The global trade finance gap grew to a record $2.5tn in 2022 from $1.7tn two years prior, according to the Asian Development Bank’s (ADB) Trade Finance Gaps, Growth and Jobs Survey published this month, incorporating data from 137 banks and 185 companies from around 50 countries.
Rebounding strongly after the Covid-19 pandemic, the trade finance gap constitutes the difference between requests and approvals for financing to support imports and exports. Although demand for trade finance surged post-recovery, heightened economic risks left finance more difficult to secure, according to the ADB.
Gap may keep growing
Firms reported access to financing as a key challenge for trade, and cited insufficient financing as the top supply chain challenge. Access to adequate financing, reliable logistics and the use of digital technology were noted as the three most important components in building resilient supply chains.
Demica’s chief commercial officer, Maurice Benisty, describes the increase in the cost of capital as the “single biggest driver” of the widening trade finance gap: “Inflation is a natural driver of an increase in the requirement for trade finance. Higher sales means higher requirements for trade. And as rates go up, the concerns from a credit and risk perspective increase because affordability of repayment increases.”
The bulk of the trade gap is likely between and within Asia, Europe and the US, Mr Benisty says, given the small size of trade finance markets elsewhere. Although the rate of adoption of trade finance may be greater in less developed markets, the gap stems from their outputs. For banks, that’s where the focus lies, he adds.
Based on the current financial environment — low growth, high interest rates, high inflation and large demand for capital investment — the trade finance gap is likely to continue to grow, says Mr Benisty. “There will be volatility,” he adds, predicting a widening gap that would shrink in a more favourable interest rate environment. And pressures on firms to reach environmental, social, and governance (ESG) targets may hinder this too.
Pressures are near and present
For the first time, the 2023 trade gaps survey focused on ESG issues, along with digitalisation, to assess their impact on supply chains and the trade finance gap. Most surveyed firms believe ESG alignment may help reduce the trade financing gap.
But ESG measures may have the opposite effect, at least in the short term, says Mr Benisty. As banks and investors look to reduce their exposure to carbon intensive industries, and as the transition to a net zero economy progresses, ESG financing pressures may pull the trade finance gap even wider.
Long term, you may see cleaner energy, more efficiency, and less friction, but in the short to medium term, I see [the push to net zero] creating more pressure.
“The push to net zero means a lot of investment across the supply chain, which drives up the amount of funding that’s required. Long term, you may see cleaner energy, more efficiency, and less friction, but in the short- to medium-term, I see it creating more pressure,” says Mr Benisty.
“Banks’ willingness to fund against ESG criteria will be a positive; we’ve seen banks who are able to price differentially for ESG-related projects and who are hungry to put money into that area. Longer term, big themes like the requirement for investment in ESG, decarbonisation, and reshoring of the supply chain — which necessitates new investment to support new trading partners — means that unfortunately, the gap continues to grow,” he adds. “It takes time for some of these countervailing initiatives and for more digitalisation to catch up. Those pressures are very near and present.”
Anywhere between 25% and 80% of the global carbon footprint can be traced back to the trade and supply chain, says the head of the ADB’s Trade and Supply Chain Finance Program, Steven Beck, who agrees it remains “a space we have to ‘green’”.
Although ESG pressures may negatively affect the trade finance gap in the short term, Mr Beck refers to the ADB’s brief on deep-tier supply chain finance (DTSCF) which, as well as presenting a solution to fill the financing gap for small and medium-sized enterprises, aligns ESG efforts with the reduction in the trade finance gap.
Supply chain linkages can be better used to achieve ESG targets if systems’ inner workings are “transparent and traceable end-to-end”, the ADB’s DTSCF brief recommends. Mr Beck refers to expectations that companies’ financial institutions must have more clarity and understanding about ESG affairs throughout the entire chain “from the base commodities, to the final product”.
In the process of ensuring that the entire chain is ESG aligned, a better understanding of the supply chain is developed, which in turn creates stronger, more resilient supply chains, driven by “transparency throughout”, adds Mr Beck.
Digitalisation can close the gap
A more streamlined approach could help close the gap that ESG efforts may initially leave open. Surveyed banks reported that sustainability progress is impeded by a lack of harmonised standards and data collection, along with reporting mechanisms for compliance, the ADB reports. Most firms pointed to the digitalisation and standardisation of trade documentation processes, including increasing rates of paperless trade, as offering a significant boost to productivity and efficiency.
Mr Benisty echoes this sentiment and points to considerable investment from banks to modernise systems and processes that have “been left untouched for a very long time”, referring to traditional trade finance as document heavy and process intensive.
But overall, trade remains an antiquated process, Mr Beck says, describing it as “ripe for disruption”. Less than 2% of global trade used electronic bills of lading last year. Two key objectives underpin the digitalisation of global trade, Mr Beck says, pointing to two key objectives which underpin the digitalisation of global trade: a change in the trading ecosystem and enhanced government alignment.
“There are some 35 paper documents that are used in trade today. We need to get the ecosystem — exporters, shipping ports, customs, warehousing and logistics importers, and banks — to agree on what the electronic form of those 35 paper documents should be,” says Mr Beck. “The ADB has created the Digital Standards Initiative [DSI]. It brought together all these components within the free trade ecosystem to agree on the electronic forms of these papers and 35 paper documents. That’s step one.”
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Hosted by the International Chamber of Commerce and based in Singapore, the DSI comprises policy-makers from governments and international organisations, including the Singaporean government, the ADB, the World Trade Organization and the World Customs Organization.
Governments must also align their domestic legislation with model laws, Mr Beck says, referring in particular to the Model Law on Electronic Transferable Records. Providing an open framework for digitalising trade documentation, it recognises electronic documents for trade, a leap forward given that “most governments actually don’t”, Mr Beck says. “And to the extent that they do, it’s not interoperable. It has to be done in such a way that it’s harmonised around the world,” he adds.
Once global trade is successfully digitalised, the impact will be transformative, says Mr Beck. “It really touches on the gaps of the transparency issue, around anti-money laundering, trade-based money laundering, on ESG alignment, greater understanding around ESG, supply chains, and trade.”
Transitioning trade from paper to digital forms should be finalised by 2026, Mr Beck says, conceding that legislative change, given its reliance on various jurisdictions, may take longer, but completion is “doable” by 2028.
