While trade finance evolved in complexity and size after the break-up of the oil market oligopoly in the 1970s, regulation of bank and corporate leverage ratios, following the 2008 financial crisis, has left a bank finance vacuum.
In this guest blog, Mikael Bonalumi, from Audentia Global, explains how alternative capital providers are filling the $2.5 trillion+ trade finance funding gap with value-added transactions backed by in-depth industry expertise.
Why is trade finance required?
As oil output has risen from 50 million barrels per day (mbpd) in 1971 to 100 mbpd today, the need to finance transactions has increased exponentially. Oil price increases have also driven the need for much more financing from the 1970s and 1980s when oil was trading at $2-$20 per barrel to its current $50-$100 per barrel range.
Banks were quick to capitalise on this opportunity and oil became a commoditised collateral. There was very little risk in issuing letters of credit and banks required no equity from the trading houses as security. Essentially, it was free money.
After the 2008 financial crisis, banks’ poor corporate governance practices were exposed and seemingly everybody wanted a piece of the market. Speculation in the markets was rife, as were lax lending procedures and excessive leveraged risk-taking. Some banks were forced out of commodity finance due to financing non-compliant transactions, further increasing the stakes.
Adjusting to new market conditions
Over the last two to three years, small and mid-size traders have had their bank lines cancelled or reduced. The remaining lines are take-or-pay-based where you pay a monthly amount as a ‘subscription fee’, whether you use the line or not, at least for smaller structures. Capital requirements as security from the banks have also increased.
Before the financial crisis, the collateral of the cargo was enough for the banks – clearly that is not the same in today’s market. As businesses’ physical trading margins are reduced in this competitive environment, they are still paying fixed costs, such as staff and rents, meaning that generating achievable stable margins over time is extremely challenging. Combine all these factors with the increased cost – and dwindling funding only places further stress on the system.
New regulations will result in the big being favored with their big balance sheets, promises of good governance and assets. However, this trend leads to systemic concentration risk, where the banks have little or no diversification in their portfolio. It also casts doubt on the small and mid-sized specialist commodity traders that deliver critical commodities from emerging exporting countries to consumer countries around the world.
How Audentia Global helps solve these challenges
Together with a team of physical commodity practitioners who had seen first-hand the impact that regulatory change is having on the physical trading community – not least the $2.5 trillion+ trade finance funding gap – we set up Audentia Global. We realised that there is a need for alternative sources of capital backed by a critically important understanding of the physical underlying commodity in order to be able to deliver additional expertise and value to a transaction.
At Audentia, we make structured credit investments in physical commodity transactions in the secondary market, by co-investing with banks to provide regulatory capital relief, and in the primary market, by acting as a bridge between financing banks and major corporates. Commodities drive the global economy, and so by introducing alternative capital to finance these transactions, we hope to provide a positive solution to the impact of these regulatory changes, while giving the traditional investor universe access to a compelling asset class.
It is now even more imperative that those with the right expertise work alongside the banks and major corporates. As new players that are not traditionally comfortable with commodity risk enter the oil/commodity market, there will be a growing need to ensure that all parties involved with investment proposals fully understand the true risks of these transactions. It may require the need to educate executives and management.
Adapting to changing times
Some trading houses are not what they used to be in the 1980s and 1990s, and their approach has become like a fund or family office that decides how to use available capital to maximize returns. Trading has almost become secondary, but it is a necessary means to monetize assets and the embedded optionality. A trader’s traditional role may very well change in the future, both in terms of remuneration, authority and prestige. Roles such as business origination and financial engineering may well be given more importance. However, we need to keep the pipeline of interesting deal proposals filled.
I would strongly advise any young trader to remain in this industry because it is fun, intellectually challenging, and gives you the opportunity to be involved in a changing industry as it transitions to a cleaner one, in every sense of the word. And you could possibly make some good money too. A good route is to spend three-five years in back office functions before getting to the front office. Use this time to invest in yourself because your market value increases rapidly if you are well trained. And be patient. There are many jobs that are tightly connected to the trading community, such as trading, business development, marketing, structured finance, M&A and projects.