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Trade finance: new opportunity for MENA

Rules for the new payment instrument BPO will be decided this month in Paris

Rules for the new payment instrument BPO will be decided this month in Paris

Gulf banks are well placed to step into the trade financing gap left by the retreat of some major international names. PAUL MELLY explains

Trade finance – historically low risk and often secured against goods of proven market value, a useful source of fees in sluggish times and a chance to gain from growth as soon as activity does pick up.

You might think that in current circumstances, this would be a priority business at most banks – and that exporters and import houses should benefit as a result.

But, in fact, trade finance has been under pressure, squeezed of funds despite its apparent attractions.

If anything, this is a tribute to its merits. With the value of trade payment paper easily realised on the secondary market, and mostly short term in nature, trade finance has become a target for cutback, as banks concentrate resources on strengthening their reserves, to meet the tough new requirements of the incoming Basel III regulatory regime.

Nowhere is this trend more obvious than in Europe, where the financial crisis has left banks under heavy pressure to rebuild their strength. And that has implications for trade in other international regions, such as the Gulf, because the European banks have traditionally been global leaders in trade financing.

So exporters and importers have had to look elsewhere for funding.

Kamel Alzarka, chairman of alternative trade financier Falcon Group, points to World Trade Organisation figures estimating that, even now, global trade stands at a record $16.5 trillion – business that has to be financed somehow.

The opening gap

Fortunately, the Middle East is relatively well equipped to cope with this new challenge.

Gulf banks are well placed to step into the trade financing gap left by the retreat of some international players, while Middle East capital markets have seen the emergence of investment funds specifically dedicated to the portfolio funding of trade finance structures.

Islamic banking and investment, an increasingly important factor in the region, is ideally suited to the funding of trade, because Sharia rules emphasise the need to link financing activity to real goods and services and commercial risk.

Meanwhile, alternative trade financiers are positioned to play a major role, too.

Dubai-based Falcon is among the most prominent. Alzarka told Cash&Trade that the volume of trade it finances has risen from $600-700m per annum about six years ago to $1.1bn in 2011 and $1.7bn last year; he hopes to reach the $5bn mark in 2015.

And Falcon’s profits have been rising, too, from $27m in 2011 to some $44m last year.

The company has particularly benefitted from bank cutbacks. For example, it now provides finance to companies in southern Europe that are strong in themselves but have seen their funding squeezed by the retreat of northern European banks that used to be much more active in the region.

Portfolio investors

Meanwhile, in Middle Eastern capital markets there are a number of funds established specifically to enable investors to put money into trade financing on a portfolio basis, just as they invest in shares or other assets.

Such funds are often Islamic. That is in part a reflection of the growing Arabian consumer and investor demand for Sharia compliant savings and investment opportunities.

But it also reflects the nature of Islamic finance, whose rules require that the provider of the funds view the exercise as a form of participation in the business risk, rather than advancing money in return for an interest rate as a conventional bank would do.

In particular, the murabaha, one of the main forms of Islamic finance contract, is well suited to funding trade, because it usually runs for less than a year, and thus fits well with standard 180-day/360-day trade payment terms.

Saudi Arabia is a significant centre for funds investing in trade finance

For example, SAIB BNP Paribas Asset Management runs the Alistithmar Capital trade finance fund, which invests in Sharia compliant trade deals. Samba Capital has three international trade finance funds, denominated in euros, US dollars and Saudi riyals.

Funds such as this play a valuable role as sources of portfolio investment for the trade finance market as a whole, particularly financing trade in commodities – where the underlying risk is to some extent offset by the fact that the goods have a tradable value in the open international market.

Managing the risk

By contrast, an operator such as Falcon is financing individual trade deals, in a wide range of manufactures and semi-finished goods, and offering a full range of facilities, from pre-shipment to post-shipment finance.

Alzarka explains how his company analyses each deal, looking at the companies concerned and, where necessary, treating the goods as security. But he points out that, unlike commodities, they are not always of a kind whose value can be hedged in the market, so Falcon uses a range of tools to manage risk.

“We use letters of credit, security over the goods. We use everything,” says Alzarka.

He emphasises that Falcon takes all deals on to its own balance sheet. It supports its activity from a range of funding sources, including its own equity, and the lines it has arranged with a number of banks and funding from institutional investors.

“We are looking to go direct to the capital markets with a bond issue, preferably this year. We are looking at a first issue of $200m,” says Alzarka.

One individual bank has already offered Falcon a facility of that size. But, whether or not he takes up that offer, Alzarka would like to broaden funding sources by using the capital market: that would allow Falcon to raise money on a long-term basis.

This would be particularly attractive for a business whose trade finance lending activities are on a relatively short term, revolving basis, of a maximum 360 days and, says Alzarka, an average 120-150 days.

“We are lending short and borrowing long,” he says. At a time of uncertainty in global financial markets, Falcon feels this is the safest position to be in.

Islamic finance potential

Islamic banks in the Gulf are also well positioned to fill the trade finance gap, because most are already subject to tougher capital requirements than those currently imposed on conventional counterparts. So they will have “less far to travel” than conventional banks to reach the new Basel III reserve requirements – and this leaves them with more available financial capacity to continue funding trade.

Some are already well established. Abu Dhabi Islamic Bank, for example, has a substantial team of trade financiers handling export, import and domestic transactions in the UAE, Egypt and Iraq.

But some Islamic institutions are short of specialist trade finance specialist staff or wary of taking on substantial volumes of trade risk.

New payment option

Meanwhile, despite the squeeze on capacity, conventional banks remain a significant force in trade finance, particularly in catering for their large core clients.

An interesting measure of the extent to which they remain committed to this area of business will be the speed of their take up of a new payment instrument, the Bank Payment Obligation (BPO).

This has been devised to suit today’s paperless electronic financial system.

The BPO is an irrevocable conditional undertaking to pay, given from one bank to another. It aims to meet the need for an electronic tool through which trading counter-parties can secure and finance open-account trade transactions via their banking partners.

The Swift interbank payment system and the banking commission of the International Chamber of Commerce (ICC) agreed to develop a clear set of rules for the BPO and these will be formally launched on 17 May in Paris.

These rules – the URBPO (Uniform Rules for Bank Payment Obligation) – can be understood as an electronic letter of credit. They will form the basis for the future widespread international use of the BPO on a uniform basis.

The new payment instrument should provide greater visibility and speed and the hope is that these attractions will persuade some banks to remain fully active in trade finance, despite the cost and capacity constraints that they face under Basel III.

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