Estimated reading time: 4 minutes

Credit rating agencies are a vital part of the financing industry. Their research, evaluation and publications help clarify an otherwise complex ecosystem. Without this knowledge, lenders would be vulnerable to potential faulty borrowers, exposing the lenders to greater financial losses.

However, companies like Fitch Ratings also work with funds and the trade finance industry. At the ITFA and BCR: Trade & Investment Forum 2023, industry experts gathered to discuss how to make trade an investible asset class. If this initiative is to move forward successfully, it will need the involvement of the rating industry to ensure safe investments.

At the ITFA and BCR: Trade & Investment Forum, Trade Finance Global’s (TFG) Deepesh Patel spoke with Abis Soetan, director at Fitch Ratings, to learn how the industry is evolving to incorporate trade as an asset class.

Credit vs fund ratings

Credit ratings are a well-known staple of the financial industry. Simply by skimming through one of the major newspapers, you would almost certainly run across a mention of investment grade AAA or non-investment grade BB ratings. However, companies like Fitch Ratings also research and rate investment funds. 

Soetan broke down the definitions, starting with the more common credit rating, “Traditional credit ratings that we’re used to, it’s sort of an opinion on the likelihood of a debt security meeting, its commitment or its obligation. 

So, for example, it has a principal payment on a fixed date or principal and interest payments. And what’s the likelihood of meeting those payments? So that sits on the liability side of a transaction.”

Having to rate funds is a bit more complicated and requires a deeper understanding of the assets and country or region context.

Soetan explained the differences in rating funds, “So when we’re rating funds, we’re not looking at the liability side, we’re looking at the pool of assets, what’s the likelihood or what’s the vulnerability to default losses on that pool of assets, from credit risk and also from market risks. And that’s a bit unique when we look at market risks, like interest rate risk and currency risk, that type of thing.”

Challenges with trade finance as an asset class

Reputation is everything in the world of international trade and finance. In order to make trade finance into an investible asset class, investors need to have high levels of trust and confidence.

However, due to a litany of problems and scandals in recent years, the trade finance industry is struggling with reputational issues.

Soetan said, “Some high-profile trade finance funds, or those sold as trade finance funds, ran into some issues, and the sector or investors tarred the whole industry with that brush.”

It will take time to recover from the deterioration of the trade finance image, but this process has started. The industry is currently taking steps to rebuild its reputation and educate the broader financial industry about more traditional trade finance funds.

Another problem with turning trade finance into an asset class surrounds the concentration of assets. If, for example, trade finance were to be securitised, the portfolios are far more concentrated than a normal consumer loan. This concentration means that rating companies have to change their programming, Soetan said, “We probably have to have a bottom-up sort of approach.”

Connecting and educating the trade finance community and investors

Making trade finance an investible asset class requires a collective effort, which means the industry needs to be collectively educated as well. While some actors, like banks, insurers and pension funds understand how to invest in trade finance, others have less experience.

Soetan said, “Once you want to get corporate treasurer investors, I think that’s where probably a lot more education is required, so they understand what a trade receivable is.”

What are the topics that Soetan think are the most important pieces of education?

• What is the expected return and timeliness of payment for an investment?
• What is the likelihood that the terms of an investment are fulfilled?
• How sensitive is an investment’s expected return to market risk?
• What liquidity risk is being taken, and is it consistent with the investment objective? 
• How does the investment vehicle or structure address the above questions (credit, market and liquidity risks)?

The wider financial world may understand the basic workings of the trade finance industry, but for many, it is an industry filled with complex instruments and unconventional structures. In order to really move the ball forward and make trade finance an investible asset class, the industry needs to attract a wider range of investors. 

Soetan thinks the very next step is education for the basic investor, “Education is important for those corporate treasurers or… cash investors. Just make it very simple for them.”

Once the industry creates easier structures and spreads the knowledge to the wider financial world, progress will occur at a much faster pace.