The New Age of Latam Trade Financing
October 3, 2018
By Lucien Chauvin
Geopolitics and technology are exerting a disruptive influence on trade finance. Latin America is not immune to the consequences – or the benefits. Lucien Chauvin reports.
Latin America, like most of the world, will have reason to look back at 2018 as the year its trade and financing environment underwent seismic change.
This change has been coming from two directions; the political landscape is altering the way developed and emerging economies see trade, and technology is advancing the way trade and trade finance are carried out across the globe.
THE LONG AND SHORT OF IT
Trade specialists are betting that the political turmoil affecting trade will be a passing phase, while new technologies will have a lasting impact, making transactions faster and more reliable.
“Politics is affecting trade. There is a situation around the world where there is an increase in economic nationalism, and regulators and supranational organisations are having to deal with disparate interests in a way they have not had to in the past, creating an environment of uncertainty for trade finance,” says Rebecca Harding, an economist specialising in trade finance and CEO of UK- based Coriolis Technologies.
Fernando Lüdert, CEO of US-based CreateTrade Capital, which supplies trade financing, believes new technology will revolutionise the way trade is done. “Change is very fast paced today. Trade finance in five years is going to [look] very different from the way it [looks] today as the latest technology offers new tools for international transactions,” he says.
Ms Harding and Mr Lüdert concur that changes already under way could force Latin America’s financial systems and the companies that use them for trade finance to come up with new options. “If volatility increases, Latin America is going to look very favourably on local and regional solutions as global ones become more difficult,” says Ms Harding.
While global trade flows recovered in 2017 and have continued on an upward trend throughout 2018, decisions in developed economies have raised unexpected fears that a negative shift is looming.
Policies from the US, once the epicentre of free trade, are incomprehensible to many. One of president Donald Trump’s first moves after coming to power was to with- draw the US from the 12-country Trans-Pacific Partner- ship and order a renegotiation of the North American Free Trade Agreement with Canada and Mexico. He has threatened to pull out of a free-trade agreement with South Korea, and trade negotiations between the US and the EU have been halted.
This year has brought even more unexpected moves, including tariffs on steel and aluminium, loud criticism of the trade policies of Europe and Canada, and tariffs on an increasingly long list of Chinese goods. The US government has so far announced two rounds of tariffs on Chinese goods, with China responding in kind both times.
Nevertheless, the US trade deficit continues to increase, widening at its fastest monthly rate in three years in July. The deficit came in at $50.1bn, up 9.5% on the same month in 2017.
A WORRYING TREND
The UK’s approaching withdrawal from the EU and increasing opposition to trade agreements in European countries, notably Italy, have also raised questions about the staying power of the European bloc and its access to markets, something that few were expecting only a few years ago.
Rogers Valencia, Peru’s trade and tourism minister, says the trend is worrying, especially if threats to alter rules adopted by the World Trade Organization are put into practice. “Right now we are hearing a lot of noise, but measures have been contained. We are carefully watching what happens,” he says.
David Anderson, head of trade finance strategy at Innovatus Capital Partners, says the new complexities will change trading patterns but will not hold up trade. “Trade disputes or rising tariffs change trade flows, but do not stop them,” he says. “For us, sometimes it creates opportunities. The key for anyone in this space is to remain nimble and adapt to changing flows.”
Innovatus closed two trade finance deals in August 2018; one with Brazilian peanut exporter Brumau Comercio de Oleos Vegetais and the other with Paraguay’s Agrofertil, a farm supply distributor.
While some trade-related actions have raised concern about future trade flows, they have been counterbalanced by new agreements at regional levels. These agreements are not just about goods, but span a host of issues from environmental protection to state-owned enterprises.
“If you take the US out for second, there have been a lot of other regional free-trade agreements that have come into place in the past couple of years and I think these will foster more regional trade,” says Tod Burwell, president and CEO of the Bankers Association for Finance and Trade, an international transaction banking association.
Three Latin American countries – Chile, Mexico and Peru – are involved in major trade developments. They make up three-quarters of the Pacific Alliance, which also includes Colombia. Launched four years ago, in 2016 the Pacific Alliance implemented a trade protocol to eliminate tariffs on 92% of goods. The alliance is often touted as an example of a new kind of agreement under which trade protocols are accompanied by harmonisation of financial markets.
Chile, Mexico and Peru also form part of the 11-country Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP) that emerged after the US pulled out of the original agreement. A deal was signed in March 2018 and should come into force in 2019. It will be implemented 60 days after ratification by six countries, and three had done this by the end of August. Outside Latin America, the CPTPP includes Australia, Brunei, Canada, Japan, Malaysia, New Zealand, Singapore and Vietnam, and represents just under 14% of the world gross domestic product.
China is also spearheading a few potentially huge plans, including the Regional Comprehensive Economic Partnership, a 16-country agreement across Asia’s biggest economies, and its Belt and Road Initiative based on historic trading routes. Four Latin American and Carib- bean countries – Antigua and Barbuda, Bolivia, Panama and Trinidad and Tobago – had signed up to the initiative by August 2018.
CreateTrade Capital’s Mr Lüdert sees these new trade tie-ups creating opportunities for trade. “Trade finance between Asia and Latin America, especially those countries on the Pacific coast, will be growing quickly in the coming years. Very strong relationships are being developed,” he says.
