Citi’s trade chief: 2015 was the riskiest year to date
By Hesham Zakai, February 15, 2016
Originally published at www.txfnews.com.
In a wide-ranging interview, Citi’s global head of trade, John Ahearn, talks to TXF’s Hesham Zakai about challenging pricing in the market; why 2015 was the riskiest year seen to date; the danger of killing the golden geese of supply chain finance and securitisation; the appeal of blockchain technology; and the industry’s ongoing battle for a fair understanding and treatment of trade finance.
Hesham Zakai (HZ): Looking at the market going into 2016, it’s certainly in flux. Increased competition, increased compliance costs, declining demand; all of this makes for a very challenging market. How do you see it panning out?
John Ahearn (JA): I think two or three things are going to happen. The first is that market spreads are going to adjust because they are currently low. In places like India, they are still pricing at 30–35bp (basis points over Libor); China also is pricing incredibly low — the pricing needs to be adjusted. On one side there is massive spread compression combined with an exceptional amount of risk coming into the market; and on the other side there are operating costs, compliance costs, all of which are going up exponentially. Eventually, we reach a breaking point where either the market has got to change the pricing or the banks decide that the capital they are putting into the trade business can be better served in other places. If the latter happens, you will start seeing market participants retreat. We are already seeing this trend with many banks announcing they are downsizing their balance sheets. It’s not that these banks are no longer committed to trade, it is just putting the capital out under these market conditions is not strategic.
HZ: You alluded to an exceptional amount of risk in the market that is really accentuating this issue. Can you elaborate on that?
JA: Two thousand fifteen was probably the most difficult year that I have ever seen as far as risk is concerned. Many of the main markets that trade banks participated in, especially the global banks, are just not there anymore. Other players, like the banks that are tied much more to commodity markets, are also affected by these challenging conditions.
HZ: And it is in this context that we have seen a number of senior trade bankers leaving the market from the likes of HSBC and Commerzbank?
JA: Yes, it’s quite phenomenal — and happening across the board. So there is certainly some expertise leaving the market, but at Citi we took a very balanced approach, which I think has served us well.
HZ: Right, and going hand-in-hand with seasoned bankers exiting the market and established players rethinking their position is the drive of digitisation and new technologies in trade finance. What opportunities and challenges do you see in this trend?
JA: We are very actively involved in looking at various technologies, including for example blockchain. We are trying to figure out how it applies to our business, by looking to develop a strong use case for the technology. The other thing that I think that is going to make life much more difficult for some of the fintechs and the start-up companies to engage in trade, is the fact that it is still a very paper-intense business. And there are many different counterparties involved in a trade transaction. Let’s take as an example a Certificate of Origin. If you need a Certificate of Origin from the US, you go to the local Chamber of Commerce; the local Chamber of Commerce may be in a back office, or a post office, and the assistant gets out the paper form, prints a stamp on it, and you pay your $10 (processing fee), or however much it may be. That process is going to be very, very difficult to digitise. Customs and other kinds of regulations also require various pieces of paper and that whole chain is going to be very difficult to digitise. One area that we have been doing a lot of work on, and we have had some success on this, is OCR — Optical Character Recognition.
HZ: And that’s working for you at the moment?
JA: That’s worked out pretty well for us so far, but there is still a lot more to do. We are working with blockchain, we are working with digital technologies, we are trying to figure out the use cases, so we’re starting out on this journey.
HZ: As part of this journey, there seems to be an increase in willingness on the part of fintech companies to collaborate, to cooperate, to leverage respective strengths…
JA: Yes, but one problem is that the standards are not the same. Partnerships can really add value to us if we can leverage each other’s supplier base — but we need to ensure that we are on the same page from a compliance point of view.
HZ: Do you think that gap is being bridged?
JA: There is going to have to be some harmonisation, for sure.
HZ: There are signs that regulators are monitoring supply chain finance quite closely…
JA: If you look at supply chain finance in its purest sense — and Citi does a very good job of remaining very pure on our supply chain finance business — it is not debt, it is clearly trade payables. Many start-up companies are putting together more and more advanced structures, longer and longer tenors, rebates, etc, which are going to bring us closer and closer to the definition of debt. My biggest concern about that is banks are experts in the field, we understand the differences — but sometimes regulators, rating agencies, and so on, paint with very broad brushes. If they were to turn around and say all supply chain finance is debt, it really kills the underlying reason that many of our corporate clients get involved — because they want the working capital benefit. If you look at companies like Citi and all the other major banks, we have extensive controls, we have a lot of requirements, we do ethical hacks on our software; we do all kinds of different things to test our systems. When you look at some of these start-up companies, what are they doing? Are they doing those same kinds of checks? Testing infrastructure is very expensive, are they doing the same thing? So really, who are these guys? They may have a very beautiful slick presentation and website, but is the server sitting under the guy’s desk at home? Is it a real organisation? It’s an interesting conversation.
