Funding Asian trade

The past few years appear to have been good for Vietnam’s export industry, as the country emerges as the big winner in the continuing trade war between the US and China. Vietnam’s exports to the US increased 36% , in the first six months of 2019 according to US trade data compared with the same period in 2018. The country has a strong infrastructure network and ports that are ready to export – essential elements for trade – while factory wages are cheaper than elsewhere. On the surface, it all looks promising. 

But there is a sting in the tale. While Vietnam is taking advantage of changing trade flows, the Hanoi government is wary of becoming a channel for China to export to the US while dodging tariffs. Chinese companies have been moving their processing operations to the countries from which they previously imported unfinished goods: for example, fish caught in Vietnam by Chinese companies will be processed locally and exported directly to the US, rather than being sent to China for processing. Vietnam’s trade ministry has responded by implementing restrictions on what can be labelled as ‘Made in Vietnam’. 

Vietnam also risks becoming a victim of its own success. Its trade surplus with the US has increased to the degree that the Trump administration could hit Vietnam with similar tariffs to those levied on China. In 2018, 20% of Vietnam’s gross domestic product (GDP) came from trade with the US, according to Bloomberg,  but in the first six months of 2019 it reached 26% of GDP. And during that period, Vietnam shipped $40bn-worth of goods to the US, while the US exported a comparatively small $10bn of goods to Vietnam, according to US Census Bureau data. 

An extension of China

These events represent just one of many changing trade stories seen in Asia, where trade flows are becoming increasingly complex and diversified. These changes are not entirely predicated on the trade war: the relocation of manufacturing away from China has been happening for several years, as both Chinese and international companies seek lower production costs. 

Gaining a share of this manufacturing business is a huge bonus for these countries, though homegrown companies do not always benefit. Bangladesh, as well as Vietnam, has picked up some of the textile supply chains from China. Thailand, meanwhile, has replaced China as the leading exporter of rubber tyres to the US – partly down to Chinese companies moving production of tyres to Thailand for export to the US and Europe. 

Chaiyarit Anuchitworawong, senior executive vice-president, head of the international banking group and manager of the international branch division at Bangkok Bank, says since the middle of 2018, the bank has seen Chinese companies from multiple industry sectors exploring investment opportunities across south-east Asia. “In 2018 the amount of investment from Chinese investors in Thailand approved by the board of investment more than doubled compared with the previous year,” he says. “This was primarily driven by a surge in investment applications in the metal products, machinery, and transportation equipment sectors.” 

However, both Chinese and international businesses should be rigorous when considering whether to diversify trade sources in an attempt to avoid tariffs. Peter Jameson, head of Asia-Pacific trade and supply chain finance, global transaction services (GTS), at Bank of America Merrill Lynch (BAML), says: “Clients are looking to diversify their supplier bases, but they have to be careful in their decisions. There is no sense in moving their supply chain to another country but then finding there is insufficient infrastructure or capacity to support the exports.”

Trade looks for financing 

Trade in Asia has become more diversified, but regardless of location, it requires financing if it is to work. While changing trade flows appear to be overhauling wider regional economic prospects, Asia is also suffering from a significant trade finance gap. Estimates put the global trade finance gap, where companies, and especially small and medium-sized enterprises (SMEs), are not receiving the financing they need to support their business, at $1500bn. Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis, says the problem is most prominent in Asia, which accounted for almost 40% of trade finance rejections in 2017. 

Thanks to its huge economy, China had been shielded from this. The same cannot be said for smaller emerging market economies. Marc Auboin, counsellor in the economic research and statistics division of the World Trade Organisation (WTO), says: “The household savings rate to loans is a key differentiator in how much financing countries can support with local resources of trade finance. The savings rate in China of 40% of GDP means that, when turned into loans, China can support with its own resources an import-export sector of the same magnitude without ‘importing’ trade finance from other countries.” 

When manufacturing crosses borders, however, it is more likely to encounter the need for external sources of funds. Mr Auboin says: “As trade moves to countries in the region with smaller savings rates, it is likely that their local financial sector will need to complement local resources with imported trade finance, if they are to support export sectors accounting for, say, 50% of GDP.”

Making the connections 

Such details highlight the demand for international bank financing. For this to be successful, there has to be a strong correspondent banking network in place. But recently a climate of de-risking has seen international banks withdrawing from some emerging market countries, as the cost of due diligence and know your customer (KYC) compliance outweighed the relatively small financial gains. 

Sriram Muthukrishnan, group head of GTS, trade product management, at DBS Bank, reports a noticeable impact. “Regional Asian banks such as DBS are stepping in to fill the gap. There is also the opportunity for global and regional banks to grow correspondent banking services for the local banks in the market to enable transactions to flow,” he says. 

