Article

By Mark Ford

Substantial change should be expected in conventional letter of credit use over the next decade and beyond if the Bank Payment Obligation (BPO) gains popularity and if open account trading continues to dominate mature credit markets. Moreover, as André Casterman said in the summer 2013 issue of DCInsight, SWIFT's traffic statistics suggest that 70 per cent of L/Cs have a presence in Asia. But those thinking current circumstances necessarily signal a decline in L/Cs everywhere except Asia may be missing the prospect of lucrative business opportunities in some of the world's fastest-growing economies.

In emerging markets worldwide, several actors are determined to increase L/C flows. These include financial institutions old and new, national export credit agencies (ECAs) and multilateral development banks (MDBs). Moreover, a reason for Asia's dominance in the L/C market could be that its stellar, export-led growth over recent years has been substantially facilitated by good L/C availability.

Therefore, emerging markets looking to emulate similar growth should be intent on improving L/C availability, which the actors seeking to stimulate L/C flows in emerging markets recognize. There is huge potential upside for the documentary credit market in Africa, Latin and South America, the Middle East and less developed areas of Asia, where the scope for technologically sophisticated trade finance systems is limited. This makes the L/C not only the ideal tool for facilitating export-led growth in these economies, but also a key to infrastructure development in emerging markets.

Driving the global economy

Intra-emerging market - or "South-South" - trade is now one of the main drivers of the global economy. It may also shape the future of the world's L/C markets. China and India may be the leading protagonists in this process now, but parts of Latin America are close behind. Two regions largely unscathed by the global financial fault lines of the last six years, Africa and the Middle East, could provide some of the world's future powerhouses when it comes to trade. And L/Cs will also feature strongly outside conventional trade finance scenarios, such as infrastructure spending, where analysts suggest as much as US$45 trillion of spending in emerging markets can be anticipated over the next 25 years.

Two characteristics evident since traditional trade financiers started backing out of emerging markets in the wake of the 2008 global financial crisis are the emergence of ECAs and MDBs as substitutes or guarantors of private sector L/C provision for South-South trade.

Oman's Export Credit Guarantee Agency (ECGA) said in December 2013 that it plans to start providing L/C guarantees for non-oil exporters looking to sell into risky but lucrative markets. It plans to provide guarantees to exporters' banks for adding their confirmation to L/Cs to issuing banks in the buyer's country against payment risks. Export- Import Bank of India has made L/Cs available in several African economies to encourage buyers to import Indian goods or services.

Pioneered by the European Bank for Reconstruction and Development (EBRD) with the 1999 launch of its Trade Facilitation Programme, guarantees for international confirming banks that take the political and commercial payment risk of transactions undertaken by issuing banks in emerging markets have proved to be successful for other MDBs, from the International Finance Corporation to the Asian Development Bank.

Such schemes appear to be popular and continue to grow, suggesting sustained demand and indicating that they will likely remain on the landscape. And they are not confined to emerging markets. In November 2013, The European Investment Bank (EIB) approved a new financing instrument for Cyprus aimed at making L/Cs and other trade finance instruments more available, replicating an instrument implemented in Greece five months earlier, which the EIB says had a positive impact.

New trade corridors

Global banks are also stimulating L/C flows in emerging markets. HSBC Bank Armenia is helping the country tool up for export-led growth. In October 2013, it said it had issued 6.9 billion drams (US$17 million) worth of L/Cs since April 2013 as part of its campaign to finance equipment purchases. The bank's director of commerce and credit, Aram Pinadjyan, described the L/C campaign as an, "unprecedented ... financing tool" for the Armenian market and said it enables Armenian businesses to obtain import finance for equipment and production lines at unprecedented interest rates.

New regional centres, such as the Middle East, are surfacing, where shifting trade corridors are a key development. Positioned between the growth markets of central and eastern Europe, Africa and Asia, it is a natural hub for global intra-emerging market trade, and the L/C is an important tool. "L/Cs remain very much a core product of the banks in the Middle East, where traders are inherently cautious and conservative, preferring traditional trade instruments like L/Cs," one Qatar-based banker told DCInsight.

International financial institutions with roots in the northern hemisphere are already equipped with systems offering global reach and tools to ensure regulatory compliance in multiple jurisdictions. They may be well positioned to play key roles in the new world trade order, and are already well ensconced in Dubai, one of the contenders to become the established Middle Eastern hub in the new South-South paradigm.

Chinese influence

According to the World Bank's June 2013 Global Economic Prospects, more than half of developing country exports now go to other developing economies. This trend shows no sign of abating and is likely to feature a move towards financing in the Chinese currency, which according to SWIFT in December 2013, overtook the euro as the second most utilized currency in L/C transactions after the US dollar.

Trade in the Chinese currency will spread beyond Asia. Dubai has ambitions to become the next offshore renminbi (RMB) trading centre, while banks including HSBC, Standard Chartered and local bank Emirates NBD, already provide RMB accounts in the UAE, and several Chinese banks have established branches in the Gulf state. But London has also signed up for RMB services, with Agricultural Bank of China (ABC) and Standard Chartered Bank announcing in December 2013 that they will become the first UK-based banks to offer RMB clearing services.

Local Southern Hemisphere specialists are also emerging to provide L/Cs in the emerging South-South paradigm. Kenya's Equity Bank is targeting Chinese customers in its bid to increase the amount of L/Cs and of other trade finance business it writes. The bank's efforts seek to benefit from China's push for more influence across Africa, and the strategy appears to be working, since the bank reports strong L/C growth on the back of such business.

If China has propelled a substantial amount of L/Cs that made Asia the epicentre of today's L/C market, it seems to be sending a clear signal that the documentary credit is still worth investing in. In December, news emerged that the central bank was set to improve L/C provision on the mainland. The People's Bank of China is expected to establish a trial trading platform at the Shanghai Free Trade Zone, which has already attracted some of China's largest banks.

With Asia's economic powerhouse declaring itself, de facto, an advocate of the L/C as a valuable tool for a growing economy, it surely behooves those looking for future documentary credit opportunities to identify other economies planning export-led growth similar to those employed by China.

Consigning the L/C to history outside of Asia may well be focusing too much on the current situation and not enough on future prospects.

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