Why trade finance is the next big opportunity in fintech
“Fixing trade finance is the most significant impact we can have in the real world.” Read more about how fintech can help fix trade finance.
“Fixing trade finance is the most significant impact we can have in the real world.”
The quote comes from one of Simon Taylor’s most recent newsletters , Fintech Brainfood. His newsletter is one of the most widely read newsletters on the fintech industry, with 32,000+ subscribers ranging from VCs, investors and fintech operators.
At vabble, we couldn’t agree more with Simon’s statement and it underpins the entire ethos behind why we set up vabble.
We thought it would be worth writing an article that further explores why the trade finance industry is especially relevant now and how we’re contributing to solving trade finance at vabble.
Simon kindly included vabble as a key trade finance fintech to watch in another recent edition of his newsletter: Fintech Brain Food: The future of money.
To learn more about investing in vabble, email email@example.com
Why is trade finance important now?
The trade finance gap is already worth more than $1.7 trillion a year . But it’s very concentrated on financing companies based in developed countries.
In developing countries, the opportunities are huge. In fact, 80 - 90% of global trade needs financing .
But what needs to happen for trade finance to truly be the opportunity we know it can be? And what exactly is happening that makes trade finance so important right now?
The issues with trade finance
In his newsletter, Simon Taylor outlines a number of issues with trade finance that must be solved for it to truly become the opportunity it can be:
- Trade finance has no central governing body and digital trade standards aren’t widely adopted: With no single central governing body, it’s tricky to ensure every country is trading in the same way. For example, the World Trade Organization doesn’t have authority over international trade, and therefore faces the challenge of getting countries to accept digital trade documents. The UN has the Model Law on Electronic Transferable Records (MLETR) , but so far only seven states have passed legislation to comply. As Simon writes: “Less than 1% of global trade is digital, and at least 100 standards have been created.”
- Hundreds of laws could apply to a single trade: Due to the global nature of trade finance, trading involves multiple jurisdictions each with its own laws and regulations. This means a huge number of laws could apply to each trade, leading companies to spend valuable time sifting through different laws in order to remain compliant.
- Compliance, fraud and AML risk is hard to manage: Simon explains it perfectly in his newsletter: “Verifying anything in global supply chains is like a relay race. You're relying on the last person in the chain to have done their job. But you have no idea how the person before you performed or what happens after you hand off the baton.”
- Trade finance and geopolitics are inextricably linked:Global sanctions, tariffs and bans all affect trade. And if a government makes a change that will affect global trade, it sets off a chain of reactions from buyers, suppliers, banks, and shipping companies alike.
There’s a lot of issues in trade finance and not many solutions. Fintech can’t solve all of them, but there are some that fintech can attempt to fix.
The timing is right for fintech to solve trade finance issues
We recently spoke to partner and newest member of the leadership team, Simon Knowles, about why he chose to join vabble . One of the main reasons he’s getting into trade finance now is timing: now is a much better time than 10 years ago.
Why is trade finance an opportunity now, when it hasn’t been in the past?
- **The push to digitise and automate trade finance: **When so much of trade finance is paper based, it’s very time consuming to try and apply filtering and screening to the invoices purchased. That’s why there’s been a call to digitise the information captured to allow more automation.
- Asset managers can get transparency today: Asset managers are used to having more information now thanks to the internet, which means they now want to know exactly what they’re investing in. This helps prevent money laundering and product mis-selling, but deeper knowledge also allows asset managers to negotiate better deals.
- **Fintech companies are already making a difference: **As Simon Taylor highlights in his newsletter, fintech companies are already starting to make some headway into making trade finance more accessible. He pointed out how Tradeteq (which is also one of vabble’s tech partners) is a fintech company that has already helped process $46 billion in instruments. The same applies to companies like Wise and Airwallex, that are providing borderless accounts and simplifying the management of multiple currencies. It acts as a preview of what lies ahead for cross-border trade.
- The rise of large language models: Being able to use LLMs to summarise the content of documents could be a game changer for the trade finance industry.
Why is this a big opportunity for fintech?
As Simon Taylor said in his newsletter: “Fixing trade finance could be the most impactful thing we can do to prevent modern slavery, create energy security and increase global GDP.”
From a financing perspective, trade financing is a little different to traditional credit. With a traditional loan, the agreement is usually between the lender and the borrower. But trade financing involves three parties: the exporter (seller), the importer (buyer) and the financier. Not only that, but it’s also backed by an actual transaction (the merchandise).
