Global Market Overview
According to the World Trade Organization (WTO), about 80-90% of global trade relies on trade finance. Services provided by trade finance companies have helped business expand globally, increasing their revenue and growth. The consulting firm McKinsey & Company estimates the global trade finance ecosystem to be worth $5.2 trillion, making up around 6% of global GDP.
Trade finance helps the global economy strive towards financial inclusion by helping in the advancement of micro, small and medium sized enterprises. A recently published report by Orbis Research projects the global trade finance market to reach a compound annual growth rate (CAGR) of 5.4% from 2021 to 2026.
A trade finance company is focused on making import and export decisions possible. Specifically, trade finance represents the diverse financial instruments and products used to facilitate international trade and commerce. Trade generally requires credit or payment guarantees.
Trade finance companies are involved in trade transactions to remove the present payment and supply risk. There are multiple trade finance services to address the demands of importers and exporters. An exporter may be provided with payments or receivables, while an importer may receive a line of credit to complete their trade.
Entities providing trade finance services can include banks, insurers, or specialised trade finance companies. The main difference between trade financing and traditional credit issuance is that trade financing is made to protect against the inherent risks of international trade. These risks can include political instability, fluctuations in currencies, non-payment issues, or faulty credit worthiness. On the other hand, traditional credit issuance usually aims to address lack of funds or illiquidity.
Trade finance framework
Risk Reduction: Trade Finance has evolved to solve some of the most inherent, basic problems of international trade. In international trade, exporters used to face the risk of not receiving payment by the importer after having shipped their goods. On the flip side, importers faced the risk of making premature payments and not receiving the desired goods.
To solve these problems and improve trade dynamics, trade finance companies have evolved to become intermediaries. They accelerate payments to exporters and confirm to importers that the desired goods have been shipped. Typically, the importer needs to provide a letter of credit to the exporter, to prove they are able to pay for the products, while the exporter provides a document confirming shipping.
Improved Cash flow: Trade finance companies may provide cash to companies based on their account’s receivables. For instance, if a company will soon export its products and has a set contract with an importer, this is an accounts receivable that trade finance companies may use as collateral. Trade financing plays a significant role in making trades more efficient, as it plays a role in fewer delays of payments and allows for optimized cash flow planning.
Company growth: Trade finance can be used to leverage a company’s current revenue. A company may not have sufficient funds to produce goods needed to complete an existing order. Through financing, they can produce these goods and complete their order. Trade finance companies use the future prospect of business to justify lines of credit, by evaluating contracts in place and future business prospects.
Repurchase agreements: One common trade finance service is a repurchase agreement. This is a short-term service agreement to sell securities to buy them back at a higher price later on. The difference in price is often minimal, and represents interest incurred. They are used for short-term borrowing and are generally considered risk adverse, as they are often based on using government, often treasury, bonds as collateral.
Trade finance boutiques Vs the limitations of institutional banks
Many banks will refuse to provide trade finance services to smaller companies. For example, short-term loans to finance production of goods may be seen as too risky, even if a set contract is in place for the goods. A 2017 study by the World Bank has found that a staggering 40% of all micro, small and medium sized enterprises face financing rejection. This is largely due to the fact that large, bulge bracket banks are not able or willing to take on the increased risk factors associated with this.
This may hinder economic innovation and company growth, as financing liquidity is concentrated on institutional, multinational companies. This offers a sizeable opportunity for boutique trade finance companies, as they are generally more willing to take on increased risk and can bridge the gap to meet the significant demand for trade financing.
Blockchain integration in trade finance
Blockchain implementation in trade finance can be done by distributed ledger technology (DLT). DLT is a computer protocol and technological infrastructure that allows for the creation of a decentralised database. This technology allows for the simultaneous access, validation, and updating of information. Information stored in DLT is unalterable. The decentralized aspect means there is no need for the recorded information to be verified by a centralised, in control party, as it is verified by the protocol.
