Article

By Mark Ford

With trade finance flows apparently reviving as the global financial crisis ebbs unevenly away, it appears the shape and dynamics of the global letter of credit market are changing. While global banks will continue to be agents of change, an emerging set of new forces will also be driving the L/C market.

Some of these new forces are emerging out of Asia, but there is also potentially significant energy for change coming from Africa and the Middle East. Some may have been inspired, if not necessitated, by the worldwide economic downturn, which left emerging economies feeling let down - or at least not well served - by the US dollar-oriented global banking sector during the crisis. Several regional and local financial institutions, sometimes underpinned by multilateral development banks, now seem determined to improve their own, and possibly the global L/C environment.

Chinese currency

Potentially the most significant change to the world's L/C markets will grow out of the recent launch of the renminbi trade settlement (RTS) pilot program discussed in the previous issue of DCInsight. It envisages the replacement of L/Cs denominated in US dollars with those written in the Chinese currency.

Several recent developments suggest that the idea of settling trades in the Chinese currency is gaining traction, and that the impact of the program if it proves successful - and converts from a pilot scheme to a trading norm - will stretch well beyond South East Asia where the renminbi would almost certainly become the staple currency for L/Cs. DCInsight has learned of one deal involving a Chinese bank using RTS to settle deliveries of commodities from Latin America to China via a US trading company.

Global financial institutions are also fast latching onto the idea. JPMorgan announced in May that it had received approval to provide RTS to China-based corporate clients as a domestic settlement bank through its Shanghai branch, JPMorgan Chase Bank (China) Co. Ltd.

The bank can originate and receive payments in renminbi to settle certain transactions and offer import L/C issuance and payment, export L/C advising, negotiation and confirmation, as well as standby L/C or bank guarantee issuance in the Chinese currency.

Other major banks preparing for a more international renminbi include Bank of America Merrill Lynch, which has joined the People's Bank of China program, and HSBC, to launch current accounts in the Chinese currency. Malaysia's CIMB Bank, Hong Kong's DBS and emerging market specialist Standard Chartered also offer the service.

The economic benefits of RTS to China should not be underestimated. It could enable China's manufacturing exporters - who are a mainstay of the country's economy - to steer clear of the negative effects of an appreciating Chinese currency. As the renminbi appreciates, China's exports become more expensive when transactions are settled in US dollars. Settling transactions directly in renminbi reduces costs and uncertainty around the exchange rate.

Other Asian/Middle Eastern developments

Elsewhere in Asia, the role of smaller banks in the L/C market is being enlarged. The Philippines Central Bank has introduced several measures to enable the country's thrift banks to issue foreign L/Cs. It has reduced staffing requirements so that these small banks now need only one fully experienced manager to oversee L/C processing. Previously, all staff handling L/Cs needed to show previous L/C experience. Cooperative banks in the Philippines have also been authorized to open more branches and offer more services.

Larger banks are clearly aware of the healthy demand for L/Cs in Asia and the increasing role smaller banks will play in that market. JPMorgan, for example, has signed a new Credit Guarantee Agreement with the Asian Development Bank's (ADB) Trade Finance Facilitation Programme (TFFP), which provides guarantees to confirming banks and revolving credits to issuing banks in developing member countries. Under the new agreement, JPMorgan can expand risk coverage via the program to new markets, including Indonesia, Nepal and the Philippines.

Larger banks are also responding to increased demand for L/Cs in the Middle East, where several local banks are already expanding their trade finance departments. Major banks such as Citibank are increasingly featuring L/Cs in their services in the UAE, and the State Bank of India is also entering the market via Dubai to facilitate L/C flows between the Gulf and India.

Africa

Africa has responded with great interest to offers from multilateral development banks to help the continent's trade finance flows. Earlier this year, the African Development Bank (AfDB) said it had received applications from regional financial institutions for about USD1bn of trade finance since launching its new facility last year.

But banks and governments in individual countries across the continent are making their own plans as well, perhaps to ensure that L/Cs do not dry up again as they did during the financial crisis. In May, Rwanda Development Bank (Banque Rwandaise de Développement -BRD) announced the launch of its trade finance facility, which aims to benefit both exporters and importers. Pre-shipment export financing, import and export L/Cs and export L/C confirmation are amongst the services on offer. The facility has a significant emphasis on services to make sure that trade documentation - for open account and other financing instruments as well as L/Cs - is properly processed. The new service is specifically designed to support small business growth and aims to boost Rwanda's exports, especially of traditional products such as coffee and tea.

Improved access to L/Cs for domestic use is a target for the government of Kenya, where commercial banks are expecting to see USD275 million flow from a stimulus package specifically aimed at providing Kenyan businesses with the financing instruments they need to participate in government contracts. The scheme aims to help local firms obtain the L/Cs, bid bonds and bank guarantees they need to back bids for lucrative contracts in the Kenyan government's ambitious construction program.

African trade finance availability should also improve as a result of initiatives to boost bilateral trade with more developed countries. In March, Export-Import Bank of India (Exim Bank India) opened a USD15 million credit line for financing Indian exports to the Republic of Benin. Eligible exports include machinery, equipment and services. L/Cs under the current credit line for goods and services, which specifically target purchases of railway equipment and agricultural equipment, can be opened until October 2015. This arrangement followed a similar USD36 million credit line for financing Indian exports of eligible goods and services to Mali.

Elsewhere in Africa, one Ugandan financial consultant told DCInsight that local banks were increasingly gearing up to offer L/Cs as the country's financial institutions adapt and develop to serve an increasingly dynamic and sophisticated business environment in the country.

These trends and initiatives in Africa's L/C markets are encouraging to see, but on their own these country-specific or bilateral L/C initiatives seem unlikely to make much of an impact on the global L/C market. However, the steady inclusion of smaller banks in Africa and other emerging markets in the global L/C system - often underpinned by the multilateral development banks working with larger, established banks - has created a dynamic that, in the long run, could make a big difference in the L/C market worldwide.

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