During the recent BAFT Europe Bank to Bank Forum, an esteemed panel of experts led by Lee Braine, Head of Advanced Technology, Barclays; Xiaonan Zou, Head of Innovation and Digital Assets, UBS AG, Group Treasury; and Jürgen Schaaf, Advisor to the Senior Management Market Infrastructure and Payments, European Central Bank (ECB) discussed retail vs wholesale CBDCs, synthetic digital currencies, possible digital euro circulation date and more. Read the full article here.
Is the temperature dial turning on global trade digitization with the latest moves in the U.S. for UCC amendments that can be adopted at a state level? How is this moving global trade digitization forward? A comprehensive approach is proving vital, but there’s no magic switch.
The summer heat is not a time when you expect things to move rapidly. Move fast and break things only applies to my fridge freezer, which has chosen this season to swoon and expire. Somewhat surprising then to recount that this summer things are moving relatively fast for some parts of trade digitization regulation in the U.S.
Digital trade in the U.S. took what is being described as a big step forward on July 13 when the Uniform Law Commission (ULC) passed several amendments to the Uniform Commercial Code (UCC) addressing digital assets, terminology to account for digital records, electronic signatures, and distributed ledger technology, providing rules for electronic negotiable instruments, and clarifying the rules for UCC applicability to hybrid transactions involving both goods and services. The measures still need to be taken up by state legislatures. And that’s the key – it’s a federal solution.
Why is this development important, and how does it move the dial for trade digitization in the US and globally? “The UCC in the U.S. already permits electronic documents of title, but promissory notes and bills of exchange must be in written form,” Edwin E Smith, Chair of the Drafting Committee on the UCC and Emerging Technologies tells TXF. “The 2022 amendments would in effect permit electronic promissory notes and electronic bills of exchange, something that trade finance parties have been looking for. The amendments would also give effect to a governing law clause in the electronic promissory note or electronic bill of exchange.”
The issue in the U.S. has been that there has never been a federal solution to the handling of commercial trade documents in digital form. “The breakthrough was really last year where the UK secured G7 ministerial commitment to digitalize commercial trade documents, which of course includes the US,” says Chris Southworth, Co-Chair of the Legal Reform Advisory Board of the ICC Digital Standards Initiative (DSI). “The breakthrough is that the US government has now identified a solution which is the UCC and is now actively progressing on reforming the law to enable those documents to be handled across state boundaries.”
“It’s a great development,” says Alisa DiCaprio, Chief Economist at R3 & Co-Chair of the BAFT Innovation Council. “BAFT and R3 actually started this process in the UCC with a paper ‘Code is Not Law’ in 2018 in which we included [UCC] in the drafting.” There’s a footnote that she is particularly proud of. “It talks about how long it took to update the UCC in the previous time (I think it was eight years), versus how long we could expect this to take (three to five years). You could compare this to how long it actually took (four years).”
Tod Burwell, BAFT President & CEO, explains the context: “The two biggest obstacles (currently) to trade digitization are interoperability of disparate technology platforms and consistent legal frameworks that support digital trade. BAFT outlined the rationale for why both of these are central in ‘Code is Not Law’. Though that paper focused on blockchain, which is where much of the digitization energy was focused at the time, the legal framework issue applied to digitization more broadly. The United Nations Commission on International Trade Law (UNCITRAL) produced the Model Law for Electronic Transferable Records (MLETR) in late 2017 and that became the reference point for how the industry could solve the legal framework problem.
BAFT was a member of the ICC Trade Digitisation Working Group that outlined a roadmap to drive digitization, and adoption of MLETR became a core component. We are now active in the ICC Legal Reform Advisory Board, which is a collection of organizations committed to driving the legal framework change in various jurisdictions, so this is clearly an important step toward our goals.”
As Smith also points out, electronic versions of LCs had already been legal under an earlier update to the UCC rules, it was just electronic negotiable instruments that were left out. “It’s illustrative of the fact that no one actually knows what rules and regulations are limiting the expansion of digitalization. There’s no one list (although the UK has done a great job identifying theirs),” DiCaprio notes.
