Trade finance is advantageous to both importers and exporters as it keeps the trade lifecycle moving forward. Additionally, given that some 80 to 90% of world trade relies on trade finance, it holds immense influence on economic growth at both the local and international levels. But what exactly is trade finance? In short, trade finance offers a variety of financing options that enable commercial trade while mitigating risk.
Trade finance facilitates trade between buyers (importers) and sellers (exporters) by providing the necessary financing for and reducing the risks associated with commercial transactions. This type of finance can benefit businesses ranging in size, from large enterprises looking to mitigate international trade risks, to small e-commerce businesses who’ve had difficulty securing a traditional loan.
Intermediaries finance transactions between importers and exporters by leveraging different types of financing instruments, including lines and letters of credit. Intermediaries come in many forms, typically banks and other financial institutions. With trade finance, loans are secured by the underlying goods or receivables that are the subject of the transaction and are inherently self-liquidating.
As we mentioned, trade finance covers a variety of financing methods. The term “trade finance” is an umbrella term encompassing several financial instruments, including both real and virtual monetary contracts, that banks and lenders use to make these transactions possible. These instruments help provide financing to buyers and sellers while also protecting funds and parties from risks including fraud and nonpayment. Below is a sampling of financial instruments commonly used in trade finance:
Lines of credit (LOC): A fixed sum, borrowed by both importers and exporters, and repaid according to predetermined timelines.
Letters of credit (LC): Written guarantees that the importer will pay the exporter an agreed-upon sum within a certain timeframe, provided the exporter adheres to specified guidelines. Written by the importer’s bank, letters of credit provide importers with an advance of goods before payment.
Cash Advances: Funds provided to the exporter before the shipment of goods. This is advantageous to the exporter in that they can avoid disturbing their manufacturing/production cadence due to a lack of funding.
Factoring: The discounted sale of exporters’ medium and long-term accounts receivable on a “without recourse” basis.
Thanks to the traditionally low-risk implications of trade finance, such as short-dated transactions and self-liquidated funds, it tends to be considered a lower risk option for investors. That said, it is not without risk. The below outlines three primary risk factors and options for mitigating their impact.
Credit risk is the risk associated with an exporter failing to receive an account payable. To protect themselves, businesses can use letters of credit to secure payments. Additionally, exporters can accept payment in full before the shipment of goods, to reduce or eliminate the risk of non-payment.
A country’s political and economic stability can prove risky to international trade finance transactions. In addition to their stability, a country can introduce non-tariff trade barriers and bans on the sale of specific goods. To mitigate these risks, it is beneficial to understand the exchange control regulations associated with countries at each end of the trade transactions.
Exchange rates are in constant flux. Foreign exchange risk encompasses the losses that an international trade transaction may suffer due to a sudden drop in currency value. Without an effective exchange policy in place, exchange rate volatility can impact businesses of all sizes. This is particularly true when the transactions are denominated in a different currency than the company’s primary one. Identifying foreign exchange risks and instituting an appropriate policy is imperative to protect against international currency risks.
A correspondent bank is a bank that provides services on behalf of another that are, equal or unequal, financial institution. This includes activities such as facilitating wire transfers, conducting business transactions, accepting deposits, and gathering documents on behalf of another financial institution.
According to a survey published by the IFC in September 2017, 27% of participating banks indicated that they saw reductions in CBRs in the previous year. With 78% of these banks anticipating that their compliance costs would drastically increase, there could be a continued strain on the relationship between CBRs and banks.
The survey also noted that, while the recent actions taken to increase financial security and stability at the international level have positive intentions, they are reported to hurt emerging markets. Increased compliance requirements, for instance, have proven too costly for some banks. Such de-risking efforts, in addition to the decrease in CBRs we mentioned, are noted to be hindrances to emerging markets.
Recently estimated at US$1.5 trillion, the trade finance gap is the deficit in financing between emerging and developed markets. A variety of factors contribute to the growth of the trade finance gap, including tight regulations and low credit ratings. Banks in these markets often have less access to reliable correspondents than developed markets. This, in turn, inhibits small business’ access to traditional financing methods and widens the already large deficit.
As access to trade financing continues to favor large firms, these developed markets can continue to develop and further expand the global trade finance gap. The majority of banks anticipate that the gap will continue to grow without a shift or conscious effort to hinder its growth. Some large companies and global banks are noted to be working together, leveraging technology to improve some of the primary contributors to the growing global trade gap.
Emerging markets that have a large trade finance gap may have limited access to funds, prohibiting them from making substantial imports. Their growth is often stunted without financial support. This is exemplified in a recent study that revealed 45% of micro, small and medium enterprises (MSME) financing applications were rejected, compared to just 17% of multinational firms. According to the study, the majority of these proposals were rejected because they failed to establish additional collateral.
That said, emerging markets account for 360-440 million of the world’s 420-520 million MSMEs, and therefore provide a great opportunity for growth. With the necessary due diligence, emerging market banks can make significant returns on equity (ROE) by financing these MSMEs.
Trade finance can be an appealing option for investors looking to expand their portfolios with self-liquidating funds and fairly typical short-term transactions. Keeping the trends we mentioned in mind, you can decide how trade finance might benefit your portfolio and business ventures.
1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.
2 Represents a net estimated, unrealized annualized internal rate of return (IRR) of your portfolio and is based by reference to the effective distribution dates and amounts to and from the investments, as well as any outstanding principal and accrued and unpaid interest as of the current date, after deduction of management fees and all other expenses charged to the investments.[read more]
3 "Annual interest" represents an annual target rate of interest and "term" represents the estimated term of the investment. Such target returns and estimated term are projections of the returns or term and may ultimately not be achieved. Actual returns and term may be materially different from such projections. These targeted returns and estimated term are based on the underlying agreement between the SPV and borrower or originator, as applicable.
4 Reflects the initial quarterly distribution declared by the board of directors on February 6, 2020, which will be payable to stockholders of record as of June 10, 2020, and the initial offering price of $10 per share.
5 The Fund will cease investing and seek to liquidate the Fund's remaining portfolio no later than 48 months after the Fund's initial closing. It may take up to twelve months thereafter to fully monetize any remaining illiquid investments in the Fund's portfolio.
6 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.
No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.
Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefor.
Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.
Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.
Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.
Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.
Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and willing and able to accept the high risks associated with private investments.
Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.
Banking services are provided by Evolve Bank & Trust, Member FDIC.
Investment advisory services are provided by YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission.