of a revamped system for a range of players including: buyers and suppliers (who would see the greatest benefits, particularly with increased access to liquidity); logistics providers; financial institutions; trade organisations; technology providers; and, governments and regulators.
For financial institutions, some of the benefits are: “A full deployment of the interoperability layer would bring a substantial structural change to the financial industry as a whole, specifically benefiting existing providers (primarily banks) while also attracting much-needed new credit capacity to the industry (from entities such as institutional investors), drawn by added transparency, access to technology, and regulatory support. In addition, the ecosystem could bring additional revenue streams and value-added services while making the processes more efficient and cost effective.”
The road map
The report stresses that the realisation of an interoperability layer would only be possible with the coordination and commitment of the broad community of trade finance participants. It noted: “Given the complexity of the market, this effort may require five to ten years to reach a level at which most participants will realise its full benefit. However, some of an interoperability layer’s building blocks could be deployed on an accelerated path, leveraging work that has already been done by trade organisations.”
This plan is structured over three phases. The first phase is over 12-18 months. This involves: mobilising the existing trade finance ecosystem. — Establishing a governance model for the interoperability layer. — Launching a detailed action plan to accelerate adoption of standards for digital trade enablement. — Finalising critical missing elements for trade finance interoperability foundations. — Building a road map to drive adoption of the key standard.
The second phase is over two to three years. This involves: Developing the reconceived ecosystem and starting scaling up adoption. — Finalising missing elements of the interoperability layer (eg, blue books, best practices). — Promotion of a broader adoption of the chosen standards applying a supply-side approach (starting with banks).
The third phase is over five to ten years. This involves: Scaling up global efforts, with solutions addressing the needs of all market participants. — Supporting development of shared utilities, based on blue books and standards. — Scaling up global adoption of the reconceived ecosystem by both the supply and demand sides.
In concluding, the report stresses the real need for all-party coordination and commitment: “The overarching goal of the proposal described in this report is to build on the collaboration already gaining momentum among participants in the trade ecosystem, to cover gaps in existing operating models, and, most importantly, to promote the wider adoption through further coordination. If cooperation and execution throughout the global trade finance community can be inspired, the joint objective - and an equitable distribution of benefits - are well within reach.”
Taking ideas forward
The report is undoubtedly a document which is trying to drive the trade finance community to pull together to bring the range of trade financing products and services properly into the 21st century in an organised way for all. As it states, much has already been done. However, refinement of all these qualities and organisation will require considerable attention over a good period of time. And, where there is a will, there is always a way.
Inevitably, not everybody has been entirely impressed with the report however, one senior executive within a US-based capital market fund which invests in trade finance assets, observes: “I was impressed by the density of meaningless buzzwords.” Possibly a bit harsh, but at times I could certainly see where he was coming from.
Expanding beyond this, the executive explains: “Within the report there seemed to be no recognition of the fact that banks have a finite amount of capital available for trade finance.” Here, the executive seems to have a point
And specifically on the issue of non-bank investors in trade, coming more into trade finance to help fill some of the gap, he complains: “I detected little or no mention of the potential for financial investors to help fill the gap.”
There is in fact a small section on institutional investors in the report, which skirts around involvement, but never properly looks at the growing involvement of private credit investors within trade finance, and the greater potential of such activity. The report noted: “institutional investors to date have not embraced at-scale trade finance as an investable asset. Indeed, the trade finance market tends to be illiquid and non-transparent for reasons including technology limitations - resulting in the lack of a transparent electronic market - and limited risk assessment expertise among institutional investors.”
A comprehensive review of private credit within trade finance can of course be found in the recent report published by TXF: ‘Private Credit & the Trade Finance Opportunity’.
Another market practitioner, Christoph Gugelmann, CEO of Tradeteq, a technology provider which set up the Trade Finance Distribution Initiative to drive standardisation for the distribution of trade finance assets had these insights to say about the McKinsey/ICC/Fung report: “The McKinsey/ICC report pulls out a number of key issues with global trade: supply chain issues creating fragility, the insurmountable barriers for SMEs attempting to access funding and lack of interoperability. At the heart of each of these problems is legacy infrastructure and the reliance on paper-processes such as faxes and spreadsheets which are slow and have no transparency or standardisation.”
And in considering ways to improve the global trade system, Gugelmann remarked: “In my view, the way to reboot this $5 trillion [financing] engine that powers global trade is to adopt and utilise new technology and incorporate modern infrastructure which enables more automation, less friction and reduced costs. The technology and infrastructure needed to parcel trade finance instruments into investable assets which helps solve the trade finance gap already exist.
“Modern AI [artificial intelligence] tools can give firms early warning signs of supply chain issues before they’re directly affected. These solutions have come about through banks, fintechs and investors working together and using innovative technology, and this is the formula required to truly revolutionise this centuries-old industry.”
Sound words. We look forward to further developments and concerted progress on the restructuring of the global trade finance system.
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