The multinational company IBM has already implemented DLT into its trade finance services, called the “IBM Blockchain Platform”. All transactions are recorded with a timestamp and unique electronic signature, based on cryptography. One of the key benefits of this is that it reduced the risk of non-payment. This platform enables companies to digitize their trade finance activities, with the aim of simplifying transactions and reducing costs for all parties. Blockchain technology can be used in trade finance to verify claims made by importers and exporters, as information can be seamlessly validated.
Conclusion: The role of trade finance companies in 2022
The trade finance industry is a vital and essential part of the global economic system. The Covid-19 pandemic exposed some of the key issues in the industry, many of which can be traced back to lacking technological integration. For instance, during the first lockdowns of 2020, physical, legal documents necessary for trade finance transaction processing were delayed, or not transmitted at all.
In technologically advanced economies, these documents were replaced by electronic ones, however, this posed a challenge in less advanced and emerging economies. Broader supply chain issues and economic hardship further disrupted the global trade finance ecosystem. The pandemic has showed that one of the key roles of trade finance firms is to keep up with technological advancement, be it through blockchain technology or cloud computing for more efficient data storage and processing. Besides this, there appears to be significant opportunities in the industry, especially for boutique trade finance firms, given the globally high percentage of unmet financing needs.
Cubri Services is a cutting-edge financial entity serving clients across our trade finance, corporate payment, and asset management divisions. We are ambitiously forward-looking and provide a multitude of innovative approaches to traditional financial functions. Driven by highly knowledgeable and experienced professionals, we focus on sustainability, impact investing and ESG implementation in all areas of business. Swiss at heart, Cubri Services is headquartered in Geneva, with satellite offices in Luxembourg and Shanghai. Our extensive partnership network ensures pristine interconnectivity in our fields of expertise and up-to-date knowledge of ample opportunities for our clients. We look forward to hearing from you.
- Aubion, Marc. “World Trade Organization.” WTO, Feb. 2021, https://www.wto.org/english/res_e/reser_e/ersd202105_e.htm.
- OECD. “Trade Finance in the COVID ERA: Current and Future Challenges.” OECD, 23 Mar. 2021, https://www.oecd.org/coronavirus/policy-responses/trade-finance-in-the-covid-era-current-and-future-challenges-79daca94/.
- World Trade Organization. Trade Finance and Smes – World Trade Organization. https://www.wto.org/english/res_e/booksp_e/tradefinsme_e.pdf.
- Botta, Alessio. “Reconceiving the Global Trade Finance Ecosystem.” McKinsey & Company, McKinsey & Company, 19 Nov. 2021, https://www.mckinsey.com/industries/financial-services/our-insights/reconceiving-the-global-trade-finance-ecosystem.
- Reiff, Nathan. “Repurchase Agreement (REPO) Definition.” Investopedia, Investopedia, 19 May 2021, https://www.investopedia.com/terms/r/repurchaseagreement.asp.
- Sangha, Parm. “The Difference between Blockchain and Distributed Ledger Technology.” Marcopolonetwork.com, 13 July 2021, https://marcopolonetwork.com/articles/distributed-ledger-technology/.
- Wass, Sanne. “Banks Poised to Capitalize on Projected 50% Rise in Trade Finance Revenues.” Accelerating Progress, 14 Oct. 2021, https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/banks-poised-to-capitalize-on-projected-50-rise-in-trade-finance-revenues-67053598.
- Murphy, Chris B. “How Trade Finance Eases Transactions for Importers and Exporters.” Investopedia, Investopedia, 19 May 2021, https://www.investopedia.com/terms/t/tradefinance.asp.
- World Trade Organization. “World Trade Organization.” WTO, https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm.
- Carbajo, Marco. “5 Facts You Need to Know about Trade Finance.” The Balance Small Business, The Balance Small Business, 9 Dec. 2019, https://www.thebalancesmb.com/trade-finance-explained-5-facts-you-need-to-know-3953592.