In a whitepaper released last year, the International Chamber of Commerce (ICC) urged the trade finance industry to work together to ensure that regulation does not hinder the availability of trade finance. Olivier Paul, Director, Finance for Development at ICC, explains how a fair regulatory environment across regions is key to the industry’s growth.
In the wake of the financial crisis of 2007, regulation and compliance requirements have had the unintended consequence of negatively impacting trade finance provision. As banks adapt to ever greater compliance and regulatory requirements, they seek to minimize risk by reducing their number of correspondent banking relationships. This phenomenon, known as “de-risking”, especially affects small and medium-sized enterprises (SME) in emerging markets that need financing the most.
Accessing adequate trade finance is already tough for SMEs, who often lack the collateral, documented history of past transactions and knowledge of the financial instruments available to them. This has led to a US$1.5 trillion gap between the demand and supply of trade finance – or gap – as SMEs find themselves most neglected by financiers.
In its report, Banking regulation and the campaign to mitigate the unintended consequences for trade finance, the International Chamber of Commerce (ICC) outlines how some post-crisis banking regulation has unintentionally led to the widening of this trade finance gap. The report argues that industry advocacy is necessary to ensure fairer treatment of trade finance, as several examples already demonstrate.
Unintended Consequences and Successful Advocacy
Despite well-meaning capital and liquidity requirements contributing to the resilience of the financial system, they have also limited banks’ ability to invest in cross-border relationships, leading to concerns relating to the treatment of trade finance instruments across regions.
For example, the Basel Committee on Banking Supervision (BCBS) introduced the third installment of the Basel Accords – a set of international banking regulation recommendations – in 2010. However, the BCBS does not have the authority to enforce its recommendations, leaving national – or supranational – institutions to write the recommendations into law.
What’s more, these recommendations allow significant room for interpretation, allowing each jurisdiction to adapt them accordingly. This results in inconsistencies across jurisdictions, leaving emerging market banks subject to the resulting ambiguity.
In particular, the Net Stable Funding Ratio (NSFR) for financial instruments supporting trade finance caused concern among many industry practitioners. The European Commission and Council, as well as the European Banking Authority, recommended that NSFR have a variable rate of 5%-15% depending on the maturity of the transaction. In many jurisdictions outside the European Union, however, the NSFR rate is either flat – at a maximum level of 5% – or non-existent.
This represented a clear disadvantage, and one affecting the whole market. As such, the industry-led by ICC – advocated for a fairer treatment of NSFR ratios for trade finance. This resulted in a significant reduction in the spectrum of rates which now stand at 5% for a transaction maturity of under six months, 7.5% for a transaction maturity of under a year, and 10% for maturity of over 12 months.
To ensure the highest success rate, it is essential that discussions between industry members and regulatory authorities take place at the earliest stages of the decision-making process. With regulatory adoption and implementation processes taking up to a decade in some cases, the industry must work together with regulators and maintain a proactive approach to promoting fair regulatory treatment of trade finance.
The document outlining the finalization of the Basel III framework was published in 2017 but will only be enforced between 2022 and 2027. Action is needed today if the industry’s voice is to be heard and acted on.
Banks have already identified several areas relating to trade finance – such as the treatment of unconditionally cancellable commitments, the minimum durations to calculate risk-weighted assets and the treatment of subsidiaries in large groups – where discussion is needed. Over the next few years, banks and industry bodies will need to engage with these topics, as national regulators translate the finalization package into national legislation.
Some 80% of international trade flows involve the recourse to a financial instrument, according to the World Trade Organization. To encourage the use of trade finance worldwide – and ensure the widest market access especially for SMEs – harmonization of regulations will be required.
Much work has already been done to promote the fair treatment of trade finance within banking regulations. However, regulations will not adapt unless all stakeholders voice their concerns. It is up to the entire industry – and ICC, as the largest and most authoritative voice in trade finance – to be at the forefront of this work.