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At the ITFA annual conference in Abu Dhabi, Trade Finance Global (TFG) spoke with Mosa Tshabalala, Head of FI Trade Sales (International), Risk Distribution and Syndications at Absa Group, to explore the role of trade finance risk distribution in the African context.

Risk distribution in secondary markets

As the second-largest bank in Africa, Absa’s approach to risk distribution centres around its originate-to-distribute strategy, which involves originating numerous transactions on the continent and distributing some of those assets through various channels. 

One key channel involves engaging with other financial institutions through various agreements, such as master risk participation agreements (MRPAs), enabling them to buy or sell trade assets in partnership. 

Other channels include insurance, development financial institutions (DFI), and institutional investors, which are becoming increasingly important as a means of balance sheet optimisation in light of the evolving regulatory landscape being driven by changes like Basel 3.1.

Tshabalala said, “Distribution plays a major role in creating further capacity for lending or providing finance [to help close the $2.5 trillion trade finance gap]. It’s extremely important that there is a market for distribution.”

These distribution channels play a critical role by serving as a secondary market where trade finance assets, such as receivables or trade-related loans, can be bought and sold subsequent to their initial issuance. 

However, the coming implementation of Basel 3.1 (sometimes referred to as Basel 4) may bring some changes to this ecosystem.

Complexity of Basel 3.1

The planned introduction of Basel 3.1 has brought forth several complexities and challenges for financial institutions.

One initial concern that has since been dealt with revolved around the effective maturity of trade finance assets. Traditionally, trade finance deals are relatively short-term transactions ranging from three to six months. 

However, Basel 3.1 called for the introduction of a requirement for two-and-a-half-year maturity. This prolonged maturity would have had significant implications for how these assets are managed, not only from a capital usage perspective but also in terms of regulatory compliance.

Tshabalala said, “If you have an effective maturity of two and a half years, it would have a major impact on how you treat the asset from a capital usage perspective. Thankfully, our regulator has now approved that we consider transactions for the tenors they are.”

This adjustment acknowledges the unique nature of trade finance and aligns the regulations more closely with the realities of the industry.

That’s just one challenge solved; others remain to be addressed before the July 2024 introduction of the new legislation. One of which is the stipulation regarding Loss Given Default (LGD) floors. 

Basel 3.1 prescribes a minimum LGD floor of 45%. This requirement can be concerning for financial institutions, as it affects how they calculate and manage capital related to these assets.  

There is also the issue of risk weight for DFIs. 

As financial institutions increasingly distribute assets through DFI programs, there is a notable change in the classification of these assets. Previously, DFIs were considered zero risk weight, but under Basel 3.1, they are assigned a floor of 45% LGD.

This change in risk weight can impact the capacity that can be distributed via DFIs, potentially affecting the strategies of financial institutions in managing their trade finance portfolios.

Tshabalala added, “The adoption of Basel 3.1 remains a major issue in everybody’s mind heading into 2024.”

Closing the gap

Despite the impending regulatory changes, the industry must still get by with its day-to-day objectives, such as narrowing the trade finance gap.

The conversation around this gap, and particularly the financial inclusion of small and medium-sized enterprises (SMEs) carries a profound social responsibility element, with its lofty aims to uplift nations with lower per capita income levels.

Tshabalala said, “To close the trade finance gap, it means that we need to have that greater capacity to distribute and share the risk.”

The fact that there is a notable trend of institutional investors showing increased interest in the trade finance asset class will certainly help with this. These new actors introduce new dynamics and open opportunities while necessitating strategic adjustments.

Financial institutions must skilfully navigate these changing conditions while ensuring they meet regulatory requirements and societal obligations.