Trade Finance, Crisis and Regulation Marc Auboin, Counsellor

1. Trade Finance, Crisis and RegulationMarc Auboin, Counsellor

2. Trade Finance: the life-blood of trade • 3 basic realities • Trade finance is systemic to trade. Little international trade is paid cash - some 70-80% of world trade hence relies on trade finance (trade credit and insurance/ guarantees). During the worst of the financial and economic crisis many companies, especially smaller enterprises in both developed and developing countries, found it impossible or prohibitively expensive to obtain the credit they needed to trade. • Normally, trade finance (letters of credit, discounting of receivables against liquidity in the context of supply-chains) is routine, very safe finance. According to ICC’s trade finance loss default registry, the default rates on trade finance over the last five year is 0.2% - one of the lowest, if not the lowest, of all financial instruments. • Trade finance is hit by contagion of financial crises – and its shortage can in turn hurt trade. Most of trade finance is short-term (between 90 and 120 days). Its pricing depends a lot on inter-bank rates. Liquidity crises can have a detrimental effect on the primary and secondary markets for trade bills (LCs, bank acceptances).

3. G-20 involvement: London and Seoul • London Conclusions “we will ensure availability of at least $250 billion over the next two years to support trade finance through our export credit and investment agencies and through the MDBs”. • Seoul Summit Document “to support LIC capacity to trade (...), we note our commitment to (…) support measure to increase the availability of trade finance in developing countries, particularly LICs. In this respect, we also agree to monitor and to assess trade finance programs in support of developing countries, in particular their coverage and impact on LICs, and to evaluate the impact of regulatory regimes on trade finance."

4. G-20 Cannes Conclusions Development Working Group • “G-20 should ask the MDBs and the World Bank group, to expand as a matter of priority their coverage of Low-Income Countries, and further expand risk limits to allow for greater support to countries in which local financial institutions cannot support trade and traders cannot afford credit conditions.” • Two priority regions are clearly emerging from the above picture: Africa and Asia. The creation of a permanent trade finance facilitation program by the African Development Bank, the only region where it is missing, must be expedited. Basel Committee on Banking Supervision - “The Basel Committee on Banking Supervision has evaluated the impact of Basel II and Basel III on trade finance in the context of low income countries. As a result, it adopted two technical changes to the Basel regulatory capital adequacy framework related to the treatment of trade finance that will help promote trade with low income countries.”

5. End of the recovery phase experienced since mid-2009. Expectations strongly on the downside in terms of trade volumes and availability of finance to support them. Specific constraints linked to funding in US dollars for non-US financial institutions -- a problem felt acutely by trade finance community since trade is largely denominated in US dollars, further pressures on liquidity and capital linked to the simultaneous implementation of Basel II and III and the impact of the banking crisis in the euro-zone. At the end of 2011, the withdrawal of European banks from certain market segments, including commodity markets made headlines. It is a direct outcome of the combination of the above-mentioned problems such as difficulties in USD funding by non US banks, new liquidity and capital constraints and market concentration. Negative expectations confirmed by ICC-IMF snapshot survey of Jan 2012 (over 300 banks). • Whether this should be cause for concern remains to be proven, as, on the one hand, some better-off banks are ready to take up some market share, and, on the other, the volumes of trade - hence the demand for trade finance, have been weakening. With respect to conditions in different regions, the relatively easy market situation in Asia contrasts sharply with the deterioration felt in the rest of the world. Everywhere, though, spreads were moving upwards, in Asia because inflation and demand for borrowing were on the rise, and in the rest of the world because of supply-side constraints. The situation in Africa is marked local capacity problems continued to be felt mostly by smaller traders, while the bigger, commodity-based traders continued to enjoy international support.

6. General Features Overall features of Basel III (stronger capitalization requirements, liquidity constraints, even stable funding ratio) are welcome. WTO is supportive of the effort for a more stable finance system, that does not undermine the real economy, including international trade. Specific features: need to review its effects on trade finance • “Basel III” regulation impose a "leverage" ratio on off balance-sheet assets, in the form of a flat 100% credit conversion factor: that includes "unconditionally cancellable commitments, direct credit substitutes, acceptances, standby letters of credit, trade letters of credit, failed transactions and unsettled securities." Letters of credit are OBS assets for process reasons. Trade assets are not a source of leverage • The imposition of a leverage ratio under Basel III, together some of Basel II rules (in particular the confusion of the counterparty risk and the sovereign risk for poor countries) can increase the market price of trade finance in low income countries and hinder trade.

7. Coherence: creating the conditions for a dialogue with the regulators to address the “unintended consequences” of the Basel framework? • The discussion must be fact-based: the Trade Finance Loss Default Register, established by the International Chamber of Commerce with participation of 10 of the largest banks in global trade finance shows that, over past 5 years, default rate on trade loans is no higher than 0.2% of assets, with a recovery rate of 60%. Trade finance are amongst the safest assets, in any regions of the world (including low income countries). • Based on these indications, the Basel Committee on Banking Regulation has been engaging in a fruitful inter-institutional dialogue, including the WTO, the World Bank, and the International Chamber of Commerce. As a result, the BCBS announced on 25 October the waiver of the 1-year maturity floor on for letters of credit and the like for large banks, and the so-called sovereign floor for trade finance claims used by banks subject to the harmonized approach • Basel III foresees a review process to evaluate every year until 2013 the impact of regulation.

8. Thank you for you attention!