This is why trade finance default rates are as low as 0.01% . Neither the exporters nor the importers are incentivised to interrupt the transaction, which makes it one of the safest forms of financing.
And yet, there’s a huge gap for trade financing. Usually, when an exporter ships goods, they don’t receive payment until some time later, with proof of shipment or delivery being presented. This means they’ll often get paid 60, 90 or 120 days after sending a shipment. All this ties up cash which could be used for expansion, growth and other business activities.
Trade finance hence presents a huge opportunity in emerging markets. Although the trade finance market is huge, it’s concentrated in developed countries. When exporters in emerging markets like LATAM need immediate cash, what are their options? Either banks or alternative financiers.
Latin American banks are notorious for being extremely risk averse, due to the volatility of currencies in emerging markets. They also charge high fees, and it often takes months for an SME to get their funding request approved. Banks are usually not able to offer all the corporate financing needed, since regulations make it hard for them to lend.
The other option is local supply chain financiers. Although they can advance the money quickly, they also often charge very high interest rates, sometimes in the range of 20 - 50% per year. In other words, Latin American SMEs don’t have many options when it comes to financing, which is why there’s a big opportunity for fintech companies.
How we’re solving trade finance at vabble
We’ve already seen how the options for financing in LATAM countries are limited and far from ideal. As Simon Taylor wrote, “the mere fact that the [trade finance] space is overlooked creates opportunities”.
This leaves a gap in the market for a solution that can offer the funding so badly needed.
Here’s how we’re filling that gap at vabble.
We’re matching institutional investors to emerging market exporters
Instead of financing a company’s receivable (another way to say invoice) ourselves, we’re connecting LATAM exporters’ assets directly to institutional investors. Why institutional investors? It’s worth spending a minute explaining the thought process here.
In developed countries, institutional investors like pension funds, asset managers, insurance companies and treasuries are constantly looking for quality assets that offer good returns.
But it’s becoming harder than ever for institutional investors to find high quality, short-term credit products that are not exposed to government or financial institution credits.
Trade finance is one of those asset classes that does not involve these two sectors, and it’s also an asset class that has everything investors look for:
- It’s a multi-trillion dollar asset class based on physical goods, which makes it less susceptible to volatility from financial markets.
- The default rates are lower than usual (below 0.5% even throughout the financial crises).
- If a default happens, the recovery time is shorter than for other credit products.
- There's a large capacity for the asset class to grow in emerging markets, due to the low penetration of receivables financing in those markets and the fact that cross-border trade will only increase.
So how does this work with vabble? When an invoice is generated, the exporter uploads it to the platform for vabble to acquire 100% of the receivable minus a small discount. Payment terms are: up to 80%, minus the discount, upfront, and the remaining 20% or so deferred until collection. This allows the exporter to avoid waiting to the collection date to get paid in full.
The buyer (the importer) pays 60 or 90 days later 100% of the invoice value directly to vabble. vabble then sends the exporter the deferred payment portion. The difference between the invoice value and the discounted value represents an implied interest rate. As vabble acts as a conduit for investors, just like that, the exporters get their more of their cash on time, and the investors, and vabble, their return on investment.
For a better explanation of how this works in practice, head to: Exporters need financing and institutional investors need good investments. Here’s how we’re connecting the two.
We’re combining tech and automation to make investing easy for institutional investors
With vabble, institutional investors can easily invest in trade financing just like they would invest in stocks via a platform business like Revolut. We’re able to do that through our partner Tradeteq, a key part of the investor-facing vabble infrastructure. Through vabble, investors get full real time visibility of the portfolio. And through Tradeteq institutional investors access a proven third party managed infrastructure of note issuance connecting them with vetted assets to invest in.
Tradeteq provides regulated entity services and acts as a program manager on behalf of the investors, providing real time NAV calculations as well as taking care of the reporting and regulation.
According to the Commonwealth , moving to paperless trade could cut up to 80% of the cost of trade finance. The costs associated with using paper prices SMEs out of the global trade finance industry. vabble is participating and monitoring all advances toward digitalisation. vabble digitises every document, allowing for automation into the second screenings, KYC, KTB, KYT and AML checks to be automated, with a fully accessible auditable trail while still keeping a person in the loop.
