Title Treasury and Trade Solutions Subtitle November 2013 Global Trade and Structured Finance: Alternative Financing Options John Ahearn, Global Head of Trade Ted Yarbrough, Co-Head of Global Structured Finance 1 Global Trade: Industry Insights and Solutions Current Economic Conditions – Financial Crisis Is the financial crisis over or entering a new phase? 1 U.S. 2 Euro 3 Emerging Markets 2007-2008 2009-2011 2013/2014 Credit & liquidity crisis Sovereign debt/bank crisis Slowdown and volatility • Aggressive risk taking by • Deficit spending led to • Recent decline in EM GDP highly leveraged FIs rising government debt growth and stock indexes • Loose credit policies fueled • Significant sovereign • FX rates plunge for Brazil, rise in consumer debt and downgrades with spillover Russia and India home prices impact on banks who held • Triggered by collapse of • Caused global recession sovereign debt G10 imports and China as financial markets seized • Fiscal austerity and credit slowdown – tighter US • Required massive amounts crunch led to EU recession fiscal policy will take a toll of fiscal stimulus, bank • Required massive amounts • Many EMs have responded bailouts and bank b/s of bailouts within the EU for by fueling rapid credit recapitalization governments and banks, growth, loosening fiscal • US now experiencing many of which were policy and launching new modest recovery nationalized infrastructure projects • Challenges linger but an absence of new bad news rd 3 wave of the crisis or just a correction? 2 Global Trade: Industry Insights and Solutions Basel III Global Impact on Banks Basel III introduces radical changes in capital rules, new liquidity and leverage ratios as well as additional rules for global systemically important banks Issue Impact • Global Systemically Important Banks • Raise Cost of Funding in Emerging (G-SIBs) Markets • Leverage Ratio • Potentially binding constraint • Liquidity Ratio • Impacts deposit pricing • Counterparty Credit Risk (AVC) • Raises pricing on LC confirmations • One Year Floor on Tenor • Raises pricing on all short-term Trade financing Increases Quality and Quantity of Bank Capital forcing new approaches to Risk Distribution 3 Global Trade: Industry Insights and Solutions Banks Now Face Challenges in Meeting New Leverage Ratios… New higher non risk based “backstop” - likely to be the main constraint to asset growth Leverage Ratios of Major Banks as of June 2013 8.0 • Regulator desire to increase capital 7.0 US requirements in a simplistic fashion 6.0 • Concern about inconsistent use of bank’s 5.0 advanced models 4.0 EU 3.0 • Non-risk sensitive approach allows for 2.0 quicker cross bank comparisons 1.0 • However it tells nothing about the true 2.5 3.0 3.4 3.4 4.1 5.1 5.3 5.7 5.7 7.5 - risk of the underlying assets Barclay Deutsche Royal BNP HSBC Citi JP Goldman Bank of Wells Bank Bank of Paribas Morgan Sachs America Fargo Scotland Impact on typical Trade Transaction Basel II Basel III – US NPR Type of Transaction Leverage Ratio Capital Leverage Ratio Capital $20M Trade LC $20M x 20% CCF x 4% = $160,000 $20M x 100% CCF x 6% = $1.2M $50M ECA financing $50M x 0% CCF x 4% = $0 $50M x 100% CCF x 6% = $3M $100M FI Trade Advance $100M x 20% CCF x 4% = $800,000 $100M x 100% CCF x 6% = $6M Significant increase in capital for Trade transactions under Basel III Leverage Ratio 1 Supplementary Leverage Ratio of at 5% BHC and 6% Bank applies to the large US banks on a non risk adjusted basis; EU banks subject to 3% Leverage Ratio Source: Citi analysis; Reuters “Big banks face tougher lending rules than global rivals” published, Jul 9, 2013 4 Global Trade: Industry Insights and Solutions … And With LCR, Correspondent Bank Model is Dead Capital becomes more expensive as the value of deposits plummets forcing changes to traditional funding models and prices – new correspondent banking models will need to emerge Traditional Model Basel III Impact Cash Management, Clearing ● Additional overall capital for banks and Custody Capital ● AVC adds an additional 25% capital to most FI transactions Regional / Global Bank Local Banks FI Trade Advances Liquidity ● New Liquidity Coverage Ratio ● Global banks provided relatively ● 30 day Net Outflow for FI deposits cheap FI Trade Advances in make these deposits significantly exchange for deposit business less valuable: – Operating deposits @ 25% ● Value of deposits offset loan rates – Excess balances @ 100% making this an attractive relationship ● 30 day drawn down for Trade Loans at 40% incurring significantly higher ● Internal return hurdles typically met asset liquidity premiums Illustrative FI Current Post LCR Total Change Transactions RoRWA RoRWA in RoRWA Returns ● At current pricing internal return hurdles unlikely to be met China 29% 