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Continued regulatory change drives trade credit evolution


Continued regulatory change drives trade credit evolution

The recent Basel Committee announcement finalising the reforms introduced after the global financial crisis will continue to drive the evolution of the trade credit insurance market, writes Marilyn Blattner-Hoyle of AIG.

Trade credit insurance has been around since the end of the 19th century and its development and evolution has been driven by economic growth and companies moving into unfamiliar markets – either new products or geographies. That growth brings with it uncertainties – do sellers know their counterparties sufficiently, especially in less well understood territories with different cultures and norms. This drove a demand to include credit and political risk when looking at risks which could be mitigated with insurance and also demand for insurers to set buyer credit limits and provide collection services.

At its heart trade credit insurance remains an effective way for companies to protect their accounts receivable from loss due to credit risks such as protracted default, insolvency or bankruptcy. During the global financial crisis the market evolved further with the introduction of policies with non-cancellable limits. And demand continues to grow. Despite political and economic uncertainty, in September 2017 the WTO issued a strong upward revision to its forecast for 2017 trade expansion – from 2.4% to 3.6% - following a sharp acceleration in the first half of the year. This is good news for the global economy as well as for the trade credit market, which will inevitably also see an uptick in demand.

Shifting sands of regulation

However, for banks looking to enter, expand or even maintain their trade finance businesses in this economic environment, there is a real and present issue around the shifting regulatory landscape in which they operate, and how the Basel III regime may develop.

Basel III, the global regulatory framework for banks that addresses capital adequacy, stress testing and market liquidity risk, has taken over 10 years to implement. December 2017 saw its finalisation, in which authorities set out new guidelines for calculating and managing the risk posed by trillions of dollars’ worth of mortgages, loans and other assets that lenders have on their books. It was the banking industries failure to account accurately for subprime mortgages that triggered the global financial crisis a decade ago and it is hoped that these new measures will increase transparency and accountability.

However, some pundits are already talking about “Basel IV” because according to many banking representatives, the requirements of the Basel Committee have expanded so much in recent years. With such a fluid and constantly evolving regulatory environment, banks’ and other financial institutions’ solutions on how to manage credit exposures need to evolve too.

A capital solution  

With these increasing capital pressures, insurance as a risk mitigation tool will be increasingly important to make deals economically viable for banks. Never has it been a better time to solidify partnerships with insurance companies to pursue these real capital benefits.

The solution here is for the bank to take out a Basel III-compliant trade finance insurance policy in order to shift the risk of corporate default to the insurer default (often a stronger credit risk), meaning the bank may not have to hold as much capital to be compliant with the rules. Flexibility of the insurer to match the bank’s own internal application of the capital requirements is key. Due to these requirements, the bank is often now the direct insured engaging directly with the insurance underwriters and the brokers, rather than just as loss payee or joint insured on a corporate seller trade credit policy. An additional benefit of this is that the credit insurer becomes a closer partner in the transaction and ongoing risk analysis and monitoring in a way that perhaps has not been the case in the traditional trade credit business.  However, there are significant differences in how banks (and their law firm advisors) are interpreting the Basel framework, so a “one-size-fits-all” approach does not work – insurers need to cater for this. 

US markets playing catch up

So far it is the European and Asian banks that have been leading the charge in optimising their opportunities by creative use of trade finance insurance, and those in North America have been somewhat behind the curve. This has been due to a variety of factors:

  • regulations differ from country to country, in terms of timing and requirements,
  • market conditions in various jurisdictions give rise to different concerns, and
  • different geographies have varying areas of operational focus.

However, the signs are that this is set to change. Although financial institutions in North America have been using trade finance insurance solutions they are starting to show greater interest in deploying them for capital benefits. As the implications and requirements of Basel III come to be felt, this will only accelerate in that region and elsewhere around the world, and the competitive advantage of those using these solutions will be felt across the board.

This article first appeared in Insurance Day on 14 January 2018.