Another piece of the tech puzzle is how to allow exporters easy access to their money. Pablo has always seen vabble as a customer centric neobank-style platform, a sort of hub that would make it as easy as possible for exporters to get access to funding, and in the future other services as well.
How does vabble execute this? Instead of going to the bank with their documentation, the exporter can sign up to the platform online and upload all their corporate information online. Once approved, they can upload receivables directly onto the platform. vabble evaluates the receivables, and if they match the investors’ criteria, vabble acquires the receivable and pays the exporter the cash, minus the discount, on behalf of the investors. The vabble platform acts as an agent to the exporters and the investors through the collection and full payment of the receivables. For these, vabble has partnered with leading banking and payment services provider JP Morgan.
We’ve put in place a reliable legal framework
In order to make trade receivables investable, it’s incredibly important that the legal framework is reliable and works.
To make this possible, vabble has invested in developing the most adequate legal infrastructure with the counsel of leading firm Sullivan Law, the firm behind the creation and development of the global standard known as the Master Receivables Purchase Agreement. Hence allowing vabble to focus on trade receivables to be sold on a “true sale” basis. This means the investor is a direct owner of the asset, which is also confirmed with the obligor, trade credit insured, and in some cases with recourse to the seller if there are deficiencies.
The vabble infrastructure leverages cutting edge legal and technological advances to determine with a high degree of confidence the absence of fraud in connection with the receivable and that it is of a certain (high) quality, such that institutional investors are able to invest in it. vabble is set up to make that possible.
How does vabble know if the receivable is high quality?
- vabble undertakes the onboarding, KYC, KYB, sanctions checks and credit monitoring of the exporter sellers in emerging markets to UK regulatory standards, and to the satisfaction of the institutional investors. vabble also links up to various local government information services and regulators to verify the authenticity of the receivables and minimise the occurrence of fraud, making sure the invoices are real.
- Receivables are trade credit insured – even though there are some investors that do not require it.
- All exporters can sign up, however only exporters who vabble is able to qualify them, and their assets, are able to transact in the platform.
Most importantly, vabble connects multiple parties that are experiencing gaps in the market:
For institutional investors, it’s opening up an asset class that offers diversity, quality and solid returns. It’s exposing trade credit insurers to presently unseen high quality receivables. It’s enabling exporters access to working capital upfront for lower cost, without adding debt to their balance sheet, without making them a debtor.
We’re at the crossroads of major trends in fintech and trade finance
Timing was one of the key reasons that Simon Knowles decided to join vabble. As he said: “It feels like the time is right for what Pablo [vabble co-founder and CEO] is working to create.”
He also noted that there are a number of current major trends in finance and technology that are at the heart of vabble’s business model:
- There’s increased demand from institutional investors for private credit assets. Investors are looking for opportunities that aren’t in the traditional equity bond market. And what vabble offers is exposure to a private, underlying transaction between well established buyers and suppliers. These are in the form of a listed security of a special purpose vehicle containing invoices and insured by a trade credit supplier: which is the definition of a private asset to access.
- The yield is higher than what an investor would get for similar risk exposure in their natural market, which of course makes it compelling from an investor's point of view.
- There's an environmental, social and governance overlay, which is increasingly becoming an important element for investors. vabble is targeted towards helping emerging markets in other parts of the world economy to have improved access to developed markets pools of liquidity, to catch up, and also to help small and medium but all size businesses.
- There’s high demand for trade financing in emerging market countries.
- Lots of small and medium businesses aren't getting trade finance products from banks, leaving a gap.
- There’s been an increase in global trade off the back of the pandemic.
This creates a perfect opportunity for a platform like vabble. As Simon Knowles has said, it also means vabble should become profitable fairly early on, with a lot of opportunity to scale globally.
vabble: a step closer to simplifying trade finance
In this article we’ve looked at trade finance and its current limitations, some of which fintech can solve. We’ve also seen the opportunities that exist, particularly in emerging markets, which is what we’re solving at vabble.
Pablo and co-founder Derek Hudson created vabble to facilitate access to liquidity in emerging markets and to help institutional investors access an asset class that offers solid returns. vabble also allows exporters access to a cost effective alternative for accelerating working capital, without making them a debtor.
A combination of timing, technology and opportunity to make an impact means that trade finance is indeed “the end boss of fintech”
_To learn more about investing in vabble, email firstname.lastname@example.org _
5/17/2023 - vabble team -
4/3/2023 - vabble team - finance, vabble, investment