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Ending the Drought - Trade Finance

Thursday, May 11, 2017   (0 Comments)
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Interview with Othman Gamero

Ending the Drought

There is a shortage of finance for trade and working capital in Latin America and the Caribbean. What is the solution?


FinFuture: Othman, what are the prospects for trade in Latin America and the Caribbean in 2017?

Othman Gamero: It is likely that 2017 will be seen as a year of economic recovery in the region. However, that recovery is from a low base. According to the United Nations’ Economic Commission for Latin America and the Caribbean (ECLAC), economic growth across the region as a whole in the coming year will be 1.3%, following a 1.1% contraction in 2016. By way of contrast, the International Monetary Fund (IMF) sees emerging markets generally growing by 4.5% in 2017, following a 4.1% rise in 2016 .

Arguably what matters more is that a number of political trends are positive. Mauricio Macri’s administration in Argentina has returned that country to conventional economic policies. In Colombia, the government has ratified a revised peace deal with the FARC rebel group – which is very good news for that country. Under President Michel Temer, business conditions in Brazil appear to be improving. All this is at a time that most countries in the region are committed to liberalization of international trade. The recent improvement in energy and commodity prices is good news as well.

FF: Great. What are the main challenges?

OG: Challenges do exist. Some are very much ‘in the headlines’. Examples include the ongoing problems in Venezuela and the rhetoric of President Trump vis-à-vis Mexico. However, financial markets have adjusted to Venezuela’s woes long ago – and it seems very unlikely that there will be contagion further afield. In the meantime, the Mexican peso has fallen to levels where Mexican exporters are now very competitive in global terms.

A far more serious problem, I believe, is the lack of trade and working capital finance. Like a drought, this is likely to be a short-term issue: however, it can make things very difficult for exporters, importers and other companies in the region that are integrated with global supply chains.

FF: Please explain.

OG: The critical change over the last few years is that the global banks have closed down, sold or scaled back their corporate banking operations in the region. Citi and HSBC are good examples. Traditionally, these are the institutions that have been the main source of finance for trade and working capital. 

In theory, the local and regional banks, some of which have bought businesses from the global majors, should be able to fill the gap. In practice, the local and regional banks are constrained by capital and risk ratios. In the past, the local and regional banks might have been able to access capital through their correspondent banking relationships with the majors.  However, that has been made much more complicated by the well-documented erosion of correspondent banking relationships across the region. In addition, the local and regional banks lack the know-how.

Finally, it is worth noting that the region’s return to economic growth – while good news generally – has boosted demand for finance for trade and working capital. The recovery is exacerbating the drought.

FF: Can FinTechs fill the gap, and provide importers and exporters with funding for trade and working capital?

OG: The one word answer is yes. However, FinTechs are unlikely to provide much of a solution in the short-term, meaning the next few months. This is partly because trade finance and working capital finance are mature markets – and many of the players have a conservative mindset. It is also because, to date, FinTechs have focused on other aspects of trade, such as documentation and payments.

To the extent that FinTechs have focused on supply chain finance, they have tended to concentrate on large multi-nationals. That has been good news for the multi-nationals and the suppliers that the multi-nationals have been able to include in their systems. It has not been so good for small and medium-sized enterprises (SMEs) who are not principally dealing with multi-nationals.

FF: What about the longer-term?

OG: The longer-term is a different story. There are a number of boutiques that have chosen to specialize in the provision of trade and working capital finance to SMEs. Many of these companies began operations in Europe (including the emerging markets of Central and Eastern Europe) and the Middle East, providing factoring and other off-balance sheet solutions.

Excitingly, these companies are now focusing on Latin America and the Caribbean. They know the actual and potential clients in this part of the world. They understand the region’s trade flows. Perhaps most importantly, they have established relationships with major banks. They could revolutionize the provision of trade and working capital finance over the next three-to-five years.

FF: So, these boutiques are basically dependent on bank financing, right?

OG: At the moment, that is basically true. However, pension plans and other institutional investors may in due course emerge as a much more important source of funding. Right now, the Federal Reserve is increasing interest rates. However, this is from an extraordinarily low level. In most developed countries outside the United States, the central banks are still keeping interest rates at zero, or lower. Large pension plans and institutional investors really need a high-quality asset class that can provide them with a positive real return over the short-term, as well as liquidity. 

Trade and working capital finance could well become that asset class. The nature of the economies in Latin America and the Caribbean – and in emerging markets in other parts of the world – mean that the provision of funding to the boutiques that are operating in emerging markets should have many of the advantages of emerging markets corporate debt. However, the tenor will almost always be lower, and so too will be the risk. Certainly, trade and working capital finance would be considerably less risky than emerging markets equities: in fact, trade and working capital finance as an asset class should respond much more directly to changes in economic conditions in the emerging markets than equities.

Taking a three-to-five-year view, I would say that there will be basically two ways in which the pension plans and other large institutional investors will be able to earn a real return through providing trade and working capital finance.  One way is to participate in deals that are organized by the boutiques.  The other is to invest directly into the boutiques themselves.

FF: What are the catalysts that will lead to major pension plans and other institutional investors becoming major providers of trade and working capital finance?

If the development of other new asset classes is anything to go by, there will need to be an education of the pension plans. That is a process that usually takes time. It is usually directed by the major wealth management firms. They are the companies that define the asset class and that act as advocates for it. 

Even at this stage, it is possible to see some of the key elements of the case for trade and working capital finance as an asset class. Moody’s has determined that the default rate for credit that is provided for trade finance and working capital finance is around 0.06%. This compares with a default rate of around 0.11% for investment grade credit that is not associated with trade finance. In essence, the new asset class should provide the potential for higher returns and exposure to the growth of emerging markets, yet with lower risk.

Excitingly, the pension plans and other institutional investors are already familiar with the concept of investing in secularized trade receivables. As advocates for the asset class, the wealth management firms are not starting from a position of zero understanding from their clients.

FF: If the pension plans and institutional investors are going to emerge as the main source of funding for trade and working capital, what are the main changes that we can expect between now and early 2018?

OG: 2017 is likely to bring a widespread understanding that there is a drought of funding for trade and working capital. The problem will become recognized to a much greater extent than it is presently. There will probably be calls from more sophisticated institutional investors for new asset classes – given that the era of ultra-low interest rates will be with us for some time yet. Meanwhile, it will become clearer that global banks are not going to be a part of the solution – as regulatory requirements force them to curtail their activities in emerging markets.

In short, it is not certain that many people will actually see the logical link between all these issues in the coming months. Over the long-term, though, innovative collaboration between boutique consultancies, wealth management firms and institutional investors will ensure that importers and exporters in Latin America and the Caribbean have access to the trade and working capital funding that they need.

That, in turn, could contribute to lower volatility in the region’s economies and improved perceptions of risk. If the region is seen as becoming more stable, trade and working capital finance may become even more readily available. The end of the drought could ultimately contribute to a virtuous circle.

Othman Gamero is the Founder and CEO of Galley Financial Corp. a Trade & Working Capital Finance Boutique, working with corporate and financial institutions. 

He has led and developed Trade Solutions for Emerging Markets in Latin-American and Asia over the last 12 Years: these include Supply Chain Finance, Working Capital Solutions, Trade Finance, Accounts Receivable, Structured Trade, Commodities Trade Finance and Correspondent Banking.

He was previously Regional Director and Head of Trade Sales Latin-America at Citibank N.A. 

Othman Gamero has also written extensively on trade-related issues for the specialized and mainstream financial media and has spoken at international business forums in 27 countries.