Trade Finance Update for Multinationals and Financial Institutions

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1 Trade Finance Update for Multinationals and Financial Institutions A Discussion on Recent Developments in Trade Finance Presented by: Ricardo Martinez, Partner, New York Lloyd Winans, Partner, New York January 31, 2012

2 Agenda Regulatory Landscape for Trade Finance Basel III an Opportunity for Trade Finance Trade via Letters of Credit Open Account Trade Supply Chain Finance Borrowing Base Facilities Trade Finance Update: A Discussion on Recent Developments 2

3 Trade Landscape for 2012 Basel III Higher Capital Requirements will impact trade finance pricing Leverage ratios may require European banks to dump trade asset portfolios Counterparty exposure rules will contribute to dollar liquidity constraints European Debt Crisis European banks hold large amounts of Greek, Italian, Portuguese and other sovereign debt US hedge funds dumping millions in CDS on European sovereign debt European banks require significantly more capital to manage the crisis South to South Trade among emerging economies is expanding rapidly New commercial corridors are linking emerging markets in Asia, Africa and Latin America Trade Finance Update: A Discussion on Recent Developments 3

4 Basel Evolutionary Developments Basel I Established a minimum total capital ratio Utilized a credit risk model largely focused on solvency risk Risk-weightings were prescribed Later a VAR model for market risk was introduced Basel II Changed Credit Risk to formulaic Probability of default, loss given default, exposure at default and maturity One year floor on tenor, regardless of actual transaction tenor Introduced a new operational risk measure Enhanced risk weighting measure Provided for assessment of bank s risk management policies, stress testing and internal capital adequacy assessments Trade Finance Update: A Discussion on Recent Developments 4

5 Basel III Increased Capital Requirements: Risk based increases from 8% to 10.5% Regulatory capital limited to common shares and retained earnings New 2.5% capital conservation buffer Potentially up to 2.5% counter cyclical buffer Introduces a leverage ratio as supplementary to risk based capital ratios. Different from Fed which bases leverage ratio on GAAP assets, Basel III will incorporate most off balance sheet items at 100% conversion factor (i.e. commercial LCs, export agency guarantees, etc) Establishes global standards for high liquidity buffers A 30-day Liquidity Coverage Ratio requiring high quality liquid assets equal to highly stressed cash outflows. A one-year Net Stable Funding ratio requiring available stable funding to equal required stable funding. Trade Finance Update: A Discussion on Recent Developments 5

6 Basel Impact on Trade Finance Leverage Ratio: Basel III Implements a 100% Credit Conversion Factor in calculating leverage ratio for contingent trade finance exposures Static CCF for all off-balance sheet exposure does not consider the short term, self liquidating nature of trade finance instruments (same ratio as derivatives) Basel Committee rejected the lowering the 20% CCF under Basel II standardized and FIRB for short term self liquidating letters of credit. Tenor- Basel Committee provides an exemption to one-year maturity floor to letters of credit, permitting the calculation on the effective maturity Other trade finance products may be exempted, subject to national discretion Sovereign Floor risk weighting under Basel II is waived for low income countries for letters of credit New Liquidity measures fail to recognize trade finance instruments as liquid assets Asset Value Correlation for Trade Finance products (short term self liquidating) is not separate from other corporate banking products consumer products have separate AVCs Trade Finance Update: A Discussion on Recent Developments 6

7 Is There an Opportunity in Basel III for Trade Finance? European Banks may seek to develop alternatives to exposures on products that attract heavy capital charges and coverage under the leverage ratio and/or the liquidity ratios Costing banks more to swap Euros for dollars Dramatic increase in South-to-South trade requires financing solutions Non-LC trade products: Open Account Trade, supply chain solutions, off balance sheet receivables purchase arrangements (reverse factoring) An Opportunity? US Banks and others can use high dollar cash balances to their advantage and drive new business in the current environment Trade Finance Update: A Discussion on Recent Developments 7

8 Trade Via Letters of Credit Contract Buyer Seller Payment Documents Application L/C Advice Documents Payment Documents LC Issuing Bank Issuance Payment LC Advising Bank Bank intermediation through processing of paper documentation and potential financing 8

9 Trade Via Letters of Credit (cont.) Pros Reliable, tested and predictable Financial protection for various parties Can provide financing (for Buyer and Seller) Cons Slow, document intensive and cumbersome Highly technical Increasingly expensive Trade Finance Update: A Discussion on Recent Developments 9

10 Open Account Trade Contract Buyer Documents Seller Payment Open Account Agreement Payment Buyer s Bank Payment Seller s Bank Bank involvement limited to payment processing 10

11 Open Account Trade (cont.) Pros Streamlined, quick Cost-efficient Simple legal structure Cons Lack of financial protection for various parties Does not provide finance option in itself Trade Finance Update: A Discussion on Recent Developments 11

12 Supply Chain Finance A SCF platform is typically electronic and internet enabled A SCF platform can provide a real-time clearing house for the purchase and sale of receivables on a discounted basis A multilateral can provide the bank additional credit capacity to support clients; suppliers from higher risk A multilateral can provide risk sharing of up to 100% of a client s account receivable (AR). A multilateral can also provide liquidity and discount AR itself AR is discounted by a multilateral using market based pricing. A multilateral may also accept bank proposed discount rate Buyer 1 Buyer uploads invoices (automated process) 5 Buyer pays full invoice amount on due date (automated transfers established) SCF platform provider (may be owned by Bank or independent) Supplier views invoices and requests early payment of approved invoices 2 Bank Multilateral Emerging market suppliers 3 Financier accepts early payment requests 4 Financier pays discounted invoice amount Multilateral provides funding or guarantee coverage 12

13 Supply Chain Finance (cont.) Does not provide financial protection So this option is best for parties that know/trust each other and engage in repeat business Does provide finance options For suppliers and, consequently, buyers Much faster & less document intensive Practical for today s rapidly changing world Cost effective Important in a world of shrinking margins Bank may have protection for any receivables it purchases under UCC Article 9 Proper legal documentation is required, however! Trade Finance Update: A Discussion on Recent Developments 13

14 Borrowing Base Facilities Loan 14 Loan Agreement & Security Agreement Lender Borrower Supply Contract Commodities Loan Agreement & Security Agreement Payment Cash Collateral Account Buyer Supply Contract Payment

15 Borrowing Base Facilities (cont.) Loan amount grows in value with Borrower s financing requirements The amount of collateral determines Borrower s ability to use its credit As value of collateral rises, so too does borrowing base Considerably less expensive than traditional unsecured revolving and operating facilities Banks internal rating suffers less Ideal preliminary step for further asset-based lending Factoring and account receivable purchases Supply chain finance Asset-backed securitization Trade Finance Update: A Discussion on Recent Developments 15

16 Contacts Ricardo Martinez Partner New York Tel: bakermckenzie.com Lloyd Winans Partner New York Tel: bakermckenzie.com Trade Finance Update: A Discussion on Recent Developments 16

17 Trade Finance Update for Multinationals and Financial Institutions A Discussion on Recent Developments in Trade Finance Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm.

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