Article

by Mark Ford

Asia appears to be where it is all happening in terms of positive developments in the letter of credit (L/C) market. As Europe's banks retreat from some Asian markets, development banks are continuing to play a key role. Asia's banks are eyeing opportunities for L/C business in a new regional bloc, and China is intent on establishing renminbi (RMB) financing as a norm in international trade finance.

These developments will likely spawn more regional L/C business and perhaps see Australia emerge as a major offshore renminbi trade finance hub. This, in turn, could shape the future of the global L/C market.

Emerging markets

In the wake of the 2008 global financial crisis, one driver of change that emerged in Asia's L/C market was the role development banks now play in support of L/Cs for Asia's least-developed countries. The International Finance Corporation's US$3 billion Global Trade Finance Program offers confirming banks partial or full guarantees covering payment risk on banks in the emerging markets for trade-related transactions, L/Cs included. The Asian Development Bank operates a similar program, which in 2011 was focused on Bangladesh, Nepal, Pakistan, Sri Lanka and Vietnam.

Apart from these programs, other drivers in Asia's least-developed countries are likely to boost L/C business. One is the upcoming launch of the Asean Economic Community (AEC) in 2015. The central banks of all Asean countries are currently working to establish harmonious banking systems and drive financial service integration that will support intra-regional trading and investment.

Full financial liberalization in the AEC is not expected until 2020, but progress is being made in creating a framework in which the services of some of the bloc's more sophisticated trade finance providers will become available in lessdeveloped countries. Negotiations on a common standard for Qualified Asean Banks (QABs) are underway. The idea is that QABs will be able to operate in every AEC country.

Market opportunities

This opens up opportunities for QABs headquartered in Asia's more mature financial markets such as Singapore and Malaysia to develop networks in countries with relatively undeveloped banking sectors that have often been closed to foreign banks. The banking sectors of the four least-developed AEC economies - Cambodia, Laos, Myanmar and Vietnam, collectively known as the CLMV - could offer QABs attractive expansion opportunities.

Access to L/Cs across the CLMV is limited, reflecting their predominantly cash-based trading systems. Banks are few and far between, offering limited services. But even in the least developed markets such as Myanmar, at least four Thai banks are presently waiting for the authorities to allow foreign banks to set up joint ventures by 2014 and to open full banking operations by 2015.

Developed countries

There is also more scope for L/C product and market development in more developed economies. ICC, for example, has urged Thailand to open up its banking sector to allow foreign banks to write L/C and other trade finance business currently preserved for local banks. Jean-Guy Carrier, ICC's Secretary General, during a recent visit to Thailand, emphasized this point. He warned that while Thailand remains an attractive country for companies to do business, competitor countries such as Indonesia and Myanmar are honing their appeal to foreign investors. Recognizing the liberalization of Myanmar's economy and the liberation of opposition leader and Nobel laureate Aung San Suu Kyi, the US recently lifted import restrictions on a number of the country's products. ICC's Secretary General told Thai leaders: "You cannot afford to stand still while everybody is moving very fast to convince investors to do business. If you stand still, it means you are going backward."

Thailand has made a start. In December 2011, the Bank of Thailand issued policy guidelines allowing foreign banks with branches in Thailand to convert to subsidiaries, albeit with a limited number of branches.

Internationalizing the renminbi

There are other positive developments. China's strategy for internationalizing the renminbi (RMB) looks likely to have substantial implications, not just for the regional L/C market, but also for the international monetary system and economies worldwide.

The strategy has two planks: the creation of an RMB offshore market and, directly impacting on the L/C market, the use of the Chinese currency in international trade settlement.

Since 2009, a series of policy measures have helped loosen the constraints of the currency's limited convertibility and provide the RMB offshore market with firm foundations on which to build and expand. Offshore market development depends on liquidity supplied by Beijing, but this is limited by China's lack of financial sector scope and sophistication, so the lion's share of funds flow to and from the mainland via Hong Kong.

Hong Kong is seeing the most action when it comes to L/Cs. In May, data from SWIFT showed that the RMB had overtaken the Japanese yen to become the third-biggest currency by value in the global issuance of L/Cs. The US dollar retained the majority 84.4% share while the euro had a 7.0% share.

Still, curious discrepancies have emerged. The SWIFT data showed that while the RMB gained a market share of just 0.34% of world currency payments, it captured a 4% market share in the global issuance of L/Cs. This appeared too high, prompting some analysts to suggest that L/Cs denominated in RMB were being used to bypass China's strict controls over the movement of capital by Chinese companies looking to borrow at cheaper rates than they can on mainland China.

But even if some RMB L/Cs are used for nefarious reasons, they are still being employed increasingly for trade finance. This could have interesting repercussions for the world's elite stock of global trading hubs.

Regional hubs

Hong Kong will want to keep its position as a hub for the offshore RMB market and, perhaps crucially, it has the benefit of support from China's central government. Beijing is actively developing policies to make it attractive for foreign parties to conduct trade settlements in Hong Kong. These policies are expected to further secure Hong Kong's place as a major international trade finance centre. Singapore, where L/Cs abound because of the city-state's role as China's major commodities trading partner, is also fighting hard for RMB business.

Meanwhile, some Australian bankers are excited about the impact the process of the RMB's internationalization could have on their business. One senior Australian trade financier told DCInsight that the process could catapult Australia's traditional financial hubs into major financial centres for Asia.

Because of the massive volumes of bilateral Sino-Australian trade already in full flow, Australia has a significant competitive advantage in the international RMB market. As China relaxes restrictions on its currency, the conditions will ripen for RMB capital market opportunities, and few countries have such strong trade flows as the raw materials trade from Australia to China - with finished goods flowing the other way. Australia's case is strengthened by the withdrawal of European banks from their traditional financing roles. All of these conditions will spur opportunities for the issuance of RMB L/Cs or denominated debt issued by Australian banks in Chinese currency.

Asia's trade finance markets are clearly in flux, and the ramifications of their growth will be felt in L/C markets worldwide. l

Mark Ford's e-mail is markford@gotadsl.co.uk