VIDEO | Has asset management embraced trade finance and what more is left to be done?

With thousands of years of history, trade is one of the oldest banking products in the world, but it has not developed much over its long tenure.

As a result, outside investors still shy away from allocating capital to the space despite its short-term and self-liquidating nature.

With the help of digital advancements and fresh perspectives, many in the space seek to change the perception that investors have of trade and make it appear like the investable asset class that it truly is.

To learn more about the role that credit rating agencies can play in this shift, Trade Finance Global (TFG) spoke with Jason Barrass, chief commercial officer at ARC Ratings.

Making trade finance attractive to outside investors

Credit rating agencies play an essential role in the industry by translating the risk of a trade finance transaction into a language that an outside investor can understand. 

“An investor, let’s say a German pension fund, wouldn’t know some of the terminologies,” Jason Barrass said.

“But they do understand when we look at the risk and say it’s an investment grade––it’s triple-B or single-A. 

“They can then reference that back to their other structured finance investments and know what the risk is compared to the other asset classes.”

In addition to these ratings, trade finance practitioners need to be willing to look outside of the comfortable industry status quo and begin to embrace the broader structured finance techniques and products.

“This will start to open up a huge amount of investor base into this wonderful asset class,” Barrass said.

“Using greater structuring skills or ways of originating, taking away paper, and removing some of the risks, we can help outside investors understand how the market works.

“If you can start to do that, then suddenly you’ve got an American investor or an Asian investor who understands the risk and the return and buys the assets. 

“This then allows the banks to re-lend and originate more and accelerate cash movement, which we know is a driver of gross domestic product (GDP).”

Rising interest rates and declining returns in global equities markets make trade finance, which traditionally has a robust risk-return profile, appear more suitable as an investment.

Trade finance is also unique because the underlying asset is a tangible transaction between a buyer and a seller, where the buyer is usually offered a discount for early payment.

Even a tiny 1-2% early payment discount annualised over a year creates a significant margin for investors.

Often, however, investors that don’t fully understand the market are wary that this return is too good to be true given the risk profile.

“Sometimes investors are a little bit suspicious with a triple-B paper yielding way above what the normal bond is yielding,” Barrass said.

The investment decision becomes much more straightforward for investors that understand how this arbitrage works and why they can get these higher returns with less underlying risk.

Barrass added, “This is part of the education process that we all have to go through with fund managers, with ultimate investors, so they’ll be more open to taking those assets.”

The future of trade finance as an asset class

When discussing the future of trade finance as an asset class, it is necessary to remember that trade is just one of the assets in the structured finance world.

Barrass said, “There’s a private credit market which has a subclass of trade which is over $1 trillion in the US alone.

“What we need to do is start to get more of these assets structured and correctly digitised, we need more players to come through who basically are removing some of the historical risks, and we need greater education also amongst credit rating agencies.”

By taking these action steps, the industry will become more apparent to outside investors, who will be better incentivised to enter the market and help fund more traders.