Arranging insurance backed trade finance structures

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1 Arranging insurance backed trade finance structures London Countertrade Roundtable Ian Henderson 21 March 2012

2 Current environment Economic environment Bank liquidity: Fewer global players active in trade finance More stringent credit and risk criteria Liquidity more regional and/ or domestic Basle II & III implications Increased costs of capital and funding Investors have ploughed more funds into hedge funds in the last 3 months with average returns reaching > 4.5%. OPEC nations are ploughing cash into U.S. Treasuries at a more than 50 percent faster rate than all other foreign investors (circa US$258bn) Multinational company cash piles growing and M&A on the rise e.g. Japanese trading company investments forecast for 2012 > 3trn (US$38bn)

3 Trade loan characteristics Short term trade Small bi-lateral deals Specific documentation Underlying trade instruments/ documents are typically not rated The obligor may or may not be rated Cross border/ multi-jurisdictional Medium / long term trade Complex documentation Less readily transferable Floating rates Cross border / multi-jurisdictional

4 Tapping the liquidity There is an opportunity and a challenge to marry low risk trade transactions with the demand from investors for better returns Who are the investors? Insurance companies Pension funds Investment funds and hedge funds Sovereign wealth funds Insurance companies Least likely as a new liquidity source given their operating models and investment requirements Funding not a possibility but support of trade finance via insurance of trade related loans

5 Tapping the liquidity Pension funds Stringent investment standards most trade finance loans are unable to meet the criteria Sovereign wealth funds Strategic and large ticket Long term Governed by founding documents and constitutional principles & guidelines Investment & hedge funds Most common source of new liquidity in the trade related arena Regulatory constraints are minimal at present Hurdle rates often exceed sustainable funding costs for commodity related debt structures and operational requirements for trade finance can be a barrier Challenge is to convert traditional trade loans into a format institutional investors can access and fund with no additional significant impact on the obligor.

6 Is insurance part of the solution? Insurance does and can play an important role in trade transactions Used by investors/ funding parties and commercial parties A risk management tool reduce direct exposure to risks related to performance (credit); yield (crop); logistics (marine cargo); country/ sovereign/ government actions (PRI) Create sufficient or additional capacity (counterparty limit constraints) Syndication/ risk distribution alternative or complimentary strategy The risk transfer can assist in reducing the capital or equity allocation requirements (banks Basle II & III) Improve leverage for borrowers if funding partners/investors will lend against the insurance

7 Typical insurance based deals Receivables financing/ invoice discounting Bulk of factoring and invoice discounting facilities are based on adequate trade credit insurance coverage/ limits of the debtor/s Insurance and advance rates vary between 70-90% of invoice value Insurers reduced their limits and geographical coverage dramatically in 2008/9 capacity has improved but SME counterparties remain difficult to be covered. Letters of credit Numerous markets continue to rely on trade being facilitated via L/C s Banks have reduced FI counterparty limits and country limits Insurance is used to increase capacity (banks) Beneficiaries use insurance as an alternative to having their L/C s confirmed

8 Typical insurance based deals Pre-export finance Traders/ End Buyers pre-pay producers/ suppliers The non-delivery / non-payment risk (credit & PRI) is insured and the funding party is named as loss payee Banks provide the PXF on a limited recourse basis (via a trader/offtaker) or on a non-recourse basis (direct to producer/supplier) and insure the non-payment risk (credit & PRI) as required by their credit approval or risk distribution strategy. Margin call financing Tri-partite arrangement between obligor, hedge provider and funding party Funding party requires credit enhancement / non-payment cover on obligor The price risk and volatility are not insured but the quantifiable amount up to an established limit following a margin call which is then not paid (a credit default).

9 Typical insurance based deals Reverse Credit Insurance A form of self-insurance Trader/ producer puts an insurance policy in place which covers their own performance/payment risk up to a certain amount. In turn this insurance policy is offered to suppliers/funding parties as part guarantee for any exposure Usually form part of a framework / portfolio Insurers are selective on the parties covered and named as loss payee, with specific claim mechanisms.

10 However The PRI/ trade Credit insurance market has paid out substantial amounts under claims over the last 3-4 years. This has shown that the product and use of insurance works for banks and investors. In turn the insurers have become much more sophisticated in their risk evaluation and portfolio management In order to get the necessary cover the insured must provide financial information, contracts/loan documentation, track record & experience, etc. Premium rates are a function of the finance rate/ economics of the underlying deal size, tenor, one-off Underwrites will need to know the motivation and reasons for buying the insurance Full disclosure to the underwriters on an on-going basis Be clear on the actual risks insured and exclusions

11 In closing Trade finance deals and structures incorporating insurance products are more common (whether disclosed or not) Insurance should form part of the package/ solution for a variety of reasons Insurance does assist in tapping into liquidity but is not a funded solution in itself The deal and counterparties need to stack up if the liquidity nut is to be cracked!

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