As
recently as two years ago, the future of Structured Trade Finance (STF) was
increasingly becoming doubtful. Supply Chain Finance (SCF) had virtually
consolidated its dominance and threatened to throw STF into obscurity. The
reason for this was not farfetched. Africa, which represented the major
playground of STF practitioners, had from 2000 maintained steady economic
progress, making it difficult from a country risk point of view to justify the
fixation on STF as the instrument of choice for financing African trade.
The
origins of STF, date back to the late 1980s and early 1990s when Africa
descended precipitously from a continent of promise to one with an uncertain
future. The global debt crisis of that period, although of Latin America
origin, reverberated in Africa with disastrous consequences, including the dry
up of international trade finance flows into the continent. The debt crisis
triggered a commodity price shock which made it difficult for many developing
economies, including African economies, to meet their trade debt obligations.
The concept of country risk took centre stage and regulators in major money centres
introduced stringent restrictions to taking developing country payment risks.
It was no wonder that the usual Letter of Credit lines to most of those
countries quickly disappeared. For instance, the African Development Bank
(AfDB)[1]
estimated that the cost of trade finance to African traders in the late 1980s
averaged 15% of the value of imports compared to an international average of
1.5% to 2.0%. This amounted, in value terms, to US$10 billion in 1986 – a
figure equivalent to 3% of Africa’s nominal GDP in that year. African traders
also paid a margin on export finance of about 3 percentage points above the
LIBOR – a pricing far higher than an average of about 1% in other regions at
that time. This is despite the fact that such financings were usually fully
secured, most times cash-collateralized and very short term.
In
the midst of all of these, in the 1980s and early 1990s some international
trading companies survived and continued to trade. However, banks supporting
them took a more hands-on approach to evaluation of the risks and monitoring of
such loans. Commodity producers and importers began to be included in the risk
assessments as banks were no longer comfortable in giving a free hand to
traders they financed to manage those relations.
STF
emerged from the ashes of that debacle and as I have argued in my recent book
titled “Foundation of Structured Trade Finance” published in 2015 by
the Ark Group/Trade Finance Review (TFR), imaginative bankers in Bankers’ Trust
Company, in the early 1990s used the principle of separability and
transferability of trade finance risks to return to African trade finance. To
finance the imports of crucial petroleum products to Tanzania, at that time,
they transferred the payment risks away from Tanzania to highly rated Organization
for Economic Cooperation and Development (OECD) Economies by taking as security
the assignment of cotton sales proceeds due to the Tanzanian authorities. Thus
STF flourished, hinged on retaining export performance risks on developing
economies with credible performance track record and transferring the payment
risk to an OECD country. Figure 1
presents a sketch of the transaction design used by banks for pre-export
financings at that time usually with the exporter being a government owned
commodity board. The design of the transaction provided for a structure that
transferred payment obligations to OECD countries thus mitigating the risk of
rescheduling inherent in unsecured loans to many developing economies at that
time.
It is obvious from Figure 1 that the assessment of
the ability of the exporter being financed to deliver on the terms of the export
contract was key to the transaction. The Lenders were usually sufficiently convinced
that the commodity boards, being monopsonist buyers of traditional export
commodities, would deliver the commodities at approximately the right time, the
right quantities with acceptable quality and to the right place.
Soon after the path-breaking Tanzanian deal others
quickly followed, notably Ghana (Ghana Cocobod), Senegal (Sonacos), Zambia
(Zambia Consolidated Coper Mines, ZCCM), Zimbabwe (Gold-backed Reserve Bank of Zimbabwe),
etcetera.
For as long as the
macroeconomic environment remained difficult, STF remained the instrument of
choice for trade financing in Africa and many other developing economies.
By
2000, Africa had begun to experience a rebound. In particular, growth rate
of real GDP, which averaged about 2% during the previous two decades (1980 to
1999), averaged over 5% (Figure 2) during the 2000s buoyed by a decade long
commodity boom, as well as macroeconomic and political reforms. With these
positive economic developments, STF began to lose its sparkle in Africa. As
many African economies obtained credit ratings, and began to have access to
international bond markets, a major plank for justifying STF, that is high
perceived African country payment risk, began to weaken. In addition, the
global economic crisis that hit in 2008 also put huge question marks on the
myth of the ironclad credit quality of OECD economies. More specifically, the
blistering rate of growth of the BRIC (Brazil, Russia, India and China) in the
2000s unleashed a commodity boom which in turn aided the sharp recovery of many
commodity dependent developing economies, including those in Latin America and
Africa. The consequence was a surge in the growth of Africa’s merchandise trade
and improvements in current account positions (Figure 3).