BAML’s Mr Jameson agrees that local banks often picked up a lot of the business after the international banks left. However, Bangkok Bank’s Mr Anuchitworawong has a different perspective. “Due to the tough compliance requirements, local or even regional banks are unlikely to take the place of international banks. Consequently, banks in high-risk countries, as well as banks with relatively low business volumes, are experiencing difficulty in getting service providers for their correspondent banking services,” he says.

Such previously risky markets are now starting to appeal to international banks again, as companies shift their production centres there. Jonathan Cornish, head of Asia-Pacific financial institutions at Fitch Ratings, says: “Banks have followed large corporate clients into new markets as a way to penetrate foreign markets. They also want to move down the credit curve to the SME level to support earnings growth.” 

But following clients to these new markets will require restarting the due diligence process from which many banks had decided to withdraw; time will tell if their enthusiasm continues when the cost of this process becomes apparent. 

Transaction tools 

Even when there is a banking relationship and the funds are available, what is the best way to conduct trade transactions? In open account transactions, the goods are shipped and received before payment is made. It is the most common form of transaction – up to 80% of global trade is conducted this way, according to the International Chamber of Commerce – and benefits from a trust relationship between exporter and importer. However, it is riskier for the exporter, who may not receive payment. 

One alternative is to issue documents, such as letters of credit (LCs), to provide a guarantee that funds will be sent in exchange for goods. While it reduces risk, it makes each transaction more time consuming and expensive. Mr Jameson says that as trade moves into new markets and partnerships with unknown suppliers, documentary trade might increase to manage risk, but BAML is yet to see significant uptake. 

Michael Vrontamitis, head of trade, Europe and Americas, at Standard Chartered, says it has witnessed a small uptick, although open account remains the most common way to conduct trade. “There has been some increase in demand for traditional risk-mitigating tools such as LCs, as banks start working with new clients in new markets. In some cases, discount LCs and financing facilities are being arranged to ensure companies can trade, but with reduced risk to the buyer,” he adds. 

Although there have been attempts for trade to be denominated in local currencies, the US dollar remains dominant. Mr Muthukrishnan says local currencies come with an element of uncertainty, and it is easier to conduct cross-border trade in the same currency. 

Trade hits roadblocks 

Superficially, it appears that trade is continuing as normal. However this raises concerns that there has been little change in trade finance products because of ongoing high barriers to access, which is where the real issues with Asia’s new trade flows begin to emerge. Natixis’s Ms Garcia-Herrero says: “The main cause [for rejections of trade finance] is the reluctance of banks to undertake KYC on these low-profit transactions, especially those proposed by SMEs through LCs. Specifically, most of the rejections are in the form of export LCs due to the increased difficulties of evaluating firms abroad. For instance, in China, the refusal rate of export LCs is reported to be about 30%, while that of import LCs is only about 1%.” 

Mr Auboin believes it is down to deeply ingrained issues that risk-mitigation methods are not being used. “In part this is because the transaction cycle is out of step with the financial cycle. LCs are often not ready when needed, and when ready they are not compliant,” he says. “In the end, the shortest route for local banks is sometimes to propose working capital loans with high interest rates, and only with the underlying collateral. These high costs put companies at a disadvantage with their competitors from countries with more sophisticated financial industries. Obtaining affordable trade finance is an important part of the competitiveness of firms.”

Multilateral support 

Though emerging markets are increasingly proving profitable, the risk aversion that caused the retrenchment of international banks remains, accompanied by demands for high levels of compliance. When companies cannot acquire financing, they are turning to guarantees from multilateral organisations. 

Mr Vrontamitis says banks can take an active role in helping to educate their correspondent banks and manage counterparty risk. “Across the correspondent banking network there is a range of support being offered by the multilateral institutions to help them to get up to speed with their due diligence requirements. Standard Chartered is proactive in this, offering support to customers through its Correspondent Banking Academy and working with multilaterals such as the Asian Development Bank on an SME financing programme.” 

The WTO’s Mr Auboin cautions, however, that trying to gain access to help could result in even more expensive and time-consuming work for the smallest companies. “This requires meeting high standards of compliance. Some banks are providing assistance, such as Standard Chartered, to help their customers to get their operations up to standard. But the process creates another layer of complexity for companies in obtaining financing,” he says.

Support could come from government: for example, India has been proactive in helping SMEs reduce the cost of trade. The Reserve Bank of India (RBI) introduced the interest equalisation scheme for SMEs to subsidise post- and pre-shipment export credit. In November 2018, RBI announced it would increase the subsidy from 3% to 5%. Asit Oberoi, global head, transaction banking group, at Yes Bank, adds: “As part of reducing the working capital cost of trade customers, RBI has also recently eased the norms of external commercial borrowing [loans made by overseas lenders in a foreign currency] and allowed working capital financing as a permissible end-use, although with certain conditions. This is expected to help the Indian parties get financing at cheaper rates.” 

