Bridging the $1.7tn Trade Finance Gap: A New Opportunity Emerges
Trade Financing Transitions into a Recognized Asset Classification
The global trade finance market is facing a significant gap, with an estimated shortfall of $1.7tn according to the Asian Development Bank. This gap, which arises from the discrepancy between demand for trade finance and its available supply, can be addressed through a combination of strategies.
Addressing the Trade Finance Gap
A key solution lies in expanding access to finance for small and medium enterprises (SMEs), a sector that often faces barriers in obtaining trade finance due to high perceived risks and lack of credit history. Supply chain finance (SCF) solutions such as receivables discounting, factoring, forfaiting, and payables finance can optimise working capital and reduce dependency on traditional borrowing, making financing more accessible for smaller traders.
Another crucial approach is the adoption of technological innovations. Digital platforms, mobile-first trading solutions, and blockchain technology enhance transparency, reduce costs, and mitigate risks such as payment defaults or fraud. They also enable investors and financiers to engage more efficiently across borders, helping to close the financing gap.
Incorporating Environmental, Social, and Governance (ESG) criteria and green finance initiatives into trade finance is another promising strategy. This approach attracts capital interested in sustainable investments and expands overall funding capacity in trade.
Lastly, enhancing risk mitigation and transparency through instruments that guarantee payments or advance funds can encourage more financial institutions and investors to provide trade-related funding.
Overcoming Barriers to Trade Finance Investment
The slow uptake of trade finance as an alternative investment is largely due to complexity, risk, liquidity constraints, and limited infrastructure for trade finance as a distinct asset class. Mainstream investors often find it difficult to understand and evaluate the variety of financial instruments, legal environments, and national regulations involved in trade finance.
Investor concerns over liquidity and risk, particularly counterparty or geopolitical risks, limit their appeal compared to more transparent bond or equity markets. Additionally, alternative investors may lack exposure to or education about trade finance opportunities, and traditional trade finance providers may not have platforms that easily facilitate investment participation.
The transition to widespread digital solutions for trade finance investment is still underway, but advances in technology and growing awareness are gradually addressing these barriers. Capital markets access for investors is becoming more accessible, with the trade finance infrastructure now enabling end-to-end straight-through-processing of hundreds of thousands of instruments in a cost-effective manner.
If the largest asset managers were to divert just a fraction of their assets into trade finance, it could solve the global trade finance gap and enable banks to lend more. With around $7.2tn of trade currently bank-intermediated, half of which could become available to investors, this development could have a significant impact on global trade.
The trade finance infrastructure also promotes transparency and standardization, dismantling old complex processes. This allows alternative investors to channel more capital into banks and onto corporates, contributing to a more efficient and accessible global trade system.
Default rates for trade finance products are lower, and the time to recover in case of default is much shorter than for other products and asset classes. This makes trade finance a less susceptible investment to financial market volatility and geopolitical factors, offering a stable and potentially profitable opportunity for investors.
This article is an Alternative Credit Guest Article focusing on Trade Finance. The views expressed in this article are those of the author and not necessarily those of AlphaWeek or The Sortino Group.
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