NOT A BANK, NOT A FINTECH: THE RISE AND RISE OF ALTERNATIVE FINANCE by Shannon Manders, ITFA Consultant



At ITFA’s annual conference in Budapest in September, Lorna Pillow, the association’s deputy chair, led a panel discussion on the recent upsurge of alternative financiers in the trade finance space.

Alternative trade financiers across the globe vary in structure, size and sector coverage, each with different USPs, including technological enhancement, asset management capability, structuring ability, and so on. ITFA’s panel brought together representatives from six diverse players: Pillow, from London Forfaiting Company, was joined by Ian Henderson from Gulf International Bank (GIB) UK; Christian Karam from Africa Trade Finance; Adrian Katz from Finacity; Cem Erseven from Cofco International; and HSBC’s Eric de Vienne, who heads up investor finance, portfolio management and distribution for the bank in Europe.

It’s no secret that trade finance has traditionally been reliant on slow, paper-based and sometimes complex structures. But with digitalisation efforts starting to make processes more efficient, and with the non-bank community in search of additional yield, what will be the future of fund managers, intermediaries, working capital optimisers, and other specialist product providers in this space? These are some of the takeaways from the panel’s on-stage discussion, supplemented by off-stage conversations.

Trade finance has become a compelling asset class for institutional investors

With all its many structures and products, trade finance has historically been somewhat of an enigma to institutional investors, who have struggled to position the sector in their investment matrix and to see beyond its high barriers to entry. “Trade assets are usually related to countries rated below investment grade, so investors expect higher returns than what trade finance can offer,” says Christian Karam, at Africa Trade Finance. “This, combined with the compliance risk, and sometimes the operational risk, has made the barriers to entry time-consuming and costly.”

However, new market players, structures and technology are paving the way for easier access to this asset class. “This type of asset is scalable, has short tenors, is self-liquidating, has a proven strong track record with low default rates, and offers steady income returns,” says Karam, who believes that that those investors who begin enjoying the dynamics of trade finance are likely to stick around, and increase their exposure.

As an asset management firm, GIB UK is focused on packaging trade finance and facilitating investor access to what Ian Henderson calls a “very bespoke and idiosyncratic world of paper-driven processes” – one which investors are simply not used to.

“At GIB we’re used to passive equities, fixed incomes, emerging market debt – these are all market rated products and benchmarked. Trade finance is quite the opposite,” he says. Nevertheless, he believes there is a “compelling argument to getting to this asset class”, particularly in the current environment. “When we see the movement in interest rates, trade finance responds on a positive basis.”

According to Eric de Vienne at HSBC, investors in the space are very particular in what they look for from a yield and format perspective. HSBC set up a dedicated distribution desk for trade assets in Europe three years ago, and today distributes close to 20% of what it closes to non-bank investors.

The idea of “partnership” is essential to managing investor relations, he says. “What we offer in HSBC is a partnership with regards to how you select the assets on a transactional basis, how we operate these assets, and how investors have access to these assets, for example on a risk participation format.”

This partnership approach includes spending time with investors to identify and explain the different types of trade finance products and how they work; the fact that minor payment delays may happen – and are not tantamount to default; and what actions the bank takes throughout the process.

Alternative financiers don’t skip complex KYC procedures

The idea that alternative financiers may not be subject to the same KYC/AML processes that banks face formed a central part of the on-stage conversation at the ITFA conference. But the panellists were keen to set the record straight.

“Funds are no different to any financial institutions when it comes to KYC compliance,” says Karam. He explains that although a fund itself may be incorporated in a tax advantage jurisdiction, its fund managers are often based and regulated in countries like the UK, France and Switzerland. As such, onboarding to fund a counterpart is as time-consuming and as challenging as it is for any bank.

“As a matter of fact, our fund incorporated in Luxembourg is co-managed by two institutions: one in the UK regulated by the FCA and another one in France regulated by the AMF. As for compliance matters, each entity is independent and applies its policies as per its regulatory requirements,” Karam says.

What’s more, institutional investors have stringent demands when it comes to investing, making it essential for fund managers to be able to demonstrate their capabilities in compliance processes. “We have institutional money coming into this space, and more often than not you’re going to have an administrator in the middle, between that money and it being deployed into the underlying obligors, and they will expect first-class KYC AML procedures,” says Henderson. “We still have to undergo full KYC, AML, credit assessment, and so on. It doesn’t stop at our counterparties doing that work – as a regulated asset manager, we do that work within our portfolios as well.

The fact is that even though compliance costs keep spiralling, the penalties are simply too onerous to ignore. “Specialist financiers know that they are not exempt if their assessment is incorrect,” says Pillow. “London Forfaiting is ultimately owned by a banking group [KIPCO] and although LFC is not a bank, we still have to follow the same compliance, AML regulation and procedures as the banks. Having offices operating through multiple jurisdictions does not make the job any easier, especially in an ever-changing regulatory environment,” she says. “The challenge for specialist financiers is that they need compliance teams who are agile in understanding, analysing and forming a risk-based decision when monitoring specific deals which are not mainstream.”

There is room for all players to participate, and fintech is easing the process

The rise of non-bank financial institutions investing in trade finance is “inevitable”, says Pillow, who believes that the increase in players in this space will allow the asset class to grow exponentially, and ultimately lead to the narrowing of the existing trade finance gap.

It is the non-bank community’s search for additional yield that is propelling players to the trade landscape, which in turn is driving competition. As Henderson explains, funds are offering returns of 6-8% in dollar terms net fees and expenses, whereas traditional trade finance banks “can only dream” of those kinds of rates.

“It’s quite exciting,” says Adrian Katz at Finacity. “For about a decade we had artificially low interest rates that have meant that the banks have had the best bid, and it’s been almost lopsided competition. But now we’re seeing much more interest from the non-bank community coming in. I think we’ll have more liquidity over time.”

In Katz’s opinion, the market is experiencing a supply and demand imbalance, an anomaly given the existing trade finance gap. “There’s far more money sloshing around than assets,” he says. “There are investors looking for assets that have a decent return, and our space offers that, but the typical CFO or treasurer is saying ‘I have all the money I need, without structure, at good rates’. We need to see things normalise with the markets.”

Meanwhile, financial technology companies are doing their bit to streamline the access process. “With regulatory and compliance costs eroding profits; increased digitalisation, distributed ledger technology and artificial intelligence will be the answer to greater efficiency,” says Pillow.

According to Henderson, the key areas that fintechs are addressing today are around compliance and risk assessment, and generating a reliable credit rating for these assets for investors.

The next major challenge to tackle is settlement, he says. “We still have a long way to go in making settlement an easy and accessible process rather than using your traditional correspondent banking networks.”