Other factors at play included improved credit worthiness of many developing countries, especially those of Africa as a result of international efforts that led to debt cancellations/debt forgiveness in some countries, improvements in investment climate and regulatory framework, political reforms, better macroeconomic fundamentals and debt sustainability, and discovery of natural resources and development of new mines and oil fields, in many hither-to resource poor economies. Net capital flows (private and official) to Africa grew at an average annual rate of approximately 45% from US$8 billion in 2001 to US$117 billion in 2007, before declining by 48% year- on- year to US$61 billion in 2008. The flows subsequently recovered to US$78 billion in 2009.
Further, capital markets became more receptive to
African sovereign and corporate risks. Traditionally, in the 1980s and 1990s, bond
issuances by African counterparties in international capital markets were few
and far between and when they occurred was restricted to South Africa and North
African economies. However, in the early 2000s, a number of counterparties,
especially African sovereigns began to access international debt capital
markets. Consequently, net bond issuances by African Sovereigns rose from
US$1.9 billion in 2001 to US$6.7 billion in 2007 before contracting to US$-0.7
billion in 2008. Net bond issuances recovered thereafter to US$10.6 billion in
2014.
In addition, short-term debt inflows (loans from
international banks) remained the single most important component of financing
from private creditors to developing countries and Africa in particular,
accounting for over 44% of total debt flows during 2008-10. These flows in net
terms, primarily trade related, rose steadily from US$2.1 billion in 2003 to
US$3.7 billion in 2010. Trade debt flows
improved significantly not only on account of better macroeconomic conditions
but also due to better financial sector regulatory environments across Africa.
In this regard, many African countries introduced regulations that led to the
strengthening of the capitalization of banks. The strengthening of the capital
base for banks in Africa impacted positively on their ability to finance trade
more efficiently as they became better trusted counterparties to international
banks. African banks also became more international, operating across
boundaries. As at 2012, more than 23 African-owned banks operated outside their
home.
As
African economies grew, its middle Class also expanded and increasingly the
continent began to be seen as a “market
rather than a donor play-ground”. A combination of these factors as well as
some improvements in infrastructure, as thanks to Chinese funding, made many
large corporates to begin to integrate Africa into their supply chains. Supply
Chain financing thus began its gradual ascendance. Receivables financing, factoring
and reverse factoring have since then taken centre stage. Whereas in the 1990s
and early 2000s, global trade finance seminars and conference circuits used to
be dominated by Structured Trade Finance, by the decade of 2000s, and early
2010’s, Supply Chain Finance had taken over; whereas it was fashionable for
global banks to boast of strong STF departments and capabilities, by the 2000s,
many of those units had begun to disappear with SCF beginning to emerge out of
their ashes.
Events
of the past two years appear to be putting some breaks on the transition from
STF to SCF. In this regard, developments in global commodity and financial
markets since the mid 2014 appear to be taking us back to the 1980s and reviving
strong interest in STF among international trade financiers. Commodity price
shocks have resurfaced hurting many African economies. As a consequence of the
commodity price decline, markets have once again become nervous. Many banks
have started cutting country lines. Government fiscal positions have
deteriorated and growth have slowed sharply. During the last five years, Africa’s
real GDP has grown at an average annual rate of 3 to 4 percent compared to over
5 per cent during the 2000s. National debt (both domestic and foreign debt) of
many countries, especially oil producing and exporting countries in developing
regions, has risen sharply. These developments coupled with rising import bills
have placed enormous pressure on trade balance and current account positions,
with many recording trade deficit the first time in more than two decades. Current
account balances, which were mostly favourable in the 2000s, have suddenly
plunged since 2015. The
immediate impact of the current crisis has been a tightening of banking
regulations in major money centers, significant deleveraging and cuts in credit
lines to developing countries, including Africa, as many international trade
finance banks sought to build up their balance sheets in response to market and
regulatory pressures. Between 2014 and 2015, for instance, trade-related bank
lending (both short and medium term) and syndicated lending to developing
economies declined by almost 30 percent. In terms of pricing, the spread on
bank and syndicated lending has widened sharply from the pre-crisis range of
100 to 150 basis points to a range of 300 and 400 basis points in 2015; tenors
have also shortened, mostly to less than 6 months. Many international banks are
increasingly demanding full cash collateral before they can confirm Letters of
Credit from some markets and many African exporters can now hardly access
export finance.
Once
again the doors appear wide open for STF. It appears that the stone that the
builders were quick to reject was again becoming the head corner stone! But how
would STF of the future differ from what we had in the past. Like many
developing regions, Africa is today better prepared to deal with adverse
commodity price shocks; financial industry has grown significantly across the
continent; and re-capitalization
of many African banks and changes in the regulatory regime in some African
markets have made it easier for banks to internationalize their activities and
participate in large ticket trade finance transactions. Evidence of improved
capacity is reflected in recently closed deals, including a deal coordinated by
Afreximbank where five Nigerian banks committed about USD1.3 billion in support
of an Independent oil producing company operating in that market; in Cote
d’Ivoire, the annual trade finance needs of its national oil refinery in an
amount of slightly under USD1 billion is fully funded by African banks; and in
Zambia, the national oil import requirements were virtually funded by African
banks. Fund from Chinese and Indian banks are also becoming very important with
their EXIM banks providing liquidity critical for the financing of investment
goods imports into Africa.
