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Middle East

Trade Finance on the Growth Path in MENA

Trade finance has already featured heavily in MENA funding over the past two years, but appears set to play an increasingly large role in the region going forward. The drivers for this type of financing include both critical new projects on the horizon and the need to service budget deficits. To this end, borrowers have looked to tap new pockets of liquidity, while the search for yield has drawn in even the most conservative lenders despite increasing competition and costs.

Dec 7, 2016 // 2:30PM

Barclays is the latest international lender to announce it is looking to tap into trade financing, an area of finance that deals with short-term financing of import and export transactions, in MENA, following several Japanese and American lenders. The interest in trade finance from foreign lenders has been seized on by borrowers from the region.

The past two years have seen sizeable deals close, largely due to a healthy increase in trade. In the first six months of 2015, trade reached US$145bn. Non-oil trade in the UAE in the first nine months of last year grew slightly at US$215.6bn compared with the same period a year earlier.

In November 2015, Egypt’s EEHC received an export finance-backed loan for the construction of three combined cycle power plants in the country, which will increase its power production by around 50%, and in June this year Petroleum Development Oman (PDO) received a US$4bn senior secured pre-export term loan facility.

The popularity of trade finance across MENA appears set to continue, with an already substantial pipeline building up. Initiatives and projects such as Dubai’s Expo 2020, the Al Maktoum International Airport, the Red Line Metro project, and a series of Qatari port and maritime related projects expect to feature significant amounts of trade financing in the funding of their development.

Qatar is also considering banking its large gas field developments through such forms of financing, while Kuwaiti projects are also likely to see some ECA-backed financing in 2017.

Fighting the deficits

A significant driver for the recent uptick in trade finance activity is the development of refinery and other ‘central’ projects which are of key importance to their respective MENA sovereigns.

The need to finance widening budget deficits despite persistently low oil prices has also been a major factor in the turn towards trade financing for all MENA countries. This is particularly true for Saudi Arabia, Egypt and Oman, which recorded government budget deficits of 15%, 11.5% and 17.1% of GDP respectively in 2015.

“Most of the deals without a specific project finance aim, which have proceeds going towards ‘general funding purposes’, are done by government-related entities. Irrespective of the borrower, the funds all go to the coffers of the relevant state,” says Nick Vozianov, Director, Loan Syndications at ING, who worked on PDO’s US$4bn pre-export finance facility.

He explains that debt financing to assist in servicing respective budget deficits by Middle Eastern sovereigns is only a temporary solution. “There is the general expectation that oil prices will recover to a point where it becomes comfortable for the budget to become self-sufficient once again. In the meantime, MENA sovereigns just borrow.”

The reason trade finance is being considered as an indirect tool to fund budget deficits is simply because there is no alternative, and countries are looking to tap into new pockets of liquidity – a situation that has brought trade finance and ECA transactions to the fore.

This has had a noticeable effect on economies in the region, particularly when considering government deficits.

“The key impact of structuring and trade finance instruments on the region’s various economies is that it helps keeps budget deficits in check and prevents the economy from entering more dangerous territory until oil prices recover. Nevertheless, there are specific projects where we are seeing the construction of pipelines and refineries, or the upgrade of existing ones,” Vozianov says.

Other advantages

However, trade financing does provide other benefits to sovereign borrowers apart from simply offering a tool to service deficits and fund ‘central’ projects. Trade finance is also positive for growth, and is a good method for recycling money around an economy, a tactic Vozianov says is increasingly being embraced across the EM landscape.

“It is just another source of liquidity, designed to capture those banks that are less willing to lend unsecured.”

Indeed, the appeal of trade finance for lenders derives from the fact that it is a relatively capital efficient and a low risk form of financing because of its self-liquidating nature. It is also short-term and does not impact balance sheets too dramatically. These qualities have drawn in traditionally conservative lenders towards such types of financing in the region.

New regulations are also playing a role. One of the most resonant regulatory responses to the financial crisis of 2008 was Basel III, which triggered the deleveraging of banking balance sheets and constrained the availability of credit. Since their introduction, the adverse economic effects of the new regulations have led to the relaxation of capital requirements for trade finance assets.

This is paving the way for a renewed interest in trade finance, especially in those regions with high Basel III compliance, according to Deloitte. Most MENA countries are on track for a phased introduction of Basel III capital adequacy and liquidity requirements by 2019.

“We are actively looking to increase our role in trade finance within MENA, particularly because of the increasingly strong Asia-MENA link,” said one MENA-focussed DCM banker at a large Japanese bank

They noted that the main driver behind the Bank’s willingness to get involved in trade financing in MENA was that it was a relatively low-risk form of lending.

“Trade financing enables us to broaden our client base, particularly to clients that are not as keen to take on medium-term credit exposures as others.”

Costs and risks

Trade financing is not without its downsides. The costs of regulatory compliance and fraud risks have increased. Conducting due diligence and KYC (know your customer) is also a necessary, but expensive, process.

Nevertheless, even the most conservative lenders seem unperturbed by these factors. The banker noted that the cost of conducting measures such as fraud risks, due diligence, and KYC can be fairly manageable – but it takes economies of scale, which often means robust coverage in the relevant market.

Lenders are getting squeezed, however. High competition amongst creditors – which is only set to increase with growing interest in the region – has driven a race to the bottom on pricing in recent years, to the point where it has become one of the central challenges faced by lenders in the region. Many are squeezed on pricing and by lower yields elsewhere, but will nevertheless continue to target the region – particularly as oil prices continue rising.

“The low cost of financing for the borrower, prevailing in the region due to current competitive dynamics, is putting quite a few banks off as they are being squeezed by the tighter margins,” says Vozianov. Despite this, trade finance appears to have retained its popularity with lenders.

“Deals do still get done and the competition is still ripe because banks remain willing to lend in the absence of other opportunities.”

Middle East

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