Trillion wide trade finance gap causes ‘challenging environment’ for insurers and SMEs

Trade credit insurance complimenting trade finance can help SMEs survive financial crunches, but the shortfall in the availability of these tools is causing significant challenges for both businesses and insurers alike.

Trade finance refers to the financial products and services that facilitate international and domestic trade, such as letters of credit, trade loans and export financing. Trade credit insurance, meanwhile, aims to protect a company against non-payment by its customers.

These two interrelated products are especially important for SMEs because they can help these businesses better manage their cash flow and obtain the goods or services needed to continue operating during times of economic struggle – even if the business is deemed more risky by being in an emerging market or having weak credit, for example.

However, speaking exclusively to Insurance Times, Allianz Global Investors’ (AllianzGI) chief investment officer of global high yield strategy and co-portfolio owner of the Allianz Working Capital Fund (ALWOCA), David Newman, highlighted that “when economies do worse”, banks – which typically use trade finance as their “bread and butter” – “typically pull financing from the weakest credits”.

This reduction in financing has been exacerbated by increased regulation on banks to not grow balance sheets amid record-levels of inflation, Newman continued.

At the same time, firms insuring trade flows will “often act very similar to a bank - when actually, [as] the world goes down, they insure the weakest companies less”, he added.

As a result, “it is likely that SMEs will see financing getting withdrawn or becoming a lot more expensive”.

According to the 2021 Asian Development Bank (ADB) trade finance gaps, growth and jobs survey - published in October 2021 - the global trade finance gap was estimated to have increased to $1.7tr (£1.4tr) during the Covid-19 pandemic in 2020 – up from $1.5tr (£1.2tr) in 2018.

The report further found that during the pandemic, 40% of trade finance applications rejected by banks were from SMEs.

ADB surveyed 79 banks from 43 countries and 463 firms from 72 countries between April and July 2021 to establish its findings.

But how has the shortfall in trade finance impacted insurance companies?

Rising premiums

In August 2022, insurance broker Aon predicted that market conditions for trade credit cover would “remain challenging”. 

Tom Danson, managing director of trade credit and surety at PIB Insurance Brokers, told Insurance Times that this “challenging environment” has affected insurance companies in several ways. For him, this includes:

• Reduced demand for trade credit insurance – as tried finance “dries up”, the appetite for trade credit insurance has “decreased”, therefore “reducing revenue for insurance companies”.
• Increased risk – as more trade finance deals fall through, “insurance companies are exposed to greater risk of default and potentially larger losses”.
• Higher premiums – “in response to increased risk, insurance companies are beginning to raise premiums, making trade credit insurance more expensive for businesses”.
• Diversification of portfolio – “some insurance companies may look to diversify their portfolios to mitigate the impact of the shortfall in trade finance on their bottom line”.

To improve both trading relationships and the current trade credit insurance landscape, Danson noted that greater collaboration is needed to “develop more innovative solutions to provide trade finance to SMEs”.

He further suggested that offering educational programmes and resources for SMEs will better businesses’ understanding of trade finance and insurance options.

“Promoting greater standardisation and consistency in trade finance and insurance practices [will also] reduce confusion and simplify the process for SMEs,” he said.

Navigating uncertainty

Some firms are already taking action to mitigate trade credit challenges.

Broking trade body Biba, for example, launched a guide around trade credit insurance in April 2022 to help businesses protect their cash flow and explain how this cover “works and the additional benefits it provides”, said the association’s technical services manager Shaune Worrall.

The ABI, meanwhile, has an infographic and article explaining the trade credit insurance process on its website.

AllianzGI, on the other hand, launched its second trade finance fund – the Allianz Working Capital Investment Grade Fund (ALWOCA IG) in November 2022, which builds on the ALWOCA launched by Newman in 2019.

This fund offers investors exposure to ultra short-term trade finance receivables with investment grade credit risk – its short interest rate duration allows resets to rising rates, while the fund’s lack of reliance on capital markets aims to help reduce volatility if the credit cycle deteriorates.

AllianzGI’s senior portfolio manager, Martin Opfermann, said the firm believes the fund is a “cash plus alternative that seeks to stabilise portfolios in today’s world of elevated asset class correlations”.

Newman added: “We believe the characteristics it offers are particularly relevant to investors today in an environment of heightened geopolitical tensions, volatile bond yields and rising inflation. In this environment, trade finance can offer the flexibility and potential returns to help investors navigate the uncertain outlook.

“As more people come in and like the asset class, there’ll be more demand for it and that will provide the extra financing which the world needs because the banks don’t have the capital to fill in all the holes.”