The catch of course with the U.S., as in any federation, is that this still needs adopting at state level. “We examined several different paths for change in the US and amending UCC was one of the most direct and comprehensive,” says Burwell. “The ULC undertook the heavy lifting of drafting actual language that would amend the UCC and approved the package of amendments last week.”
“Next this needs to get taken up and passed by the American Bar Association, which we are hopeful will take place in the next few months,” Burwell explains. “Ultimately, each individual state in the U.S. must then adopt the amended UCC articles within their own local law. We understand that this is already in scope for the 2023 legislative agenda for many of the states. So far, there has been positive support for advancing amendments for digitizing trade, however, there are other aspects of the amendments that address digital assets, which is being looked at with more scrutiny given recent developments. At this point, we are cautiously optimistic but excited that the first hurdle has been crossed.”
Is there likely to be traction for state adoption? Smith for the ULC is also optimistic. “We anticipate that the 2022 amendments will be presented to states in the 2023 legislative sessions,” he says. “There is already momentum behind the amendments. Several states, anxious to be leaders in the digital asset space, have already enacted prior drafts of the amendments.”
How does Smith see the ULC’s move on UCC in the wider global context? For instance, with developments in the UK trade digitization legislation and some (slow) momentum on MLETR adoption after it was championed by the G7 last April? “Much of the 2022 amendments are consistent with the UK trade legislation, UNIDROIT principles and the like,” says Smith. “There was close coordination between our drafting committee and these other groups.”
Importantly, a comprehensive, rather than piecemeal approach is key. “There has always been a risk when governments take a patchwork approach. We’ve seen several governments take this approach, for instance Germany, Japan and Korea, and in the end it doesn’t deliver the outcome we need. In the case of Germany, they are now introducing new legislation to address the gaps. For trade transactions to go digital, all documents need to be digitalized or the system reverts back to paper. In the case of the U.S., a federal solution will still need to be adopted at state level but this is a big step in the right direction,” says Southworth.
As Southworth points out, we are talking here about commercial documentation, which governments often don’t understand so they need industry groups to help them point out the legal barriers and solutions as well as ensuring laws are aligned to MLETR. “Once the legal framework is in place, we can start getting into practical cross-border pilots to test systems and consistently implement interoperable standards.”
The U.S., of course, is a very important to global trade. And that’s one major reason why the move is so significant. “The big economies are now all working on legal reform through the G7. China is also actively moving forward as well,” Southworth notes, pointing to China’s rapid adoption of UNCITRAL Model laws and the ICC China’s industry task force up and running. The Chinese government is actively looking at what the legal barriers are in Chinese law and what the solutions are.
“We don’t know what the solutions are yet, but the most important thing is they are engaged and they’re actively working on it. We also have a funded technical assistance projects with help from the Multilateral Development Banks via the DSI. The Asian Development Bank (ADB) will be supporting China and Georgia with other countries to follow across the region. We also have a legal assistance taskforce in the UK to help low to middle income countries across the Commonwealth. These assistance projects are crucial in making sure no one gets left behind and all SMEs are able to benefit from the initiative. They will task in lawyers to go in and help work through the legislation, identify the barriers then build a roadmap to reform,” he says.
The EU is also concerned about fragmentation with G7 members reforming laws so are also actively trying to find a pan EU solution. “That means the big three blocks are all moving forward and the G7 economies, which is game changing news. It was only 18 months ago when none of this was happening. We shouldn’t also forget to mention that the WTO Ecommerce Agreement, currently under negotiation, includes an MLETR commitment which will bring another 86 countries into the initiative,” Southworth says.
