Date: 27th January 2021
Credit: AFP via Getty Images
The past three years have been a turbulent period for international trade; trade tensions between the United States of America and China, fears of a disorderly Brexit in Europe, trend away from globalisation, a negative global output outlook more generally and of course COVID-19.
Merchandise trade has shown the largest drop while services in trade grew in 2019, although at a slower pace. Trade in natural resources showed the strongest drops in 2019 and 2020 mainly due to lower demand and as a result - lower prices, while manufactured goods trade decline was modest. Agricultural trade grew in 2019. In addition, available data for 2020 indicate a sharp decline in trade growth (about 8 per cent), largely due to the COVID-19 pandemic. The sharpest drop in international trade occurred in the second quarter of 2020, with global merchandise trade falling by more than 20 per cent relative to the same quarter of 2019. Trade trends for the second half, although still negative on a year-over-year basis, are better than during the first half. Notably, the relative recovery in the second half of 2020 was largely driven by China.
Whilst the data is negative, the past three years and most critically COVID-19 have, as Mukhisa Kituyi (Secretary-General of UNCTAD) so eloquently puts it:
“Covid-19 has served as a reminder that we live in a closely interdependent world that brings opportunities but also carries dangers. It has, just as importantly, shed light on a whole series of pre-existing conditions - from heightened inequality, to unsustainable debt and rampant environmental destruction - that were left unaddressed after the Global Financial Crisis. The world at the end of 2019 was, in truth, a good deal more fragile than many were willing to acknowledge.” 
Shocks to the System
Many issues were uncovered indirectly because of COVID-19, particularly with respect to questionable risk management practices and several fraudulent behaviour cases in the commodity trading sector – commodities representing circa 30% of global merchandise trade. Whilst such issues are not specific to the sector, given that these businesses typically operate on thin margins, heavily dependent on working capital availability and by their very nature at the heart of global trade, for these businesses any severe shock to the system means that they are the first to be impacted with a swathe of defaults – similar events were also seen during the Global Financial Crisis.
These corporate defaults have severely impacted many of the traditional trade finance lenders, many of whom have registered large impairments, and accordingly rationalised their activities in trade finance via exiting many SME relationships to focus on larger borrowers as well as wholesale closures of divisions. Given that 80% of global trade is facilitated via financial institutions, this is of grave concern, particularly to SMEs who are being impacted through no fault of their own.
Not all is negative however, whilst such events are painful, it has led to much needed change in the market, one of the key developments being the establishment of The Code of Best Practices for Commodity Financing, published by the Association of Banks in Singapore (ABS) with backing from the Singapore government. This Best Practices note is designed to "articulate key principles governing prudent commodity trade financing practices" and has been supported by 28 of the major banks. This will bring greater consistency and transparency to the market.
Impact on SMEs
SMEs have long been considered the backbone of the global economy, representing as much as 80% employment in many economies.
Globally, SMEs continue to suffer from uncertain economic conditions caused by the COVID-19 pandemic. Whilst governments have taken steps to support, more proactive interventions are required to ensure their survival and long-term prosperity from a wider group of stakeholders – particularly private credit and impact investors.
SMEs desperately need liquidity and most mainstream economists seem to agree that (international) trade will be a vital form of relief for firms in 2021. As such, the supply of trade finance must be a high priority to stem the economic damage wrought by the pandemic and power a recovery capable of restoring growth and productive employment. However, the size of that challenge should not be underestimated - the ICC estimates that at least US$2 trillion of ‘fresh’ capital will be required to restore cross-border trade to pre-pandemic levels.
Development Capital’s Response
Government responses, particularly in the developed markets have been to provide emergency capital injections and schemes to protect jobs – i.e., survival measures. However, these also need to be complemented with additional capital, specifically working capital. The pandemic has made many businesses realise that it is not necessarily equity or long-term finance that they require, but rather liquidity to operate in the form of working capital.
As the Covid-19 pandemic began to severely disrupt supply chains and global trade flows, many Development Financial Institutions have stepped up to support. For example, the European Bank for Reconstruction and Development raised the limit on its trade finance guarantee facility to €3bn. The International Finance Corporation also received $4bn in additional capacity for its Global Trade Finance Programme and Global Trade Liquidity Programme.
These interventions have already played an important role in stabilising market confidence, avoiding delays in processing transactions and providing additional coverage for trade lines.
Whilst these are large numbers, Development Financial Institutions generally have limited capabilities to support trade finance - limited to providing guarantees, leverage lines to commercial banks or directly financing large corporates. The pandemic presents an opportunity to explore how such institutions can work collaboratively with other market participants including Trade Finance Funds.
Building Back Better
COVID-19 obliges us to think carefully about what makes for a healthy and resilient world and as such the businesses within it. This will lead to structural reform across our lives and economies, and there will be a significant focus on sustainability and SMEs.
Whilst commercial banks will most certainly play a lead role, there is significant room for Development Finance Institutions and specialist Trade Finance Funds to support and facilitate this transition. Despite the uncertainty and volatility, we have seen, trade assets generally present a low risk, given their specific and senior-secured nature – this results in low default rates, as evidenced by ICC data collected over the past decade.
The global economic crisis caused by COVID-19 throws up a stark choice: continue misguided policy choices or collectively chart a new path that leads from recovery to a more resilient, more equal and more environmentally sustainable world in line with the ambition of the 2030 Agenda for Sustainable Development.
Neither path is preordained. Building a better world is a matter of conviction and collective action. The lives of future generations and of the planet itself will depend on the choices we all take over the coming months.
 UNCTAD: https://unctad.org/  Bloomberg: https://www.bloombergquint.com/opinion/why-banks-are-exiting-trade-and-commodity-finance  Bloomberg: https://www.bloomberg.com/news/articles/2021-01-20/rabobank-closing-commodity-lending-offices-in-cost-cutting-bid  Argus Media: https://www.argusmedia.com/en/news/2165157-singapore-sets-out-commodity-trade-finance-guidelines  The Banker: https://www.thebanker.com/Comment-Profiles/Viewpoint/Protect-SMEs-trade-finance-lifeline  ICC: https://iccwbo.org/publication/icc-trade-register-report/