Trade Finance – An Asset Class that Underpins Socio & Economic Development

The availability of financing is essential for the health of any trading system as it helps to target funds where they are needed, at the heart of a business. Global trade is a US$17 trillion industry[1], of which 80% is supported by some form of financing or insurance[2], making it one of the largest potential asset classes, dwarfing others such as the leveraged loan market.

Moreover, a strong trading system is essential for delivering the United Nations Sustainable Development Goals (UN SDGs). Trade finance has the potential to play a big role in creating that system. It can provide much-needed support to increase decent work opportunities, boost economic growth, foster industrialization & infrastructure and reduce inequalities.

The first trade finance funds appeared following the global financial crisis in 2008, when banks started reducing their trade finance exposure to meet Basel III capital requirements, although in recent years the asset class has gained increased interest from institutional investors, driven by demand for a scalable investment opportunity with low volatility and consistent return, as well as low correlation against the broader financial market. Additionally, borrower demand to diversify their sources of liquidity has increased, with significant demand coming from borrowers who cannot access the broader capital markets.

Moreover, with an increasing focus on ESG and Impact assets that go beyond the somewhat limited sustainable bond and equity markets, trade finance offers a potentially compelling opportunity – aiding socio-economic development in developed and emerging markets as well as SMEs – grassroots level impact. Although I must add, strictly speaking, I am of the view that whilst trade finance itself should not be classified as an impact investment, if specific sectors, countries and borrowers are targeted, investments can have significant positive impacts. For example, “essential” sectors – food & agriculture, consumer staples and pharmaceuticals. Not only have these sectors generally shown resilience over the past months (and years) they also support significant impact potential, both in markets were goods are sourced (& produced) as well as markets where they are consumed.

The World Trade Organisation (WTO) undertook a detailed study[3] of how global trade (and accordingly trade finance) impacts the UN SDGs, the results outlined trade’s unrivalled impact opportunity and clearly demonstrates why many consider trade finance as the socio-economic lifeblood and foundation for all other activities.

Some of the many UN SDGs positively impacted by targeted investments include:

SDG 1 - Poverty

Trade has already shown to be a very powerful engine for poverty reduction. By boosting growth and supporting development, it has been of great help to developing countries. It even led to an early achievement of the Millennium Goal to cut poverty in half by 2015. This extraordinary accomplishment is owed to a rapid and unprecedented economic development that took place in the last decade and a half.

SDG 2- Zero Hunger

Despite significant advances in farming & agriculture technology and practices, a large proportion of the food consumed in developed markets is still grown in emerging markets, e.g. rice and avocadoes. By extending trade finance to producers, secured on the offtake from importers (who typically have a significantly better credit risk profile), producers in emerging markets are able to access capital that can transform the lives of their workers whilst investors retain developed market credit risk.

SDG 5- Gender Equality

Growth offers opportunities for all. Trade-triggered economic growth directly brings more opportunities for women’s employment. Women constitute up to 90% of the workforce in export processing zones in most of developing countries such as Sri Lanka. One third of the world’s SMEs are women-owned. So empowering SMEs has a direct impact on women.

Also, WTO’s initiatives support the service sector, globally the largest source of employment for women. In 2015, 62% of women were reported to be in this sector. Also, this sector holds a large share of GDP in developing countries. Enhancing this sector will contribute to improving gender equality by providing education opportunities and decent work. Furthermore, it will reduce inequalities and not only within but also among countries. But, to be effective, trade efforts need to be supported by adequate gender-friendly policies.

SDG 8 - Decent Work and Economic Growth

Trade-triggered economic growth increases the income-generating capacity. This is a prerequisite for sustainable development. The WTO is making efforts to create a globally stable environment that allows economic activity to flourish. In such an open environment, businesses are safe and are given equal opportunities for growth and development.

SDG 9 - Industry, Innovation and Infrastructure

Encouraging trade opens doors for technology exchange, creates space for innovations and encourages sharing of knowledge. A win-win for all. Innovation is crucial for new economic opportunities, such as environmental goods and services that are considered essential to achieving SDGs. The global market for sustainable natural resource products has been estimated at US$ 50 billion by the International Trade Centre.

Beyond Socio-Economic Impact

Trade finance funds have managed to return 6.82% per annum, outperforming both their fixed income counterparts and the global investment grade bonds which returned 5.43% and 2.58% per annum respectively since the end of 2009. The high-yield bond markets generated a marginally lower annualised return of 6.58% over the same period, hampered slightly by the recent COVID-19 pandemic[4].

Given that trade finance is utilized at the heart of a business operations (i.e. where a business requires working capital to secure stock or accelerate receivables from sales already made) vs. general loans (e.g. revolving credit) where use of proceeds is not restricted it enables investors to track end to end where funds are being utilized, and where the risks lie. This triangulated alignment of interests from the key stakeholders, a buyer, a seller and the financier is largely why trade finance has consistently demonstrated low default rates (0.53% on an obligor weighted basis for import / export loans) and high recovery rates (62.30%), even in emerging markets[5].

Additionally, by virtue of the low volatilities associated with the trade finance strategies, fund managers comprising the Eurekahedge Trade Finance Hedge Fund Index have generated exceptional Sharpe ratios over the recent years, outperforming their benchmarks by a significant margin. Over the last five years, trade finance fund managers generated a Sharpe ratio of 6.12[6].

Apart from the risk-adjusted returns, trade finance hedge fund managers have also managed to provide downside protection. The Eurekahedge Trade Finance Hedge Fund Index has posted a maximum drawdown of 0.31% over the last five-year period ending May 2020[7].

In light of COVID-19, BCG expects global trade to fall sharply, however basic goods and commodity trade (representing circa 60% of total merchandise exports) should remain resilient, both from a volume perspective as well as default rates perspective, given their criticality[8].

[1] World Trade Organisation Report 2019 [2] World Trade Organisation - [3] World Trade Organisation - [4] Eurekahedge - [5] ICC Trade Register Report 2019 - [6] Eurekahedge - [7] Eurekahedge - [8] ICC Trade Register Report 2019 -