Let’s go into the weeds a little. The good news remains that the alignments are already working. “Article 7 UCC [which governs documents of title covering goods and usually concerns commercial shipment and storage of goods] has been a major source of inspiration when drafting the MLETR and therefore the two texts are already largely aligned,” says Luca Castellani, Legal Officer at UNCITRAL. “The amendments to Article 7 UCC are rather minor and they bring Article 7 closer to MLETR. Moreover, other relevant US legislation, such as UETA and e-SIGN, is also closely aligned to UNCITRAL texts such as the UNCITRAL Model Law on Electronic Commerce, which brings U.S. law and UNCITRAL law even closer.”
“So far, Article 7 UCC has been broadly applied to electronic warehouse receipts, which are, however, issued only for the domestic market. It has not yet been used extensively for electronic bills of lading, possibly because of lack of technical infrastructure or readiness, including in other countries. EssDOCS has issued negotiable electronic bills of lading (eBL) under Article 7 UCC but limited to inland waterways,” says Castellani.
“I believe it is important to promote awareness of the close relationship between Article 7 UCC and MLETR. Many bills of lading are issued under New York law, which may already allow for their digitization: an in-depth discussion of this issue should be promoted,” he adds.
Internationally, digital adoption of instruments such as eBLs remains vanishingly small. Last week, BIMCO, a large international shipping association which represents shipowners, published BIMCO eBL standard for bulk shipping. It pointed out that less than 2% of world trade is carried using the instruments. The Digital Container Shipping Association (DCSA) has also recently announced phase two of its eBL platform interoperability proof of concept (PoC). Meanwhile, the Maritime & Port Authority of Singapore (MPA) has set up two project consortiums to develop and trial eBL solutions across two cargo segments and cites that fewer than 0.1% of bills of lading have been issued digitally since 1990.
With better frameworks in place, standards evolving and laws changing, it will be incumbent on industry to take the next steps to adopt. Needless to say, there will have to be a big push.
The passing of UK Electronic Trade Documents Bill is scheduled to come into force by the middle of 2023 on current plans. In anticipation of the changes, the priority now is to inform the market and support companies to get ready to go digital. The ICC Centre for Digital Trade & Innovation has just launched its ‘Get ready to go digital’ campaign for this reason with more support coming in September including training for SMEs.
“With legal, standards and rules frameworks now in place, the priority now is to work with industry to invest in the digital systems we know will deliver a cheaper, faster, simpler trading system,” says Southworth. “The big point around English law is it’s not about England, this is about English law and it’s role in trade worldwide.” With the Commonwealth countries using the same pieces of centuries old foundational law, the Bills of Exchange Act and Carriage of Goods by Sea Act, they should, theoretically be able to adopt the new bill wholesale or with minor changes. The potential is there to accelerate legal reform faster than any other global network.”
“That point is not lost on the rest of the Commonwealth, where Australia, Canada, New Zealand, Singapore, Caribbean and African nations continue to gear up. There’s potential for 53 countries to move very quickly. Low to middle income countries will need technical assistance which is why the DSI and UK support programs are so important if we want trade to work for everyone. We need to send clear signals to the market that this is coming and it’s coming much faster than anybody would have previously believed two years ago. And so that means we need to work together to help the market prepare,” Southworth says.
“The news of the UK bill is welcome as it aims at being compatible with MLETR while building on the significant English commercial law tradition,” adds Castellani. “That may help in reaching the network size needed to kick off trade digitization on a major scale. The legislative work in Germany is likewise significant.”
Burwell at BAFT is cautiously optimistic that the UK and U.S. digitization efforts will have much wider ramifications. “Until now, there have been seven countries that have formally adopted MLETR, and several other countries are either considering it or have similar legal frameworks under consideration. Though they have made high level commitments, none of the G7 countries are quite there in having the legal frameworks. The UK and the U.S. moving forward would be game changing for a couple of reasons:
We are hopeful that if/when the U.S. and UK move forward with legal frameworks to support digital trade, that will also have a domino effect on other jurisdictions and we can trigger the process to put the legal frameworks in place across other significant trading jurisdictions.”