Fundamentally, the structure of trade finance would benefit from an overhaul. Joon Kim, global head of trade finance product and portfolio management at BNY Mellon Treasury Services, says: “There is a will to change trade [finance], but it is not moving fast enough. Over the next few years there needs to be an increase in the number of correspondent banking relationships to meet the demands for financing. Having a recognised KYC registry could help with the process. It would create a set standard, and will reduce the need for multiple checks from the various banks.”  

Would digitisation help? 

The modernisation of trade finance has been a topic of discussion for several years, but has made very slow progress. For example, Swift’s Bank Payment Obligation (BPO) was launched in 2013 with much fanfare and the hope of digitising trade transactions, but met with limited success. In early 2019, trade publication GTR reported that Swift was to close its Trade Service Utility, the underlying technology behind the BPO, in December 2020. 

Mr Kim says: “There is a need to digitise the anti-money laundering and KYC process to mitigate the level of risk and make processes more efficient and cost effective. A number of organisations, such as Swift and the Bankers Association for Finance and Trade, are attempting to bring in standards for trade, but it will take considerable time for them to converge into a common standard.” 

Still, the push to digitise continues. In some cases, a standardised platform can help legitimise industry practices. Mr Muthukrishnan says: “It is common in the rubber trade for companies to place orders for rubber purchases via WhatsApp or text messages. DBS has worked with a major rubber trading company called Halcyon to create trading platform HeveaConnect to digitalise this entire flow. Having business conducted through a traceable supply chain can build in sustainability credentials and meet growing consumer demand for sustainably produced goods. A similar approach can benefit other agri-commodity ecosystems, such as cocoa and coffee.” 

The information to create such a chain is already available, but currently held in silos. Finding a way to access the data already in the ecosystem is one solution. An example is Yes Bank, which became the first bank in India to launch a digitised export and import solution with Yes Transact Smart Trade. The solution reduces processing times, making import payments based on the bill of entry details and matched against the RBI’s import data processing and monitoring system database. 

Attention has also moved towards blockchain, as the technology goes beyond its development stages. Bangkok Bank has facilitated its first distributed ledger technology transaction by sending an LC from Indonesia to Thailand using the Voltron initiative, built on R3’s Corda blockchain platform. On a regulatory level, Hong Kong has taken decisive steps forward with the development of its blockchain trade finance platform. The platform, eTradeConnect, aims to make trade more efficient and increase trust between parties with greater transparency on the transactions. 

The shape of trade could change with the increasing influence of the digital economy: the value of business conducted online across south Asia is forecast to be worth $240bn by 2025, according to a Google-Temasek study published in 2018. As business takes place, data is automatically produced and stored. DBS’s Mr Muthukrishnan believes the shift online is having an impact on trade financing. “As the focus moves towards e-commerce companies, data can be used to make decisions on loans. By consuming business data in the banking ecosystem, we can assess if these companies are credit-worthy, and identify those that have a strong propensity to conduct their business successfully, and thus re-pay debts. There are challenges, of course, as some Asian countries have rules about data being taken offshore,” he says. 

Mr Anuchitworawong adds that e-commerce is having an impact on how goods are exchanged. “Order sizes are becoming smaller and smaller, rather than the bulk trade of the past. With [the Asean e-commerce] free trade agreement in place, we are seeing more customers buying directly from the source of supply, and this is cutting out the middleman,” he says. 

Emerging asset class 

Beside the adoption of new technology, another solution to closing the trade finance gap may lie in the diversification of funding sources. The development of trade finance as an asset class is in its infancy, but is gaining appeal to investors attracted by its relative safety and assured rate of return in an otherwise low-rate environment. 

With bank financing looking unlikely to fill the gap, expanding the pool of investors to include pension funds and institutional investors makes sense. It is in this space that marketplaces, such as LiquidX, are emerging. LiquidX works with banks and institutional investors to make financing available digitally. The US-based finance supplier has taken steps into Asia as it teamed up with Singapore Customs as part of the Networked Trade Platform, which brings together the trade ecosystem in one place. 

Glenn Kocher, head of sales and client services at LiquidX, believes the inclusion of a diverse pool of funding is the essential element in ensuring the financing needs of companies of all sizes are being met. “The non-traditional lenders will be instrumental in increasing the level of available capital to the asset class, as institutional investors bring a different liquidity profile by virtue of taking a more credit market-oriented approach. Typically this translates into faster speed of deployment and more flexibility across geographies and credit qualities,” he says.

Institutional investors are more open to risk. Mr Kocher says: “Institutional investors are not deterred by emerging markets, and many have a risk exposure limit of 20% to 50% of their portfolio. Furthermore, they are not necessarily subject to some of the same increasingly costly regulatory constraints that traditional lenders face.” 

Even with the prospect of an extra source of financing, Asia remains ravenous for trade finance. Unless the flow of cash can keep pace with the relocation of industry, there is the risk of throttling Asia’s manufacturing machine.