Where Can Institutional Investors Buy Trade Receivables?

Basel III and its new regulatory demands created high marginal costs of equity capital for banks, particularly with non investment grade exposures. Banks became increasingly keen to offload trade finance exposures when regulators raised capital requirements, reduced leverage and placed liquidity requirements on banks.

For the last several years, large banks have looked to move to an originate to distribute trade finance model and have been experimenting with various trade structures and products to distribute trade finance exposures to non banks investors, most notably:

  1. Synthetic securitizations – Synthetic securitizations involve an outside investor taking the first or second loss on a portion of the trade finance portfolio in exchange for a stream of payments. These transactions help reduce capital required, but banks continue to fund the loans. These transactions appear to be primarily occurring on a bilateral basis between a subset of the largest banks and a limited number of credit hedge funds. There has been one notable public deal, Standard Chartered’s Sealane I and II securities (in 2007 and 2011). Sealane created a complicated special purpose vehicle structure that involved creating a term note whereby short-term trade finance assets were replenished.
  2. Outright securitization – Citigroup and Santander recently sold $1 billion of trade finance assets in a SPV structure designed provide both liquidity and capital relief to the banks. The deal was priced at 83 basis points over Libor. Citibank has been working on this arrangement since 2008, a point that demonstrates how complex implementation of these programs can be in post 2008 world.
  3. Direct loan sales – large banks are increasingly attempting to bring investors and non-banks into their secondary market distribution efforts for trade loans.

To date, the scale of No. 1 and No. 2 above has been limited, with mass take-off not appearing imminent.

Right now, 2 of the best ways to invest in trade receivables appear to be:

  1. Invest in an institutional fund – that is the model for pension funds, endowment funds, family offices, etc. There are several trade finance funds out in the market today, and they are very different in terms of business model, structure, etc. Some examples include hedge funds Markham Rae and BlueCrest, plus specialists Federated Investors and Crestar.
    Banks that have done this in the past had bad experience – French banks have tried to create funds. Societe Generale set up a commodity finance fund in their asset management arm. There is a conflict of interest, with the bank originated its own loans for the fund. The risk of ADVERSE SELECTION is enormous. Investors parting with hard on cash aren’t stupid
  2. The second way is to invest in assets that are transferred from supplier and e-invoicing networks.

Understanding where and how these vendors transfer assets is a first step. None of these technology vendors offer collateral transfer or perfection of interest services embedded in their third-party finance models. So far, the arrangements made between tech vendors and third parties have been private arrangements (e.g., Tungsten and Investment Insight, Taulia and Greensill, Basware and Arrowgrass).

Trade finance and trade receivable assets are still a relatively niche area, not fully understood by many, but certainly offering attractive alpha yield opportunities in today’s short term fixed income environment.

Making this an asset class goes beyond stating it. There is critical infrastructure that needs to be put in place (custodians, asset managers, etc.) to scale this.

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Voices (3)

  1. Michel Fontaine:

    I believe we will see a major shift in the secondary financing of receivables. Many large corporations are starting to push were extended payment terms where many suppliers are stuck between a rock and a hard place.
    I believe the software platform giving full transparency to a very granular level with so many of those problems. In addition, this platform would have to do the servicing of those receivables.

    This is what we have built and continue building. I believe strongly in the expansion of trade finance and will come greater knowledge among bankers and users.

  2. David Gustin:

    Hi Lee
    It is best explained by a real live example. In the Qingdao fraud case, Citibank purchased metal from Mercuria and sold it back. But there was fraud, as the actual amount of the commodities purchased was grossly inflated by the Chinese counterparties. In essence, money was being exchanged without any real time verification of the hard physical asset. This happens any time an investor buys an asset – hence the reason we have custodians when we buy mutual funds – who act as our trusted counterparty to manage the flow of money between the money manager and us.

  3. Lee Pruitt:

    Hi David – very interesting article indeed. It’s really exciting to see the convergence and the “connected commerce” you’re covering. I was hoping to gain more insight into point 2, investing in assets transferred from supplier and e-invoicing networks. Could you expand a bit further as to what you mean by “collateral transfer”? Thanks

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