Trade Finance

I’ve been very bad at keeping this blog up to date, so I’ve decided to get back into it, and try and write something at least once a month. This should hopefully keep my writing skills up.

This months topic? Trade Finance, something I’ve come across in my quest to learn more about economics.

The term Trade Finance is not something I have come across before, but I have now seen it mentioned twice this week online.

What is Trade Finance? It is one of the world’s oldest and largest financial activities, helping to support and facilitate an estimated $18 trillion dollars worth of global exports of merchandise and services annually.

Trade finance signifies financing for trade, and it concerns both domestic and international trade transactions. A trade transaction requires a seller of goods and services as well as a buyer. Various intermediaries such as banks and financial institutions can facilitate these transactions by financing the trade.

Typically Trade finance has historically been a stable, profitable and robust business for banks, with minimal realised loss ratios and low correlation to either the real economy or other banking activities. Banks use Letters of Credit, short term loans, guarantees and other instruments to support around $7trillion a year shipping goods and providing services between countries.

More recently investment managers are opening up the market to non-bank investors and one such manager Markham Rae (who have their own dedicated trade finance team www.markhamrae.com), provide a trade finance strategy for pension funds, insurers, Local Authorities and family offices. So, why is trade finance attractive to these types of investors? Very good returns, seems to be a major benefit. In the current economic environment is it hard to find good yield – and this type of investing is currently yielding 8%.

Other benefits of including the trade finance strategy in to investor portfolios are:

  • Capital repayments and returns. The returns will be paid in the form of a quarterly and predictable payment
  • Diversification and granularity
  • Low correlation to the economic cycle
  • Socially responsible – global trade is reliant on this method of financing, supporting grass roots trade
  • No exposure to rising interest rates
  • No legal exposure or liability to the underlying transaction
  •  Alignment of interest between the manager, the investor and the regulators.

All the benefits sound very good, but when is the best time to invest in this strategy? It appears that now is a good time to invest as the banks’ international trade finance business is now going through a period of substantial reorganisation. Regulatory capital requirements for bank trade finance portfolios are much higher under the current Basel II regulation than they were previously and will increase yet further as Basel III is phased in over the coming years.

Maybe one day, I will be able to give up the job and trade full time!

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