Trade finance receivables as an asset class

Trade finance funds have become more attractive lately. This reason for this isn’t mysterious: investors are looking for non-correlated additions to their portfolios. Trade finance receivables are a plausible candidate for addition. In a recent conversation, Peter Mulroy, the secretary general of FCI, the world’s largest network of factoring companies, agreed with the hypothesis that institutional investors such as pension managers or endowments might well consider exposure to this class, but he explained, “It’s complicated and it’s not uniform. Many people don’t understand it. But if you do it right it is an excellent asset class,” and is the fastest growing part of the financial services sector. Consider, for example, as a hypothesis a small Indian concern (RiceCo) that is sending its product to Retail Chain Inc. (RCI) in the United States. RCI may not be a risky counterparty, but even at best RiceCo may have to wait months for RCI’s payment, even after the rice has arrived in the US. This can generate cash-flow issues. A trade finance fund might offer RiceCo 80% of the invoice value as an advance. It can get this to the exporter within 24 hours of the submission of the invoice, and contingent on confirmation that the goods have been shipped. The fund then steps into the exporter’s shoes and will be the recipient of the money from RCI. It will then forward the still-owed 20% of the invoice, minus its cut, to the rice exporter. This way the exporter avoids the cash-flow problems, and hands over to the fund any counterparty risk. The above hypothetical transaction is not risk free. In a crisis, even a Costco can become a risky counterparty. Even without a crisis, where the importer is a small or medium-sized enterprise, the counterparty credit risk is accordingly greater. There are risks on the other side of the deal, too. The exporter could end up shipping shoddy or non-conforming merchandise, putting the trade financier in the middle of a commercial dispute. Investors in a trade finance fund also have to consider headline and political risks. Trade wars can disrupt the flow and make it difficult for the fund to deliver a satisfactory return, Mulroy observed. But beyond all these concerns, in Mulroy’s words, “the biggest risk for the factoring industry is fraud.” Funds in this business have to be careful they don’t end up holding invoices that don’t in fact correspond to any ongoing transaction. This brings us to the interface between strategy and technology. There are two great tools for addressing fraud: artificial intelligence, and blockchain. As they both mature, they are producing a “revolution to the industry in transparency and authenticity.” Then there is Big Data. Consider in this light the business model of Drip Capital, a Palo Alto, California-based trade finance company with offices in India and Mexico. Drip describes itself as in essence a Big Data approach to the problem of finding and matching both the right SME exporters and the right US/UK buyers. Mulroy spoke of the major technological advancements of our day in alphabetical terms (ABCD) as: AI, blockchain, cloud-driven computing, and data. He isn’t surprised at Drip’s data-driven approach, though from his point of view the A and the B are both even more salient.

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