Banking News

Crucial Global Trade Backstop Under Pressure

(27 April 2020 – Global) Banks and insurance companies assert that global merchandise trade flows could be dented further if a key financial product used to facilitate it is not supported. As the coronavirus pandemic and border closures negatively impacts global trade, private credit insurance, a guarantee that importers, exporters and their trade finance providers utilise to facilitate goods trade is now firmly in the spotlight.

Defaults are traditionally rare in trade finance, generally because loans are of a short term nature. Trade finance deals tend to last 60 or 90 days. Between 2008 and 2017, 0.4 percent of letters of credit (LCs) issued by banks on behalf of importers defaulted, according to the International Chamber of Commerce (ICC). Already Banks and insurers are reporting that the COVID-19 pandemic has yielded late payments on trade transactions, defaults and a withdrawal by credit insurance providers. Trade finance deals are private, and there is minimal pricing data available in the public domain. When borrowers default, creditors lose up to one third of what they lent (30 percent), the ICC estimates.

Trade insurance is a financial tool that ‘flies below the radar’ when markets are operating smoothly. The instrument effectively reassures both sides of the transaction in the event of payments or delivery default. Trade credit insurance (often labelled accounts receivable insurance) protects sellers against a buyer’s non-payment of debt, up to a certain percentage, typically 70 to 90 percent of the bill.  Most trade credit insurance policies include a ‘waiting period’ after a bill is due before a policyholder can make a claim, and 180 days is typical. It is expected that the first wave of COVID-19 trade credit claims will arrive by June 2020 and continue throughout the year. The anticipated surge in trade credit claims will likely be met with efforts by insurance companies to avoid paying claims. Trade credit insurers often raise the defense of “non-disclosure” to avoid paying claims.

Up to EUR€600 billion (US$650 billion) of trade finance was facilitated using private credit insurance in 2018. Major trade insurance providers include Euler Hermes (an Allianz subsidiary), Coface (French bank Natixis backed) and Atradius NV.

East & Partners Australian Trade Finance research reveals consistent improvements in overall customer satisfaction for trade insurance as a product in the last ten years. Custom research also reveals the proportion of active users of trade finance insurance varies significantly across institutional, corporate and SME segments, averaging 18.5 percent market wide. Usage is much higher among Asia’s corporates, evidenced by East & Partners Asia Institutional Trade Finance research focused on the Top 100 revenue ranked corporates in ten countries. A high degree of variance is evident between multinational corporations and domestic enterprises. Will these trends be broken as uncertainty ramps up?

Trade finance was halted in its tracks and global merchandise trade almost collapsed during the 2008 global financial crisis (GFC). Banks and internationally trading enterprises believe the situation is significantly worse at the outset of the current COVID-19 pandemic health crisis. Looking back to the last financial markets crisis, gross domestic product (GDP) in the United Kingdom (UK) fell by five percent in 2009 and defaults (nonpayments) increased by more than 50 percent according to credit insurer Coface. Economists now estimate the British economy will contract by at least six percent and as much as 13 percent in 2020, inevitably resulting in insolvencies.

The price of credit insurance is rising as much as 30 percent according to an employee at a European insurer. Some credit insurers could be forced to take drastic steps to protect themselves from increased risk, such as reducing as much as a quarter of coverage they extend. "That will leave a lot of suppliers high and dry and a lot of buyers nobody wants to sell to" the employee added.

“Companies have delayed payments in the leisure, entertainment, transportation, retail and hospitality sectors” stated Barclays Global Head of Trade and Working Capital, James Binns.

“The cost of credit insurance has gone up several times recently. That trend will continue or insurers will be more selective about coverage if governments don't step in” said Ebru Pakcan, Citigroup Global Head of Trade.

“Creditors can be at a disadvantage partly because letters of credit are often used by companies trading across challenging jurisdictions” said Tradeteq CEO Christoph Gugelmann.

"We are witnessing a troubling contraction in the credit insurance market. This is causing a lot of difficulties for companies” stated insurance broker Assiteca SpA President, Luciano Lucca.