Under
current environment, STF banks must be prepared for new realities – the
conceptual framework would be the same but there has to be a complete change in
mind-set. As I posited in my book, of the various definitions of STF, the one I
fully subscribe to is that:
“it is the art of transferring risks from parties less able to bear them
to parties more equipped to bear them in a manner that ensures an automatic
reimbursement of the advances from the underlying transaction assets”.
With this
definition in mind, we have to accept the universality of the concept of STF.
We must not be held hostage to the idea that a deal is an STF deal only when
the performance risk is retained in Africa (or any other developing country for
that matter) and payment risk is transferred to an OECD country; we have to
abandon the notion that items that can qualify for STF financings must be
exchange-traded commodities; and we must come to terms that STF deals can be of
maturities exceeding one year.
With the
changes that have occurred in the past two decades, the new STF structures that
would emerge in response to current crisis will have to contend with the
following:
- the dominance of China as the leading trading partner of many developing economies that would be candidates for such deals. While China is investment grade rated, there is limited knowledge of the credit quality of some of their trading companies and manufacturers, given the economic slowdown China is itself witnessing. STF practitioners have to accept the reality of China’s dominance and seek to learn more about the credit risks of counterparties there as well as the regulatory and institutional arrangements for trade debt payments;
- the European debt crisis that came right on the heels of the global economic crisis negatively impacted the credit ratings of some European Economies as well as their banks and corporates. Many have lost their stellar credit ratings destroying the main plank on which the traditional STF stood. More in-depth buyer due diligence must of necessity include country risk considerations;
- the gradual relocation of some global companies to Africa as well as some degree of success achieved by some African economies dependent on extractive industries in pursuit of value-addition have resulted in the rise in the primary processing, at origin, of some key commodities hither-to exported raw. For instance, Cote d’Ivoire had since 2014 become the country with the largest cocoa bean processing capacity in the world. The efforts of Dangote Group in Nigeria have seen the company begin to export cement. As a result, STF banks must under the new dispensation abandon the notion of commodities as the base of STF;
- related to (iii) above is the disappearance of commodity monopolies as the trading entities STF deals were comfortable with. With the exception of Ghana Cocoa Board, those boards have all disappeared and replaced by privately held corporates without the inherent monopsonistic/monopolistic advantages the boards used to have. STF practitioners now have to understand or identify the success factors for the new entities and how best to manage the performance risks;
- with the growing supply chains across Africa, export financing, even for commodities, may mean taking another African country payment risk. We see for example, the Ivorian oil refinery buying crude oil from Nigeria for refining and export to near markets, such as Burkina Faso. STF practitioners will have to figure out what that means for deal structures;
- many African economies are beginning to consider the use of the Renminbi as a trading and reserve currency. If this gains momentum, it will have implications for STF;
- whereas in the 1980s and 1990s, many credit insurers, including Export Credit Agencies put most African countries off-cover, today the picture is different. Many of these institutions have decent limits for African country risks. In addition, there was no African Export – Import Bank in the 1980s; today, it exists and operates a relatively sizeable balance sheet. There are similar regional banks and insurers in Africa such as the PTA Bank, Africa Finance Corporation (AFC), Africa Trade Insurance Agency (ATI), Ecowas Bank for International Development (EBID), who since the 2000s have become reasonably better resourced and operating in the trade finance space. STF under current environment will have to incorporate them in deal designs to convert seemingly unbankable deals to “bankability”.
In summary, STF has evolved with the boom and bust
cycles of the global economy. From a near demise in the 2000s, STF has
re-emerged as the most reliable and trusted trade finance instrument in
developing markets. Nevertheless, STF structure will have to take on new form
or features in response to the changes that have accompanied the economic
cycles. In particular, STF deals must opt for structures that take cognizance
of the new realities in the global trade finance market, including the
emergence of the Renminbi as a global reserve currency, the slowdown of China coupled
with uncertainties surrounding OECD economies, the emerging consciousness among
African economies and many other developing regions regarding the need for
industrialization and intra-regional trade, the emergence of a relatively
stable and strong financial services industry in Africa as well as emergence of
African champions who have become dominant players in African trade.
[1] Source: AfDB
(1992): The Feasibility Study for the Establishment of the African
Export-Import Bank; AfDB, Abidjan
No comments:
Post a Comment