HZ: Given this, do you envisage a period of consolidation in the market?
JA: I think we are very much into a situation like the internet bubble of the early 90s. I’ll meet a company, we will have a conversation. The company has got $15–20 million in revenue, operating losses of $10–15 million and their market capitalisation is $400 million; you sit there and ask ‘how is that possible?’
HZ: Let’s talk about another area where there has been some buzz recently: securitisations. Deutsche Bank have just completed what they refer to as the largest-ever trade finance portfolio securitisation of $3.5 billion, not long after another completed by Standard Chartered. Citi was something of a forerunner with its Trade MAPS programme. Can we expect to see it active in this space again soon?
JA: I think this comes back to a regulatory set of conversations again, and it’s going to be very interesting. Some of these banks engaged in synthetic securitisations. Regulators have indicated that they don’t like synthetics. When Citi did Trade MAPS, it was off-balance sheet; it really was an industry-setting transaction.
HZ: In terms of the institutional investor market, do you feel that it is ripe for buying more trade assets?
JA: We are already selling large amounts of assets to institutional investors, we are very active in our EAF (Export & Agency Finance) business and in a variety of others, and they buy our supply chain finance assets and so on — not in the form of securitisations, but instead they are treated as risk participants. When we did Trade MAPS, it was substantially oversubscribed, so there was a great appetite from institutional investors. What I thought was very interesting on the Trade MAPS deal, was that we did two different roadshows: with the first roadshow we really introduced the asset class and explained to the institutional investors what the asset class was, how it worked, etc, because many of them do not understand trade. Then we did the formal roadshow, launching Trade MAPs, where we had oversubscription. My concern is that if people go out early and start doing securitisations of very poor assets and all of a sudden somebody takes a significant loss because the securitisation wasn’t well done — it impacts the entire industry.
HZ: Turning to your position as chair of the BAFT Board of Directors and some of the themes that have come up at today’s BAFT conference, will the regulatory treatment of banks, particularly vis-à-vis money laundering, be something you prioritise in your role?
JA: Well, the first concern that I have there is that trade and the role of trade, in banks in particular, is misunderstood, because people talk about trade-based money laundering, and whenever you hear that word, people immediately think: ‘Oh, it’s all the stuff that goes through the banks.’ But the reality is that most trade-based money laundering never goes through the trade organisations of a bank; it actually goes through the open account systems etc. I think one of the things, and as the chairman of BAFT is something I’m really starting to push, is trying to differentiate between trade-based money laundering, which is a global problem, and the trade that goes through trade finance houses and their back offices.
HZ: Are you concerned that regulation which has led to disintegration of correspondent banking networks could end up ultimately impacting the social development of economies in emerging countries?
JA: First of all, there has been major de-risking going on, but I’m not sure that de-risking has really had an economic impact at this point yet. We are seeing a reversal of the last 20–30 years, where a bank demonstrated its standing in the international community by saying it had banking relationships with 150 correspondent banks, or 120 correspondent banks. In these cases, they were very small banks with massive amounts of correspondents; unfortunately, in most cases, they didn’t have the flow to feed all of those banks. Now, under the new guidelines and requirements, the costs of compliance have gone up dramatically. So what you are really seeing on the de-risking side really has much more to do with an economic conversation than anything else. At some point, it is going to have a true economic impact, and I think probably later this year or in early-2017, we could start seeing that because many banks are again actively de-risking.
HZ: Very finally, what are your BAFT priorities for 2016?
JA: It’s very important for us at BAFT to ensure we have a strong value proposition for our members, so we are doing a lot of work on the regulatory side. This involves not only writing position papers and working with our constituents to help standardise the rules and regulations, but also helping them understand what the current rules and regulations mean. Because if you look at how some of these regulations are written, they can appear very opaque. The second thing, going back to our conversation about technology, is that we have created an innovation council. The innovation council’s goal is not really to innovate, but to look at all the innovators out there, and make sure that everyone understands what is going on in blockchain and other spaces, so we can help our members to also understand. The other important role that I think BAFT will try put forward is to help make sure that there is a level playing field. For example, is a fintech company able to do all of this stuff without any regulatory burden, and a bank — who is doing the exact same thing — faces a massive regulatory burden? I think that is really where we are spending our time and effort. I think so far we have done a very, very good job; we constantly poll our group, and most people are very happy with the value content that we bring. That wasn’t always the case, so I think we have made a major move and are going very much in the right direction.
Originally published at www.txfnews.com.
