With a heightened awareness of credit limits, trade limits and exposures in the financial institution (FI) space, in doing business with each other FIs are seeking an understanding of where the opportunities lie. As we navigate through the ‘perfect storm’ of the current economic crisis, trade – which continues to deliver and drive business – should be one of the main areas of focus.
Trade keeps business lines open and it is an area that has generated a great deal of co-operation between banks, which is likely to continue into 2012 and beyond. Leveraging the multinational relationships between corporates, FIs have put in place trade facilities that support their clients’ activities while at the same time enable FIs to grow their own books. As a vehicle for driving revenue and activity, trade has become crucial for FIs.
In addition to internal reviews of business being undertaken by FIs as they assess their risk appetites to ensure they have a book they can sustain and support, external factors – in the form of regulation – are also forcing a reassessment in the FI business space.
Regulations such as Basel III and European Market Infrastructure Regulation (EMIR) will have an impact on trade activity between FIs. For some banks, the changes these regulations will bring about will force them to look at new ways to do business, in some cases becoming more reliant on partners. For others, there is an opportunity to take a leading role.
Regulators are very keen to ensure that no bank puts itself, the market or market infrastructure in a position of harm in undertaking trade business. Currently, there are many different regulations which govern the operations of financial institutions, not all of which are trade-specific. However, what is common with all of these regulations, is the obligation that the FIs will have to find a way to navigate through the regulatory environment in a way that provides comfort and reassurance while still allowing for growth opportunities. At the same time, the FI will want to benefit from the upsides that trade provides, notably increased flows, increased revenue, greater opportunity to build relationships – both with FIs and corporates – and increased opportunity to grow flows across borders.
The biggest trade flows in the world are found in channels that flow across different continents. This is appealing to some FIs because it enables them to operate in regions and markets in which their other lines of business are not involved.
The vast majority of FIs will continue to support the trade that their customers require of them and that will help those customers to grow their businesses. In today’s economic climate, this will typically require FIs to be very focused on a smaller number of corporate clients but it will also lead to working more with partners that can support their business through regional capabilities, higher levels of risk appetite or funding.
One of the key challenges with regulations is that every bank is expected to ensure that it is managing within the expected boundaries now, in order to demonstrate to its stakeholders, governments and the market that it is being prudent. This obviously has a knock-on effect in trade, which is heavily dependent on a bank’s ability to fund and the extent to which a bank can leverage its exposure to drive the right outcome.
Trade Market Makers
A smaller number of FIs will emerge as ‘market makers’ in the trade space. These institutions will approach the trade business as not only an opportunity to support their existing book, but also as an opportunity to continue to: grow in the market, acquire market share, to increase the range of corporate clients that they support because they have the facilities to do so, and to grow the range of FIs they work with because they have the risk appetite and the funding to do so.
These institutions will look at the current market scenario, albeit with the same caution and the same prudence as other FIs, but they’ll see the trade space as an opportunity to grow. The polarisation in approach between different FIs will drive strong competitive differences in the trade space, based on:
- Risk appetite.
- Ability to distribute risk.
- Ability to select deals.
- Quality of service.
- Ability to manage risk.
- Depth and breadth of market and relationship coverage.
- Strength of client and partner relationships.
A key difference will be risk appetite, which will be determined by the answers to the following questions: to what extent are we willing to take on more risk? To what extent will we be compelled to reduce risk? To what extent will we address only our current customer base, or even a reduced subset of that customer base versus acquiring new customers?
A key element of trade activity is the secondary market, both in terms of selling into it and, for some institutions, buying secondary risk as a means of generating new revenues and using them in a very responsive way. The ability to distribute risk and equally to acquire risk will separate the types of participants in the market.
Banks are even more beholden now to ensure that they question every single opportunity, no matter how attractive they appear, and question whether or not they are deals that they need to invest in. Every financial institution has to judge for itself whether or not the deals that it is being offered are worth having; if something looks too good to be true, generally it is. The way in which banks select deals, and whether they have the institutional self-confidence to turn down particular deals, will define their role in the market in the medium term.
Another differentiator will be price, which will be a key determinant of behaviour – some institutions will price to win business in order to grow their books, or they will price to mitigate risk and in some cases price themselves out of a deal deliberately because of the risk overhead.
The choice comes down to confidence and approach; banks need to decide exactly what the value of trade activity is to them and how that measures against their current risk appetite, which will have a direct correlation to pricing. If deals are competitive and they’re being asked to price very low in order to win the business, they have to make sure that that business is worth winning.
To a large extent, banks are paid to put a price on risk and in that sense it becomes even more important in the trade space among FIs because the price will be a large indicator of where your appetite is, where your comfort is and where you perceive the risk in any given transaction. Whereas price was once a competitive driver, it has now become an indicator of risk.
Quality of service
The service element is obvious in cash management and payments, but trade, too, has service aspects that are important. These include the ability to process trades, meet Know your customer (KYC) obligations and the ability to put in place agreements and structures quickly. Quality of service becomes a key differentiator and some banks will be very well set up to handle trade in whatever region or to make sure that trade going into other regions is handled at high speed. Other banks will be looking for FI partners to support that type of multi-regional activity where they just don’t have the service capabilities of some of the other players.
The ability to manage risk is a key determinant in selecting partners and corporates are seeking out the banks that they believe will manage risk well. This is also an approach that FIs are taking – judging each other in terms of how well they perceive that the other party manages risk. The ability to manage risk and be a risk compliant partner that can offer a low-risk opportunity has never been more important.
Depth and breadth of market and relationship coverage
The type of trade activity an FI has, and is offered, is increasingly being determined by a number of questions, including: who has the relationships with the multinational corporates that are driving trade? Who has the relationships with the FIs and the different markets to facilitate the trade? Who has the in-country coverage on both ends of the transaction to support the deal? Who has the market knowhow? Who has the legal resource in the different countries to put this in place?
Strength of client and partner relationships
The strength of a relationship between banks will determine the success of the trade business. Banks that aren’t naturally strong players in the trade business will see a good level of activity if they are managing their relationships well and if people feel comfortable with extending the scope of opportunities that they share with that bank. Relationships in some ways can often transcend some of the other differentiators already cited, and will influence the way in which a bank looks at another bank. If the relationship is very strong, they will obviously make every effort to mitigate any concerns they have elsewhere.
In these difficult market conditions, FIs are more closely than ever examining the relationships they have in the trade business. For the majority of institutions, knowing which partners are of sufficient credibility, that manage their risk well and can provide the biggest opportunity is going to be one of the biggest driving forces in the trade market during the next 12 months. FIs will engage in a smaller number of relationships in order to drive more activity with less risk.
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