19% -10% India 9% 5% -4% Recent Citi analysis concludes that proposed LCR rules will cause typical returns from Correspondent Russia 25% 13% -12% Banking relationships to significantly decline: ROA Brazil 18% 13% -5% down 20 bps and RoB3RWA down up to 10 points Source: Citi analysis; 5 Global Trade: Industry Insights and Solutions Market Trends – Top 10 Banks Gaining Concentration Overall Market Growth 1.8% with the Top 3 Trade Banks Growing at 9x Market Growth Trade Market Share Trade Market Share 2008 2012 Top 3 Trade banks +5 points of 7% 12% market share 8% #4-10 Trade 10% banks +2 points of market share 1,500 to 2,000 78% 85% Trade banks - 7 points of market share 1,500 to 2,000 Trade Banks #4-10 Trade Banks Top 3 Trade Banks Drivers of Consolidation Scale needed for cost efficiency Required investment in technology and infrastructure – we spend more annually on IT than most Trade banks make in revenue Regulatory complexity and capital rules Access to USD funding Portfolio choices by banks to focus on core businesses Global network required to serve client’s global supply chain Source: Oliver Wyman report on Trade Market dynamics for market size; Top 10 Trade Bank size based on financial disclosures or estimates 6 Global Trade: Industry Insights and Solutions Market Trends – New Spotlight on Risk Distribution Basel III forces banks to rethink how they will use their balance sheets to generate returns shifting the emphasis from the traditional Book and Hold approach to an Originate to Distribute business model Activity Use of Bank’s Action Comments Direction Balance Sheet Book to Hold Asset Basel III capital requirements make returns Yes on Balance Sheet less attractive Funded participations done on a True Sale basis enhance returns No for existing deals, however as balance sheets becomes constrained under Basel III, originating banks will need to find Bank to Bank additional capital sources Distribution Yes Unfunded participations are problematic as they remain on the seller’s balance sheet and are dependant on the participant’s rating Need to develop investor appetite from Sell to alternative No insurance companies, investor funds investors and multilateral agencies Leverage Industry Partnerships such as BAFT / London Group, Partner with other No ICC Trade Register, AFTA and NAIC as well as club vehicles such banks as Trade Maps BNP Paribas’s Lighthouse (2013) Securitization No Standard Chartered’s Sealane II (2012) programs Citibank’s CABS (2006) 7 Global Trade: Industry Insights and Solutions Treasurer’s View – Macroeconomic and Geo-political Trends Governments are responding with protectionist measures and supporting their own companies with Trading patterns have changed: increased Export Agency roles in volume of world trade is slowing again providing financing and liquidity after growth of 22% in 2010. Demand against even short-term trade growth is currently concentrated in the transactions emerging markets and basic consumer goods Access to liquidity has Sovereign risk concerns and improved but it is still being market uncertainty have impacted by market turmoil. spread from the emerging Increased use of markets to the EU. Austerity receivables discounting, to measures imposed on obtain liquidity from sales some countries have the potential to cause unrest Access to risk mitigation has Commodity prices have been very become more difficult while the volatile, making transactions riskier need has increased. Credit (especially term transactions). insurance is hard to come by and More difficulties arise between costs have gone up. Significant buyers and sellers global move to share risk with banks on commercial based Small companies have felt the transactions effects of the crunch disproportionately. Large companies are increasingly concerned about counterparty risk in their supply chains 8 Global Trade: Industry Insights and Solutions Treasurer’s View – Changing Landscape Impacting Strategy Recent market developments and changes in the regulatory environment have brought increasing limelight on the treasurer’s role. Host of new regulations determining key strategy topics A few examples Implications Strategy • Basel III (Global) • Dodd-Frank (US) Improve risk management: Emphasis on visibility & • FATCA (US) control • Repeal of Regulation Q (US) Centralize Treasury Operations • Financial Transaction Tax (EU) Monitor regulatory changes and model impacts • MiFiD II (EU) • Solvency II (EU) Increase cash operational control; Manage local and Focus on Working Capital • Securities Law Directive (EU) regional cash operations Management within a global model • Single Euro Payments Area (EU) • Independent Commission on Banking (UK) Improve forecasting & cash Improve Risk Management • FSA liquidity regulation