Exporters need financing and institutional investors need good investments. Here’s how we’re connecting the two
In this story, we’re going to dive into the gaps Pablo, founder of vabble, noticed in the trade financing market, and how vabble is planning to solve those.
In the past 10 years, international trade has skyrocketed – but the financing to support firms that are doing cross-border trading has trailed behind.
In 2020, there was a trade finance gap of US$1.7tn . In other words, $1.7 trillion dollars in payments are locked up in invoices, rather than being used to fund growth.
This gap has only gotten wider throughout the pandemic, and has especially impacted SMEs. To help close this gap, solutions like vabble are helping investors deploy capital to help those SMEs access more financing.
Pablo Terpolilli, a banker with 25 years of experience in the trade financing space and co-founder of vabble, noticed several gaps in the trade finance market, and is building a solution that will connect the industry in a way that hasn’t been done before.
In this story, we’re going to dive into the gaps Pablo and his business partner, Derek Hudson, noticed in the trade financing market, and how vabble is planning to solve those.
But before we dive in, it’s important to set the scene for trade financing in 2023 and explain where exactly the opportunity lies.
Note: vabble is currently raising investment. Want to learn more about how to invest? Reach out to firstname.lastname@example.org to learn more.
What is trade financing and where is the investment opportunity?
International trade is the purchase or sale of goods and services that happens between companies in different countries; which for the sake of this article we’ll characterise as the exporter (seller) and the importer (buyer).
At first glance, you’d think that an international trade transaction would be relatively simple: an exporter generates a product, ships it to the importer, and then the importer pays.
However, it’s a bit more complicated than that. When should the importer pay? When the ship is loaded, or when they receive the goods? And what happens if something goes missing or the load disappears? And what about currency fluctuations between both countries? These issues can be resolved easily by involving a third party: the financier.
Usually, when an exporter ships goods, they don’t receive payment until there is proof that delivery is presented. This means they’ll often get paid 60, 90 or 120 days after sending a shipment. This ties up cash which could be used for expansion, growth and other business activities, and also explains why 80 - 90% of global trade requires financing .
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: exporter (seller), the importer (buyer) and the financier. It’s also backed by an actual transaction (the merchandise).
This is key to understanding trade financing’s uniqueness: due to the fact that multiple parties are involved and the transaction is backed by merchandise, default rates are as low as 0.01% – very low compared to other forms of credit. That’s because neither the exporters nor the importers are incentivised to interrupt the transaction, making it one of the safest forms of financing.
Now let’s look at how trade financing as an asset for institutional investors.
When an exporter (say, a copper supplier in Peru) generates an invoice form an order from an importer (say, a manufacturing plant in France), the expectation that the importer will pay that invoice is called a trade receivable.
This trade receivable can then be sold to an investor at a discount, allowing the exporter to get paid sooner. When it gets sold on the secondary market, trade receivables then become an interesting asset class for investors.
Traditionally, trade receivables as an asset class has been ignored by investors because they have traditionally been in the domain of the banks, requiring a level of complexity in checking documents that not many investors are familiar with nor have the resources to do.
But as we’ll see in this article, this asset class offers big opportunities for investors, for a few reasons:
- Trade receivables are short term and self-liquidating.
- They are often secured or credit-enhanced (via insurance).
- There is a high variety: loans, receivables, payables and traditional instruments, all with different risks and parameters.
To get further clarity on how trade financing works, it’s worth breaking down the different ways exporters can get financing for their trade:
Purchase financing is the simplest form of trade financing, where both parties use “letters of credit” (LCs). An LC is a legal document made by an issuing bank to make a payment on behalf of the importer once the goods have been received. When the exporter presents proof of delivery, the bank makes a payment on behalf of the importer. The bank charges the importer a service fee. It’s essentially invoice financing, completed by the bank.
Trade receivables financing
Trade receivables financing involves secured lending, where a finance specialist will give a company short-term financing when it sells its trade receivables or they are used as collateral for a loan. This is usually performed by banks or specialty finance firms, and this involves the sale of receivables. The key difference with purchase financing is that in this case the exporter is taking out a loan to cover the advance payment.
A third and newer form of financing, is securitisation of those receivables. In this case, exporters will sell their trade receivables to a third party at a discount. The discount will depend on the structure of the exporter, what commodity they’re trading and the country they're based in, amongst other factors.
Securitisation is structured as a sale from the seller (exporter) to a special purpose vehicle which will survive any challenges such as insolvency (also called a “true sale”). The quality of these receivables can often be improved by offering credit insurance, which covers for non-payment and insolvency risk.
To learn more about the different types of trade financing, read this document: Trade Finance Loans as an Investable Asset Class
As we’ll see later in this article, vabble implements a combination of securitisation and Special Purpose Vehicles (SPV)s.
Trade financing as an asset class has been popular in developed markets for decades, but developing markets have largely been ignored. The Latin American financing gap is in the billions, as more SMEs than ever require alternative financing options due to the Covid disruption. This is where an interesting investment opportunity lies.
At this point, you hopefully understand what the trade finance industry looks like in 2023, and why it’s an interesting asset class. Let’s now look at the various gaps in the market that Pablo noticed and how he set up vabble to fill those gaps.
The issues Latin American exporters and institutional investors face in the trade finance industry
1. There are limited options available for exporters to get financing
Trade financing is nothing new and has been a part of trade since the industry first began. However, the financing side of it has historically been concentrated in developed countries in Europe, the Americas and Asia. Very few companies are offering financing for exporters in emerging economies.
But the quality of a receivable has nothing to do with where the exporter is based. If the importer/buyer is a high grade European industrial, then the quality of the receivable should be the same, whether the exporter is in Peru or in Germany.
What does matter, is the fact that a lot of these exporter SMEs based in emerging economies like Latin America often have to wait for months to get paid. Although these payment terms are normal in the world of international trade, for most companies in Latin America it can seriously cripple cash flow and business.
This is why there is an estimated financing gap of $350 billion within Latin American SMEs .
Invoice financing itself is a great solution for those SMEs – but it’s not perfect. The most common form of invoice financing (trade receivables financing) essentially puts the exporter in debt, which means the receivables go from being an asset, to a liability, or are pledged as collateral to a loan, further restricting their ability to trade.
Is there not a way to offer financing to Latin American exporters in a way that keeps costs and liabilities down?
2. In emerging markets, sources of capital are very limited
Although the trade finance market is worth more than $1.7 trillion a year , it’s concentrated in developed countries. Emerging markets have practically no access to working capital.
These exporters need immediate cash, so where can they turn to? Either alternative financiers, or banks.
Banks in Latin American 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 the SME to get their funding. Banks are usually not able to offer all the corporate financing needed, since the regulations make it very hard for them to lend.
The other option is local supply chain financers. Although they can advance the money quickly, they also often charge extremely high interest rates, in the 20 - 50% range per year.
In other words, Latin American SMEs don’t have many options when it comes to financing.
3. Institutional investors have a tonne of liquidity, but aren’t getting the returns they want in Europe
In developed countries, we have institutional investors like pension funds, asset managers, insurance companies and treasuries that are constantly looking for quality assets that offer good returns.
For the past decade, developed economies have seen trade growth stay stagnant due to fiscal consolidation. On the other hand, emerging markets have seen a huge growth in imports, taking up a larger proportion of world trade growth every year.
It’s becoming harder than ever for institutional investors to find high quality, short-term credit products that are not exposed to credits in the government or financial institutions. Trade finance is one of those asset classes that does not involve these two sectors, and it pays finding it.
It’s becoming increasingly hard for institutional investors to find high quality, short-term credit products that are not exposed to credits in the government or financial institutions. Institutional investors are constantly looking for yields above benchmarks, and trade finance is one of those asset classes that yields above the implied risk level.
Trade finance receivables offer investors the opportunity to invest in high quality, short-term, non-financial credit risk, which makes them an attractive alternative to bank deposits, or MMFs for institutional investors.
According to a report by Insight Investment, trade finance can offer yields that are higher than commercial paper years. The consistent returns and shorter duration means that they are a better alternative to fixed-income or cash management/treasury portfolios. Also, the fact that they are exposed to multiple geographies and various commodities is good for diversification.
How come institutional investors are not battering down doors to access this asset class?
For a few reasons:
- There’s a lack of credit information on these exporters in emerging markets.
- There is no standard legal framework used for this transaction.
- Investors are often hesitant to operate in markets that they don’t know a lot about, and there is so much information on global trade that it can be daunting.
- The lack of digitisation and automation, which has made the distribution of this asset class too expensive and complicated.
- Investors are not resourced to carry on the identification, onboarding, KYC, AML and sanctions check, credit monitoring, and servicing and collection.
But this is an asset class that has everything investors look for:
- It’s a multi-trillion dollar asset class based on physical goods (so less susceptible to volatility from financial markets).
- The default rates are lower than usual (below 0.5% even throughout the financial crises).
- The time to recovery if a default happens, is shorter than for other credit products.
- 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.
To summarise: exporters in emerging markets have high quality receivables and are in dire need of working capital. Institutional investors are always looking for higher yield, low-risk asset classes. How can we connect the two?
How we’re connecting Latin American exporters to investors: the vabble platform
We can’t talk about vabble without first sharing the background of its founder: Pablo Terpolilli.
By all accounts, he is one of the best people to operate a company solving for these gaps. He is himself from Latin America (Argentina), and started his career in banking and financing in Buenos Aires. He eventually moved to the US and then the UK, and worked in financing, including trade financing throughout his entire career.
For the past 25 years, he has been advising companies on financing, and lately on trade tech, helping distribute various credit products including trade finance to institutional investors.
While working with Tradeteq, a successful startup developing an infrastructure for the distribution of various alternative credit asset classes, Pablo came up with the idea for vabble (a play on the word “receivable”). With his contacts, 25 years of experience in financing and collaboration with Tradeteq, vabble was born.