“I think we have to be realistic in understanding that trade digitization won’t be achieved with the flick of a magic switch: it is a long and complex process,” cautions Castellani. “MLETR removed one major stumbling block but we need a lot of other components, including a robust ecosystem and onboarding regulators. At the same time, Article 7 UCC and its underlying notions shared with MLETR such as control have significantly influenced other new Articles of the UCC (for example on digital assets), and UNCITRAL is starting work on a new project, on a legal instrument on negotiable multimodal transport documents, that will build significantly on MLETR. In short, the impact of MLETR on trade digitization may be deeper than it seems, but at the same time may also be less immediate and apparent than one may wish.”
TFG was delighted to partner with BAFT for their 2022 Global Annual Meeting in Washington, DC. Throughout the three day event, attendees heard from many experts discussing the current state of the industry, what they learned during the past few years, where the industry is headed, and the challenges and opportunities that lie ahead.
There is certainly a lot of ground to cover with regard to establishing robust definitions and standards.
BAFT has established its own working group to explore these but is also collaborating with the ICC and others to ensure that there is a clear set of definitions for ESG in a transaction banking context.
Once standards are established, the next step is to develop the reporting and KPIs; these are where the real benefits come in but you must have the standards and definitions first.
“BAFT has a group looking at what types of reporting should be done, what the relevance is, and what KPIs should be used,”
Tod Burwell, President & CEO of BAFT
The COP26 net-zero alliance has been working towards creating a carbon-neutral environment, but their work does not have a transaction banking context to it – which is something that the BAFT working group is hoping to address.
The last piece is to educate the stakeholders, policymakers, and advocates so that any policy we end up with do not exclude certain markets. Not all parts of the world live in the same circumstances so any policy needs to be carefully designed to not exclude anyone.
Many experts also warn about implementing solutions that are policy-led rather than client-led.
Statistically, 80% of carbon emissions are generated by G20 countries, so it does not necessarily make sense for policies generated for this advanced minority to be applied to the geographies that only generate the 20% of emissions.
There has been substantial discussion recently about the fragmentation of global markets into regional trading blocs.
While this may occur, there is no doubt that some degree of globalization is here to stay.
There are certain countries, like Korea and Germany for example, that naturally do not have very many of their own commodities, meaning that they are forced to source these on a global basis. These countries also tend to have specialized economies that rely on global exports and trade.
This reliance from many different economies on global markets means that globalization will not go away any time soon.
All the talk about carbon emissions and the need to transition to green energy has created a sense of urgency in the industry. Unfortunately, it is simply not feasible to transition to zero-carbon overnight.
Too many countries have energy infrastructures so heavily reliant on brown energy sources that they will need to spend years, if not decades, building up green energy infrastructure.
We do need to start the transition as soon as possible, but we also need to be cognizant of the required timelines for an effective transition.
It is also important to bear in mind that a lot of companies, especially smaller companies, do not have massive amounts of resources to commit to making a green transition.
“Many small and medium-sized enterprises globally, although agile and adaptable, may face difficulties in developing an ESG strategy or have little data and know-how to supplement this.”
Manish Kohli, Global Head of Liquidity and Cash Management at HSBC
“They are often less advanced in transition planning compared to larger multinationals, meaning they require a different approach and a different level of support.”
Preferential financing is when a bank agrees to offer a lower rate of financing to a client so long as that client adheres to a certain set of green commitments.
The idea, in theory, is to financially reward companies that stick to their green commitments.
Some of the banking leaders at the conference fear that, despite being a noble concept, it may not work as well in practice. This fear stems from the idea that such a model misaligns the green incentives from the financial ones.
While banks would like to see their clients succeed in their green commitments, under a preferential financing model, not only will a bank not receive any immediate financial benefit from going above and beyond to assist in these efforts, but doing so may actually cause them to lose revenue in the short term.
Via Trade Finance Global (TFG)
In April 2022, BAFT named Deepa Sinha as its new Vice President of Payments and Financial Crime. TFG’s Deepesh Patel interviewed Sinha to learn what led her to the association, her view on fighting financial crime, and her insights into the progress made in the payments space.
