New trade finance vision could open opportunities for asset owners
Trade finance is arguably the oldest branch of finance — facilitating the movement of goods and services around the world — and has grown into a $5.2 trillion dollar ecosystem. However, evidence is mounting the private debt segment of the sector needs to improve.
A recent Asian Development Bank study estimated that the gap in trade finance availability reached $1.7 trillion in 2020, representing 10% of global trade.
“Supply chain disruptions generated by Covid-19 have actually broadened the gap,” said McKinsey senior partner Alessio Botta.
The financing gap is a particular challenge for small, and medium-size enterprises (MSMEs) in emerging markets, according to a new report from McKinsey & Company in association with the International Chamber of Commerce (ICC) and Fung Business Intelligence.
The report outlines a new vision for the global trade finance ecosystem.
A 2017 World Bank study indicated that 65 million MSMEs were credit constrained, and financing rejection rates for such businesses run at 40%, said the report.
“Paradoxically, the technology needed to make the market more interoperable and fill the gap is already available, but it is applied at relatively small scales and without the support of common global standards that would enable significant adoption,” Botta told AsianInvestor.
CHALLENGES FOR MSMES
The report aims to reconceive the global trade finance system which can presently be characterised as a complex and fragmented ecosystem of decades-old manual processes.
The sector has historically been dominated by banks with around 40% of global goods traded being supported by bank-intermediated trade finance. However, the system continues to present challenges for MSMEs which is the predominant focus of the report.
“There is a technical challenge with making trade finance assets available in a secondary market because of lack of common standards and technical interoperability,” said Botta.
Recently, isolated ‘digital islands’, or closed systems of trading partners, have been formed to address specific pain points, but they do little to improve the overall picture, according to Botta.
“Some fintechs are trying to solve this, but often with solutions that - despite being technologically very advanced - create additional siloes and fragmentation in the market."
The proposed construct to reform trade finance would be built on three main blocks: first, digital trade enablers, which would be standards enabling digitisation of both trade finance and global trade at large; second, standards enabling specific digitisation of the trade finance industry; and third, best practices for trade finance interoperability. Governance could then be provided by a single global industry entity or by a consortium, McKinsey & Company said in the report.
BRIDGING THE GAP
Driving access for MSMEs to these emerging digital processes by scaling innovations such as digital identity, paperless trade, and transaction-based credit assessment in addition to traditional balance sheet credit scoring is key to the new vision as outlined in the report.
Enhancing the global interoperability of trade finance could also open the door for increased institutional investment.
“As of today, trade finance cannot be considered as an asset class. Indeed, given the lack of common standards and of a market infrastructure, trade finance assets are mostly locked into banks’ IT systems,” said Botta.
The report outlines a road map for digitally connecting and facilitating interoperation among existing networks through sets of shared standards, processes, protocols and guiding principles.
“The solution discussed in the report certainly opens the doors to an open infrastructure where banks could develop business models on trade finance and institutional investors would be able to contribute to filling the gap,” said Botta.