What has Mr Lüdert and other onlookers fired up is the technological developments that could help close the yawning gap in trade financing, particularly in developing economies such as those in Latin America and for the small and medium-sized businesses that dominate the region’s landscape.
The financing gap internationally is estimated at about $1500bn, some 9.4% of the $16,000bn shipped across international borders annually. Mr Burwell of the Bankers Association for Finance and Trade, describes the gap as “stubborn and persistent” and sees trade finance as “the oil to the engine of trade”, so closing the gap is essential.
The two big tools that could help bridge the gulf are blockchain and to a lesser extent artificial intelligence (AI). Proponents say blockchain, or distributed ledger technology, will not only help companies manage the export of goods in a more timely and efficient manner, but allow for existing trading platforms and those under development to eventually be linked in a seamless fashion.
Kerim Derhalli, founder and CEO of UK-based smartphone app Invstr, sees blockchain as the fourth stage of the internet revolution, creating more peer-to- peer collaboration. “Blockchain removes the barrier of trust,” he says. “It lets you trust someone in a different part of the world because it effectively offers a guarantee by the community through the chain.”
Nitin Gaur, director of IBM’s Blockchain Labs, believes blockchain “tries to solve two constructs; time and trust. At the end of the day, what it does in trade finance is smooth the flow of goods and money.”
THROUGH THE LENS
Earlier in 2018, IBM and shipping line Maersk launched an ambitious blockchain solution, TradeLens, to digitise the supply chain ecosystem in a bid to improve efficiency. The system currently involves exporters, customs offices, ports and shippers both on sea and land. The next step is to involve financial institutions to provide a common ledger for letters of credits, bills of lading and bills of exchange.
“The movement of money is a challenge because it involves trust,” says Mr Gaur. “TradeLens is evolving and growing. We need to bridge this with the financing net- works of the world to provide full traceability.”
IBM is also involved in the Global Trade Connectivity Network (GTCN), a cross-border blockchain platform for trade finance backed by the Monetary Authority of Singapore and the Hong Kong Monetary Authority. The GTCN could go live in the first quarter of 2019.
“The intent of the GTCN is to provide a hub of sorts to connect trading networks popping up all over the world,” says Mr Gaur. “If you are selling a bill of lading from one bank to another, that bill of lading can move seamlessly on the network without having to go through complex human verification.”
Mr Lüdert sees blockchain at the heart of a broader revolution in trade finance, allowing new players to emerge besides traditional sources because the nature of trade is changing.
“Trade finance used to be based on a two-way street, buyer and seller, but the entire supply chain model is being disrupted,” he says. “We are moving from a bilateral model to one with multiple players. Blockchain provides reliability as more players are involved.”
He adds that the trade world is now populated by small companies producing and selling goods and that do not have the time or the track record to approach a traditional bank. Banks want financial statements, profit margins and track records that small companies cannot produce.
“Banks want to know to know where you were three years ago, where you are today and where you will be in three years,” says Mr Lüdert. “Small companies do not have this information, making them unbankable. We are filling this gap.”
For Mr Anderson at Innovatus, technology not only helps companies seeking trade finance, but also those providing it.
“Technology helps you increase volumetrically the number of deals you can do,” he says. “It helps you with your loan supervision and raises red flags. Formerly this was something that required a lot of bodies and really only big banks could do it, but I think the exciting thing that has happened over the past few years is that smaller shops who are in the private debt space are now able to take on volume and manage the operational risk.”
Mr Burwell sees the use of AI making great strides within banks in a host of applications, including analysis for trade financing. “AI has been around for decades, but its use has accelerated. We are seeing a lot of banks using it more frequently in financial crime risk management, fraud identification and credit analysis,” he says.
He adds that while blockchain and other technologies are advancing, opening options for non-bank play- ers in trade finance, they are not a replacement for due diligence and knowing your client.
“Non-banks still have some of the same issues because if they do not fully understand the risks in the market, or if they do not understand the clients they are doing business with they can run afoul of financial crime regulations and other concerns,” he says. “Technology is not a free pass for non-banks not to know their clients.”
Ms Harding cautions that blockchain is not a panacea, and that while it has the potential for being very useful in some applications and as an anti-money laundering tool, it is not going to radically alter sources of trade finance.
Invstr’s Mr Derhalli, while a champion of blockchain, does not see it opening the door too wide for non-bank players to disrupt trade finance today.
“Trade finance is quite a complex product and I don’t yet see it being disrupted by non-bank players,” he says. “In time you imagine a decentralised database where verification of the different stages of shipments and independent sources of capital can finance against those different stages of processing.”
Similarly, Ms Harding says it is important to keep in mind that new technology is not purely the domain of start-ups, but that banks and financial systems in gen- eral also make use of new technology.
WORKING WITH TECHNOLOGY
Some of the earliest trade finance platforms actually began with banks, and several of them are moving from the concept to implementation.
HSBC and ING Bank announced in May that they had completed a trade finance transaction using R3’s Corda blockchain platform. HSBC provided a letter of credit to ING for the purchase of soy beans. The transac- tion involved two units of agricultural distributor Cargill, with Argentinian soy beans going to Malaysia.
Bank of America Merrill Lynch is inching closer to scaling up the use of its blockchain technology, and is also part of the R3’s ecosystem.
“I think banks are aware of that fact technology poses certain challenge,” says Ms Harding. “Banks are beginning to work with fintechs rather than against them, and this is a big change that I expect that to continue.”