While use of trade finance continues to climb, the International Chamber of Commerce's Banking Commission has warned the financial services market that small and medium-sized business (SMB) access to trade finance is disproportionately low, as large financial institutions (FIs) pull back from the SMB borrower segment. Despite the recent surge in alternative finance and FinTech solutions, designed to tackle the gap, the Asian Development Bank — which has pegged the global trade finance gap at $1.5 trillion — found evidence that FinTech firms have yet to make a meaningful dent.
Meanwhile, the trade credit insurance market has progressed along its own separate trajectory of innovation and FinTech disruption, with service providers targeting smaller vendors as potential customers that need to insure their invoices against nonpayment. However, the intrinsic link between trade finance and trade credit insurance offers an opportunity for providers of trade credit, according to Glenn Kocher, managing director of global trade finance technology firm LiquidX.
"We very much see [trade finance and trade credit insurance] as an adjacent asset class," he told PYMNTS in an interview. "But they've probably grown up separately because, traditionally, banks have looked at one as a financing opportunity or corporates looked at one as a monetization opportunity, and the other is pure risk mitigation. But I think, for a number of reasons, you start to see the two go more hand in hand."
Despite the separate upbringings of the trade finance and trade credit insurance spaces, the two areas have endured similar points of friction through the years. Trade finance and working capital are "old school" asset classes that — though worth trillions of dollars in size — continue to be transacted in a legacy fashion, said Kocher. That not only means a lot of manual processes and paperwork, but very little transparency and efficiency.
Digitizing the trade finance process is what led LiquidX to launch its trade finance transaction platform. However, as the company began to explore the points of friction that occurred prior to a trade finance transaction, Kocher said LiquidX learned more about the issues pertaining to risk underwriting and trade credit insurance, which similarly struggled with a lack of efficiencies.
While suppliers often struggle with those challenges as they look to protect themselves against the risk of nonpayment, he noted that lenders also bear those burdens.
Trade credit insurance can be a valuable tool to banks as part of the broader underwriting and risk mitigation process, which is particularly important as regulations impose stricter rules on banks' balance sheets. Kocher said those regulatory restrictions have tested FIs' ability to maintain relationships with their corporate customers and borrowers without increasing risk exposure. Trade credit insurance can be a valuable way to do just that.
It's one reason why the financial services space has begun to promote the convergence of trade finance and trade credit insurance processes. At the same time, the emergence of alternative and non-bank lenders has opened doors for new players to fill the trade finance gap. Since these players often lack the infrastructure to mitigate risk at the same level as a multinational bank, access to trade credit insurance is key to addressing specific repayment risks to which they are exposed. The tool, Kocher explained, acts as a sort of "outsourcing" of the underwriting process.
LiquidX's response to the opportunity to merge trade finance and trade credit insurance for lenders resulted in a recent partnership with insurance broking firm Marsh to launch a new platform, allowing relevant parties — including banks, investors and suppliers — to access trade credit insurance from the same platform through which trade finance deals are executed.
By not only digitizing, but integrating these two once-separate processes, Kocher said participants in the global trade space have more opportunities to gain deeper visibility into processes and transactions as they occur. Distributed ledger technology may be in a position to take that initiative even further, he added, by facilitating real-time visibility of trade transactions and access to trade document data, from quoting and pre-purchasing orders through settlement.
It's a valuable proposition for corporate traders to streamline workflows, as well as for financiers to further underwrite and mitigate risk.
"This could, first of all, solve problems on the treasury side by reducing the number of disputes, to make cash application and reconciliation a lot more efficient, and to improve cash flow forecasting and cash conversion," he explained. "But you also get a digital, objective identification of the underlying assets that give underwriters visibility in real time."