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Trade finance, one of the oldest forms of institutionalised credit, has recently expanded its horizons, inviting a broader spectrum of investors. 

The emergence of trade finance as a noteworthy asset class has sparked widespread interest, prompting banks to reconsider their distribution approaches in response to the consistently evolving capital barriers. 

Recognising these challenges, Trade Finance Global has introduced TFG Distribution Finance, dedicated to constructing robust asset portfolios for both existing and prospective funders. 

Leveraging its profound knowledge of the trade finance industry, TFG Distribution Finance employs a distinctive matching system that matches borrower needs with available capital in an innovative manner. 

In this episode, Mark Abrams, Global Head of Trade Receivables Finance at Trade Finance Global was joined by Salman Khan Galindo, Portfolio Manager – Alternative Investments at Santander AM and Matt Taylor, Head of Alternative Debt at Legal and General Investment Management (LGM). Together, they shed light on the allure of trade finance for investors, the evolving investor landscape, and the pivotal factors influencing the risk-reward paradigm within this asset class.

Trade Finance Investments: A unique proposition

Trade finance is garnering considerable attention as an asset class for various compelling reasons. Khan underscored its unique appeal, explaining, “The asset class gathers a set of conditions that has for long been sought by investors in the market, with added differentiators from traditional fixed income in the form of short duration, little to no correlation, and diversification amongst others.”

These singular features set it apart, making trade finance an increasingly attractive option for investors.

Further differentiating itself from other asset classes, trade finance stands out in terms of risk, duration and returns.

As Khan remarked, “In terms of risk, working capital lines are arguably senior to any other debt in a company’s structure in the context of priority of payments. Bottom line is that working capital is their day-to-day operations which if ceased to be paid lead to the subsequent collapse of the rest of the capital structure”. 

Additionally, from a duration standpoint, he noted, ” In terms of duration, companies working capital are typically below 90 days, depending on the company size and working capital cycle. But this provides a lot of turnover of the portfolio, reducing duration risk.’’ Beyond this, the returns in trade finance exhibit a broad spectrum, offering diverse risk profiles tailored to meet various investor preferences. 

“Trade finance returns can be very broad, ranging from working capital facilities for blue chips between 20 basis points all the way to smaller SMEs north of 15% per annum, depending on counterparty and structured risk. So you’ve got a full array of risk profiles to suit the needs of each,” he added.

From his side, Taylor also emphasised the inclusive nature of investments in the trade finance industry, noting, “This space offers something for everyone. Investment grade-only funds can target very high investment grades, deep sub-investment grades and everything in between.”

“There’s the simple, where there’s a clear risk to a single buyer, giving senior unsecured exposure to just one credit. Then there’s the complex, which might involve a trade receivable securitisation, taking the risk on a diversified pool of buyers, or providing junior capital to a bank loan book.” 

At LGM, Taylor explained, “We focus essentially on the investment grade space, covering the spectrum from simple to complex, to best suit individual client risk-return requirements. We also ensure we’re comfortable with the underlying credit risk. While credit insurance is sometimes used in transactions, it’s considered a nice-to-have rather than a must-have.”

Furthermore, Taylor highlighted how investments in the trade finance industry have evolved from a bank-centric approach to a more diversified investor base, reflecting a growing recognition of the opportunities it presents. As he stated, “Historically, this sector was dominated by banks, and they still hold a prominent position. 

However, institutional investors, insurers, pension funds, and other asset managers are increasingly active in this space, whether directly or through bank distribution.” This signifies a noteworthy shift towards a more inclusive and dynamic trade finance market, where a variety of financial institutions and investors are engaged.

Tackling barriers and enhancing accessibility

Addressing the hurdles that impede wider participation in trade finance assets, Taylor identified three key barriers.

First, he pointed out the lack of awareness and education when it comes to trade finance as an asset. “I think the first is awareness and education for what is a very broad church of opportunities. Under the trade finance banner, there’s little standardisation. So in a sense, what we call trade finance actually covers a multitude of products,” he said.

Secondly, Taylor elucidated the intricacies of assessing the credit risk of trade finance assets. Unlike some other asset classes, trade finance products are often unrated. Factors such as seller risk and the potential need for a securitisation approach can further complicate matters.

Such complexities underscore the importance of having a well-equipped internal credit team. “Ultimately, those without an internal credit team would struggle to play unless they could do it via another asset manager,” he noted.

Lastly, he referenced the operational intensity that is distinctive to trade finance investments. “Many private credit investors are set up to manage one to two investments per month,” he noted. “But given the short-dated nature of this asset, it can be two or more a week.”

In this context, he advocated for the adoption of a programmatic approach, suggesting collaboration with banks or other entities to establish longer-term notes for investors, potentially mitigating some of the operational challenges.

Supporting the notion that education is crucial in overcoming these barriers, Khan stated, “Events such as investor days are indeed very helpful, getting investors to familiarise themselves with general concepts and slowly getting to grips with this new asset class.”

Furthermore, he stressed the significance of standardisation for the advancement of this asset class. “For investors to feel comfortable with this asset class, standardisation is key. Investors need to be able to assess who are the main market participants and analyse investment opportunities on a like-for-like basis,” he said.

According to him, the implementation of standardised practices in asset purchase could lead to substantial advantages for asset managers, adding, “different originators provide assets in different formats and there seems to be a lack of a norm. I think standardisation in the way we as asset managers purchase assets would benefit the asset class as a whole.”