The commoditisation of trade receivables in a digital era

We are living in an increasingly uncertain world where companies and financial institutions face new challenges which add complexity to how they manage liquidity, counterparty risk, capital efficiency and returns on investments. Addressing these challenges through incentivising collaboration, accelerating the development of innovative solutions, encouraging the improvement of existing mechanisms available in the market, or simply providing a different perspective on new needs can lead to further opportunities for market players.

Trade finance is one area of finance that is evolving quickly in this environment. The industry is going through a digitalisation journey and is attracting global interest and investment. This is due to the attractive risk profile and the self-liquidating nature of trade finance assets, the support these instruments provide to the real economy and their resilience during turbulent times. The use of sophisticated structures is also adding to the resilience of the industry and allowing financers to support more complex types of risk.

Addressing the trade finance gap

We must acknowledge that the difference between the demand for trade finance and those who are able to access it has led to the trade finance gap reaching a high of US$1.7tn in 2020 according to the Asian Development Bank (ADB).1 The gap widened during the pandemic due to economic uncertainties and supply chain challenges, particularly impacting small and medium-sized enterprises. In order to close this gap, sophisticated solutions are required to provide comfort for investors to deploy capital to those who are often unable to access their required financing. This would include well-structured transactions with the use of credit insurance to provide sufficient risk mitigation.

Within the trade finance industry, one solution for the financing gap that is being used more often as an alternative to traditional structures of open account programmes is the securitisation of trade receivables. While this may not be a new concept, it has been evolving rapidly, supported by new technology, distribution channels and credit insurance providers. This has led to investors, who were typically more familiar with capital markets transactions, entering the trade finance space. The emergence of these new players is supporting a more open industry. At the same time, the structured solutions currently used in trade finance are helping traditional lenders to manage capital and risk more efficiently while supporting the growth of the programme they have offered to their clients.

In a typical trade receivable securitisation structure, the seller sells to its customer (the ‘buyers’) on credit, which creates a working capital requirement for the seller. This can be financed through the sale of the receivables, created between seller and buyers, to a special purpose vehicle (SPV) on a revolving basis, for a set period (subject to early termination on the occurrence of certain triggers). The SPV is financed by issuing notes or borrowing loans from bank or non-bank funders who are repaid by the SPV utilising the proceeds from the buyers’ payments. Receivable securitisation transactions are often set up with a medium or long-term view (for example, three to five years), with the possibility for periodic extension(s). This enables the seller to have access to a stable and committed source of capital and amortise the setup costs of the transaction over several years.

Other trade finance structures are simpler and do not use an SPV. For example, the seller may sell its receivables directly to a bank or non-bank funder or borrow a loan from the funder, secured by the receivables portfolio.

The credit quality of these transactions can be enhanced by offering credit insurance to the SPV covering the non-payment and insolvency risk of the buyers, subject to certain pre-set eligibility criteria being met in respect of the receivables and the buyers. Credit insurance can support the transaction in obtaining a credit rating from an international rating agency. This would potentially allow larger concentrations on certain buyers compared to uninsured options, and gain access to the asset-backed securities market by appealing to investors who may not have the expertise or the mandate to invest in traditional trade finance products. In addition, the insurance policy wording can be Basel III/ CRR-friendly, which could translate to a better return on capital for the participant banks and more competitive funding terms and cost savings for the seller compared with either unsecured or secured but uninsured financing.  

The role of technology

Data assessment is essential, and technology plays an important role in these transactions, facilitating real-time receivables performance reporting to all interested parties. This leads to more informed decisions and verifies that the receivables offered for purchase comply with the agreed eligibility criteria. Ultimately, it provides more certainty to all parties involved in the transaction.

Distribution of trade finance assets has evolved over the years. Nowadays, tech platforms are expected to play a key role in the commoditisation of receivable securitisation transactions, not only through the distribution of assets, but also by streamlining the end-to-end process among all parties in a digital environment.

Pulling together all the elements of the structure and technology can create a more attractive investment and opportunity for investors to diversify into a new asset class of trade receivables, but within a structure they understand.

The transformation of the trade finance industry is in its infancy with exciting times ahead, supported by new participants joining with fresh ideas. This will help drive the modernisation and technification of the industry, contributing to the reduction of the trade finance gap.

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Reference

1. https://www.adb.org/news/global-trade-finance-gap-widened-17-trillion-2020

This article first appeared in GTR’s Supply Chain Finance issue, August 2022.

For more information about the wider team and AIG’s capabilities in this area please contact Meera Saunders, Head of Strategy and Operations, Trade Finance at meera.saunders@aig.com