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Financing Trade as an Alternative Asset Investment Class

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Global Trade plays a major part in our daily lives, on all levels and yet the importance of its financing, as an alternative investment is often underestimated. 

Global Trade is calculated to total around US$18 trillion annually and believed to be growing at a rate of 10% per annum. Yet financing trade is somehow overlooked. 

Research from the influential International Chamber of Commerce and similar global institutions has shown financing trade flows to be comparatively: –

  • Low-risk
  • Stable
  • Liquid
THE RISE OF NON-BANK LENDING

It is generally believed that the recent introduction of certain regulations, like Basel III, has increased the cost of capital of trade financing and supply chain lending for those traditional financiers of trade, namely banks. This has resulted in banks’ shrinking appetites and thus reduced balance sheet space for trade finance assets.

As a result, this has increased trade and supply-chain lending from non-banks such as trade finance funds and digital trade lending platforms. These structures allow for private-accredited investor groups, family offices and hedge funds to partake in benefitting from the returns of financing trade flows in all its disguises. According to an International Chamber of Commerce report from 2016 (see below table) , the default rate on trade finance instruments, such as for example, export letters of credit (LCs), can be as low as 0.04%. 

In addition, due to the short-term nature of trade financing cycles, investments into trade finance is considered relatively liquid in nature.

DEFAULT RATES
Asset Class Default Rate by Exposures (%) Expected Loss (%) Time to Recovery (Years)
Import L/C 0.08 2 0.5
Export L/C 0.04 2 0.3
Loans for Import/ Export 0.21 7 0.4
Performance Guarantees 0.19 1 0.2

 

It was reported by GTRVENTURES that TRADETEQ’s CEO Christoph Gugelmann commented in a recent Euromoney article: “At present, there is US$9 trillion bank financing in financing trade only, but only US$25 billion of that derives from institutional investors. This is compared with capital market bonds, where the institutional investors are doing about $29 trillion of investments.”

Many hold the blame on the global economic crisis commencing around 2008 as a major reason for the estimated US$1.5trn trade finance gap, as consistently estimated by both the Asian Development Bank and the International Chamber of Commerce. This shows that MSMEs in emerging markets are hindered by growth due to the lack of trade finance offered through their traditional sources, namely banks, who as commented earlier have been heavily restricted. 

However, the opportunity set for example commodity trade finance as an investment asset class, as well as the sizeable gap in trade finance, leaves an important opportunity for non-bank financiers.

Greenwich Associates produced the research publication: Trade Finance: A Promising New Asset Class, back last year, claiming the net return on commodity trade finance, an industry in excess of US$130+ billion, lies at 3.5% to 5% net returns. This premise is also supported by the Trade Register, an International Chamber of Commerce initiative which looked at typical default rates within import Letters of Credit, showing that weighted default rates were at around 0.38% on average.

Glancing closer into real companies’ experiences, monetizing illiquid assets into cash through, a programmatic and reliable way, should be an important objective for companies. Optimising the cash conversion cycle can improve companies’ financial profiles whilst also benefitting them in their operational linkages.

Companies will also benefit from identifying more reliable performing purchasing partners enabling them to grow more safely and reduce the volatility of earnings from unwelcome credit losses and failure to chase their buyers in a timely manner when payments are past due.

One important example of such a Programme for investors is currently offered by a UK FCA regulated company to SMEs, which offers an opportunity through its Programme to invest in an Invoice Factoring Service, aimed principally at SMEs, through its subsidiary based in the heart of Europe, which Programme offered to SMEs, briefly summarised, is as follows: –

AN INVOICE FACTORING PROGRAMME AIMED AT SMEs AS AN INVESTMENT OPPORTUNITY
  • Average Invoice size of companies is €UR3,200, with an average DSO of 34 days
  • Eligible Receivables are purchased on a true-sale basis from the companies
  • Each seller is individually approved by an experienced Investment Committee and is

reviewed regularly.

