Trade Finance Environment
The global trade finance market is represented by two key sectors traditional (banking) and alternative (non-banking) trade finance. Additionally, satellite markets of suppliers, developers and vendors also exist, providing innovative technological solutions and software to support the evolution of trade finance. These are markets such as the DLT- and blockchain-based digital asset market and the DeFi solutions sector, which includes the widely popular crypto lending market. This list also includes trade finance software providers, i.e., the TradeTech sector, which is part of the global FinTech industry, and various supply chain finance solutions. In summary, the constellation of major and satellite technology markets and sectors can be represented as follows:
Traditional Trade Finance
Traditional or documentary trade has been practised for many centuries. It involves banks acting as intermediaries to facilitate the exchange of payments for shipping documents. It is recognised as transaction/ shipment-based finance with risk mitigation and a fee that underlies transactions between buyers and sellers.
The traditional trade finance system works in a series of pair-based relationships: consigner/consignee, consigner/issuing bank, issuing bank/advising (confirming) bank, and advising (confirming) bank/exporter. Information (including documents) and money are exchanged for each relationship. The International Chamber of Commerce (ICC) highlighted regulatory issues as one of the top concerns among its respondents, comprising 251 banks in 91 countries. The Basel III Accords developed as a response to the 2008 financial crisis have heightened banking regulation, especially concerning capital requirements. On top of regulatory pressure, banks are also facing competition over pricing in traditional trade financing contracts, prompting them to abandon deals that may be unprofitable and reign in exposure to this space.
Traditional Trade Finance Pain Points
The primary funding source is the traditional banking system. A 2020 International Chamber of Commerce (ICC) report says that banks reject more than 45% of SME applications for trade finance annually. Moreover, SMEs find acquiring private loans from the grey market dicey as high interest rates (18-30%) mean paper-thin profit margins, if not downright losses. Many SMEs avoid even seeking trade finance, given the time-consuming nature of the application process and high rejection rates. Application processes also require high levels of disclosure and documentary proof, especially in international trade. Additionally, conventional trade finance entails the risk of fraud, errors, and other setbacks due to paper-based workflows. Given the rapid pace of global commerce, it is no surprise that the traditional trade finance sector has been shrinking in recent years. And yet, in some cases, a bank loan is not a solution, and traditional banks have several downsides compared to alternative lenders.
Alternative Trade Finance Solutions
Alternative lending is a growing industry nowadays. "Alternative" means any money loan offered outside traditional banking institutions. An alternative digital ecosystem includes new organisations that provide new services, new products, new forms of risk and performance analytics, new job functions, and ultimately a new set of terms and language that are integral to it. The response to this developing ecosystem is very polarised, not helped by the technical and fast-moving nature of the underpinning technologies. However, dedicated trade finance strategies are increasing acceptance among institutional private credit investors. The rise of alternative asset managers such as hedge funds, private equity funds, real estate funds, pensions funds, and insurance companies are also increasingly acknowledged as a significant driver behind global economic growth.
Private credit and alternative lending marketplaces can provide borrowers with the tailored and flexible finance solutions they need to thrive and innovate. For these reasons, alternative lending based on innovative technologies is expected to become a more substantial part of the trade finance market.
Nearly half of the corporates surveyed recently chose to access private credit supplied by alternative asset managers because they could not access bank financing.
Faster execution times, bespoke financing, and strong relationships were respondents' most popular benefits of private credit. On the other hand, higher fees were the main reason for corporates who reported no current involvement with alternative asset managers or private credit. Thus, while the market will broadly remain price-sensitive, borrowers may increasingly consider non-price factors such as speed and flexibility as alternative asset manager involvement in trade finance grows.
Alternative Trade Financing Benefits
Alternative trade financing offers advantages for businesses in many cases. The inability to gain bank funding (48%) was the main reason corporates chose to access private credit. However, other reasons for accessing it were primarily due to private credit’s benefits rather than the banking sector's limitations, such as fast execution times (48%), bespoke financing (43%), and strong relationships (38%). Traders note the speed of decision-making (71%), flexibility (57%), and the ability to carry out complex deal structures as additional benefits of the private credit market. Furthermore, alternative finance providers that step in with products and services tailored to trade are often smaller and more agile than traditional banks, which allows them more rapidly process funding requests and approve transactions.
The use of alternative finance mechanisms is expected to increase liquidity for the trade finance system as an expansion of the secondary market. 83% of UK, US, and Chinese firms are considering switching to alternative finance providers over traditional banks for trade finance.
Alternative trade finance providers usually have a digital architecture of common standards and best practices to make trade finance more inclusive and collaborative. At its root, market digitalisation is powered by technology capabilities that can complement and disrupt established market frameworks and business models by forming a digital ecosystem and a new set of operating rails. The development of this new set of financial rails has myriad implications across financial markets. The disruption to established intermediaries will be driven by several variables, including technology capabilities, scalability, and the pace of adoption by market participants.
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