Trade finance strategies offer compelling risk-return profiles with low correlation to bonds and equities and with the added bonus of favourable Solvency II treatment, but also need significant investment to implement.
That was the clear message from the first Insurance Investment Exchange breakfast roundtable of 2019, in partnership with Allianz Global Investors, as over a dozen senior investment professionals from leading insurers debated why the US$13 trillion trade finance market is of growing interest to insurers. Opportunities have grown for insurers to step into the breach as banks retreat and investors are now launching into this asset class after exhaustive research and development programmes.
Trade finance has traditionally been the preserve of the major banks, but the decade since the financial crisis has seen that change, as the demand for finance has grown faster than the banks can comfortably cope with, especially non-investment grade business. This has seen them open up some better quality risks to sub-participation but the latest Asian Development Bank estimates still show that global demand for trade finance exceeds supply by US$1.5 trillion.
Alongside this gap, the emergence of fintech has eased the once huge administrative burden involved in trade finance as it has automated much of the process using e-invoicing and blockchain technology. This has been accelerated by the introduction last year of the European Union Directive on electronic invoicing for public procurement which means a growing number of suppliers to public entities have to use electronic invoicing.
For insurers looking beyond traditional fixed income and equity portfolios, trade finance has several attractions, said Allianz.
As the duration of investment grade credit lengthened and yields were squeezed over recent years, many insurers moved into private lending earlier in the decade. This boosted returns for early movers but that advantage evaporated as more people moved in.
This is where trade finance can offer a potentially attractive solution and where Allianz believes a collaborative working capital strategy offers the ideal way in for insurers. This is not a light undertaking though. It involves accessing multiple sourcing providers, necessitating market wide research; delving deep into trade credit and the expertise in counterparties such as credit insurers; appreciating the significant volumes and high turnover of small transactions that make up a meaningful portfolio for investors; and building robust platforms and technology to manage these deals cost-effectively and in a timely fashion.
None of this easy and the partners chosen by insurers to help them implement this are vital. Executed properly, however, this can give insurers a perfect spread of risk across a wide range of firms needing trade finance from SMEs in the UK to major global players. Exclusivity with one provider has immediate attractions, but also means taking on bad risks as well as good ones and leaves investors vulnerable to changes of strategy on the part of the platform providing access to the trade finance deals. In contrast, a well diversified portfolio will have a natural resilience to regional, seasonal and sector risks. The short-term nature of the underlying loans – typically only three months – also provides additional flexibility.
The attraction to insurers is that trade finance offers better spreads and shorter duration than comparable fixed income products. By Allianz Global Investors’ estimates, a target portfolio yield could be 3 month Libor plus 275bp – over a 100bps wider than investment grade corporate bond indices of three years maturity.
There was also an open and broad discussion around the table about the risks associated with trade finance – dilution, late payment, bankruptcy and reputational risks in particular. Due diligence to ensure the initial quality of each loan is key, as well as operational robustness to monitor positions as well as move money in and out quickly.
The depth of discussion indicates asset managers and insurers have moved on from debating the possible merits of the asset class at a high level to considering how to actually implement and action portfolios. In an environment of uncertainty, finding new directions can only be a good thing.
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