To date, vabble has attracted the backing of some of the largest financial players in the world, with JP Morgan as their house bank and the main payment services provider, and Goldman Sachs and other institutional investors as investors in receivables.
The idea behind vabble is simple: a technology platform that uses workflow automation to allow investors to enact each and every step in order to invest in the trade finance asset class. In essence, it’s a platform that connects institutional investors to Latin American exporters with high quality receivables.
Let’s look at how the vabble platform solves for each of the gaps above:
With vabble, institutional investors can easily invest in trade financing through a tech platform
Pablo met the Tradeteq founders while working at Goldman Sachs in London, and they’ve been in constant contact since their founding the business in 2011.
That’s why Tradeteq is a key part of the vabble infrastructure. With Tradeteq, institutional investor sign up, create an account and can start looking for assets to invest in. Tradeteq provides regulated entity services, and acts as a program manager on behalf of the investor, providing real time NAV calculations and taking care of the reporting and regulation, data residency requirements while offering a clear view of the investor portfolio.
Along with its collaboration with Tradeteq, vabble is able to provide a key piece of the investment puzzle: the technical and legal infrastructure for the origination of these assets.
In order to make trade receivables investable, it’s incredibly important that the legal framework is reliable and works. To make this possible, vabble allows trade receivables to be sold on a “true sale” basis. This means that the investor is protected via ownership of the asset, which is confirmed with the obligor, trade credit insured and in some cases there is recourse to the seller. This provides enhanced protection to eventualities such as accidents on route, insolvency, and commercial disputes.
With a thorough onboarding process led by experienced former bankers present in the region, and a strong legal framework in place, it doesn’t matter if the receivable is from South Africa, Guatemala or Chile. If vabble can determine there is no fraud and it’s high quality, then investors can invest in it.
How do they know if it’s high quality? vabble takes care of the Know Your Customer (KYC) onboarding, the sanctions check and credit monitoring. They are also linked up to the regulator to minimise fraud and make sure that the invoices are real. All receivables are insured by trade credit and though any exporter can sign up to the platforme, only exporters who qualify can transact in the platform.
With the Tradeteq and vabble platform, Pablo has now solved two of the challenges above: the lack of legal infrastructure, and the lack of automation and distribution via technology.
With vabble, the investors’ money is connected to exporters
vabble is therefore well connected with the institutional investor side of things. How do they get the money across to the exporter?
Once vabble receives money from investors, vabble pays an advance to the exporter. They will advance up to 80%, based on proprietary data models they refine the conditions they can offer to the exporters, and collect the rest directly from the buyer/importer. This is what it looks like in practice:
After the transaction takes place between the exporter and importer (here called corporate obligor), vabble – agrees to purchase the receivable from the exporter early at a small discount to be determined, paying up to 80% up front, and the remainder once collected from the original buyer.
The obligor also agrees to make the payment directly to vabble in full upon maturity, or thereabouts. vabble resells to investors the confirmed receivable, and once it matures, the investor is paid directly by vabble.
With vabble, exporters can upload invoices and quickly get financing
The final piece of the puzzle is enabling easy access to the exporters. Right from the beginning, Pablo envisioned vabble as a neobank style platform that would make it as easy as possible for exporters to get funding.
It’s important to note that vabble doesn’t allow all exporters to finance every invoice. It’s vabble’s job to qualify the exporter and the receivable, ensuring that the invoice is paid from a good payer. To ensure the highest quality and security, vabble engages credit monitoring and trade credit insurers that will vet the investment and ensure it has a strong credit rating.
If the exporter qualifies, getting advanced cash flow from their invoicing is as easy as clicking a few buttons on a platform.
Instead of going to the bank and bringing in the documents, the exporter can sign up to the platform online and upload all their corporate information. Once approved, they can transact on the platform and upload receivables directly onto the platform. vabble evaluates the receivables, and if they match the criteria of the investors, vabble acquires the receivable and pays by advancing up to 80% of the cash.
With Pablo’s experience and background in the sector, the company already has boots on the ground in those emerging markets, as well as former bankers, who know the company and the management, and therefore give immediate access to corporates.
With the vabble platform, the infrastructure exists to offer end to end processing of a trade receivable, allowing alternative investors to add capital in the market, and providing more liquidity for exporters.
Most importantly, vabble acts as a connector between multiple parties that are experiencing gaps in the market. It’s a true win-win-win:
- To institutional investors, it’s opening up an asset class that offers higher returns
- To trade credit insurers, it’s exposing them high quality receivables
- To exporters, it’s offering them working capital upfront for lower cost, without making them a debtor.
With vabble, we’re connecting people around the world, and helping reduce the credit financing gap for SMEs in emerging markets.
To learn more about investing in vabble, reach out to email@example.com
5/17/2023 - vabble team -
4/3/2023 - vabble team - finance, vabble, investment