Trade Receivables as a Short Term, Fixed Income Product – Part I

This is a four part series on the emerging interest of Trade Receivables as a short term, fixed income product.   Part I talks about why the time is now.

The discussions I hear around investing in Trade Receivables as a short term fixed income product sound to me a lot like the movie “Its’ A Wonderful Life” when George was told to invest in Plastics.  His reply, “Plastics, Now, you listen to me! I don't want any plastics, and I don't want any ground floors, and I don't want to get married - ever - to anyone! You understand that?”

There are a lot of complexities around this space, but bottom line, it comes down to convincing Institutional Investors of the risks versus rewards.   The reward part is pretty easy –all fixed income investors looking for cash options have to do is look at the returns on U.S. Treasuries, Corporate Commercial Paper, and Bank Time Deposits and know those returns are at or near zero.  But the risk part is where it gets very interesting.  But let’s come back to that in a future post.  First, let talk about what the buzz is about.

What’s Driving the Interest in Trade Receivables

Trade finance receivables are short term, uncorrelated, primarily contract risk, not market risk. Low interest rates are forcing investors to look at new things in search for yield and trade receivables has sparked interest in a broad group of institutional investors, examples include companies like BlueCrest Capital, Guggenheim Partners, Integrate Financial as well as many unnamed Private Equity Funds and Family Offices, Pension offices, Property & Life Insurers and even Corporates themselves.  The question is why now?

There are three drivers:

  1. Regulatory Arbitrage – put simply, non banks do not have Basel III regulatory capital to be concerned about which enables capital arbitrage depending on the risk.  Basel III significantly impacts the amount of capital required by banks.  Basel III will increase capital ratios and calculations of risk weighted assets (RWA), will set a minimum leverage ratio and liquidity coverage ratio and extra loss absorption capacity of systemically important banks.  The increased regulatory costs are such that third party capital in many cases is more efficient than bank capital creating an opportunity for third parties, be they private equity funds or pension funds. What does this mean in English – for every $1 of funded (or unfunded obligations), banks and others have to put up more capital to absorb losses compared to their non bank counterparts.  Non Banks have to put up less, significantly less when it is non investment grade .
  2. Compliance Arbitrage – Banks must abide by the Patriot Act, Bank Secrecy Act, Dodd-Frank and other regulations that impact how they sign up new accounts, deal with non client relationships and manage transactions.  It is time consuming and expensive and continues to get more, not less onerous.  Non Banks simply do not have these same requirements.
  3. Receivables have a significant yield difference versus other short term investments - Trade finance and trade receivable investing can range from short term to long term, and direct to securitized investments. Short term trade receivables involve typical tenors of 30- to 90-day paper originated by either large corporations or B2B and Supplier Networks; long-term examples are 10- to 12-year paper that finances large-scale trade among firms like Ryan Air or Boeing.

 

The table below provides an example of yield pick up
Picture1

In our next post, we will overview what investors have been buying.

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