  • Invoices are purchased by a bankruptcy-remote compartment of the FCA regulated Company’s Luxembourg securitisation vehicle
  • Credit risk of the buyers is fully covered with insurance by a well-known A2-rated insurance company 
  • The Programme is funded by the issuance of two classes of Notes:
  • 95% Senior Notes, coupon €URIBOR + [4%], WAL [3-5] years
  • 5% Junior Notes, coupon [12%] fixed, WAL [3-5] years
  • Required total Programme funding size for 2019 is €URIBOR [70] mm 
THE PROGRMME PROVIDER’S USE OF ITS PROPRIETARY SOFTWARE TECHNOLOGY
  • Proprietary software provides SMEs with a system to efficiently manage their Invoices
  • Proprietary software assists management of risk taken on the purchased Invoices
  • Secure, cloud-based platform on a virtual private server with unlimited scalability
  • Shadow VPS in a physically different location, guarantees continuation of service in the event of an unexpected loss of data
  • Connectivity with all major ERP/accounting systems; connected to all major credit insurers and a wide variety of banks
  • Monitors and manages overdue Invoices including direct links with collection agencies and bailiffs
  • Schedules calls and actions; sends statements and reminders in buyer’s language

 

Monetizing illiquid assets into cash in a programmatic and reliable way should be an important objective for companies. Optimising the cash conversion cycle can only improve its financial profile and operational linkages. Through an efficient funding programme SMEs may also help companies identify their better performing buyers benefitting from a supplier’s credit, so that they may safely grow and reduce volatility of earnings from credit losses. By doing so, at the same time, avoid failure to follow-up with debtor buyers in a timely manner, when payments become past-due and from debtors.

Anything and everything physical supporting trade flows, from chambers of commerce, shipping firms, freight forwarders, trade brokers, customs authorities, to seaports and airports, (plus over the last 20 years, involving the further support of sophisticated hi-tech software and hardware), are all important nodes which impact upon trade transactions, as much as the financial aspects.

Besides specialist trade finance funds and trade lending platforms, corporates and marketplaces are already now involved in some form of trade lending activity. Examples of this are the mighty Amazon and Alibaba, that now extend financing to their merchants.  Whilst Maersk, as a shipping line, has opened a separate unit to provide trade finance to its customers. More effective collection of suppliers’ credits has become an important part of oiling the wheels of international trade.

Additionally, credit insurance is a regularly used mitigant by trade financiers to protect them against buyers’ insolvency risks, so trade credit insurers play a vital role in unlocking greater liquidity for trade, especially for small and medium enterprises (SMEs). Other types of insurance in the international trade world include political risk insurance, cargo, shipping and marine insurance, currency insurance and product liability insurance, all protecting users.

Because cash too often gets trapped in corporate balance sheets, improving working capital efficiency and governance will lead to less bankruptcies. Other types of insurance in the international trade world include political risk insurance, cargo, shipping and marine insurance, currency insurance and product liability insurance and insurers also need to be creative in offering solutions and processes that enhance their risk management models.

Optimising the efficiency of procedures today for Invoice collection in order to improve      operating and financial performance, is a must for SME’s, as overly slow repayment from customers delayed follow-up of past-due Invoices is often blamed by companies, (as lobbied by the Federation of Small Businesses to the UK government for tighter regulations), to be one of the major reasons for SMEs bankruptcy. Therefore, ensuring adequate Invoices are being generated for growth using an efficient collection service, whilst avoiding unnecessary capital investment in receivables, is seen as a key to value creation.

Faced with the evolving needs of and changes in global trade practices, shipping lines, freight forwarders, exporters, insurers are improving their game in terms of 1) offering more sophisticated trade services, 2) investing in innovation and product development, and 3) improving their interaction with customers.

Notably, with the trade finance market seeing a constant stream of new entrants, from invoice financing platforms to blockchain-based technology consortia, the emergence of hi-tech solutions in this digital-age coupled with artificial intelligence can bring various trade elements together. Therefore, various start-ups now have the chance to “pitch” their business models, strategies and activities to interested financiers acting as a panel of expert judges. Strong emphasis will always be placed on innovation, efficiency and providing greater access to finance particularly for the benefit of the underserved SME market. 

Cash too often gets trapped unnecessarily on corporate balance sheets, so improving working capital efficiency and governance should only lead to improved operating and financial performance for SMEs, thus creating more creditworthy clients. A win, win situation for all!

In summary, financing trade flows and by doing so, adopting and providing enhanced technological services, thus improving SMEs balance sheets, is undoubtedly a respectable alternative asset class for investors to consider when searching for portfolio optimisation and low volatility returns, akin to investment grade bonds.

Should the reader wish to learn more about current trade finance investment opportunities and to understand their applicability to SMEs more fully by receiving a Teaser, then please contact CFS Management Ltd on 020-7323-0207 – Paul Mills, or make email contact at: – paul@cfsm.co.uk

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