Deepa Sinha has been in the finance and treasury space for more than 25 years now, in both corporate and bank settings, accumulating a perspective on what’s needed from both.
During that time, she has worked for large banks such as Capital One and been on the advisory councils for J.P. Morgan, Wells Fargo, Bank of America, and Citi.
She also spent some time working for large corporates like the Carlyle Group and Caliburn International (now Acuity International), as well as non-profits like AARP.
Much of her experience lies with the implementation of treasury management systems and enterprise resource planning systems integrations, leading internal IT and business teams, and working with various internal and external stakeholders to build consensus and accomplish objectives.
PATEL: What led you to join BAFT and head up payments and financial crime?
SINHA: BAFT is the organization that international banks active in transaction banking look to for industry best practices, solutions, advocacy, policymaking, and knowledge-sharing.
I have been in the finance and treasury space for more than 25 years now and BAFT will provide me with an opportunity to fill an advisory role to our members on not only what their clients are looking for, but what is developing in the space, and how it can affect them and their business.
As technology advances and various international policies and regulations evolve, BAFT offers the knowledge and capabilities in this space to be ahead of those evolutions and advancements.
That’s why I wanted to join BAFT.
PATEL: What has been the impact of the pandemic on financial crime?
SINHA: The pandemic has been a time for both challenges and opportunities, with regard to financial crime, and associated regulatory compliance.
If we look at the data behind financial crime patterns, there is an uptick in cybercrime, which corresponds to an increase in electronic commerce and payments. The efficiency of newer payment methods presents an opportunity and a challenge for banks, regulators, and organizations like BAFT to strengthen regulatory compliance.
There is much work to be done, but the incredible team at BAFT is positioned well and has the ability to work closely with our members, partners, and policymakers in continually striving for success in these areas.
PATEL: The trade industry has suffered some serious fallbacks due to fraudsters and issues around money laundering. Do you expect to see this increase moving forwards?
SINHA: We see trade-based money laundering and fraud as two distinct problems that require different solutions.
In most instances, trade-based money laundering is separate from trade financing and takes advance of fragmentation in the value and payment chains. Banks alone cannot solve this – it requires collaboration with customs, shipping companies and other stakeholders. Banks are using artificial intelligence and other tools to get better at mitigating money laundering, but it remains a stubborn problem.
As payments get faster and more frictionless, the risk increases. Fraud, however, is heavily driven by paper-based processes and we are seeing improvements in mitigating fraud as technology solutions are increasingly implemented.
As digital identity becomes more widespread, and duplicate financing solutions gain more traction, fraud mitigation will improve even further. However, we know that criminals constantly find new ways to evade the law, so we have to remain diligent.
PATEL: Although within the industry there is a general consensus that regulation, reporting on and fighting financial crime are important, it’s also time-consuming, costly, and potentially at the cost of serving smaller MSMEs. How do we tread the line?
SINHA: As in everything, balance is the key. In order to protect assets and interests, and prevent financial crime, regulations, compliance, and due diligence are quite necessary.
However, in finding that balance, we also want to make sure that those same regulations, compliance, and due diligence responsibilities are not overwhelming, especially for smaller and medium-sized companies.
There still has to be some collaborative work between banks and regulators to fine-tune the “risk-based approach” to compliance. BAFT is committed to working with our international banks to understand and lessen the challenges associated with compliance, and also working with regulators to advise how ineffective regulations pose a hindrance to conducting business and actually increase overall risk.
PATEL: Has the pandemic accelerated the need for FIs to speed up and innovate in the payments space (real-time 24-7-365)?
SINHA: Not only did the pandemic accelerate the need for financial institutions to speed up innovation in the payments space, but it also accelerated the deployment of innovative solutions and adoption by corporate clients.
Across the board, the name of the game is digitization. How we interact with the world as a populace is primarily online now, from shopping to groceries to paying our bills and both the banks and the clients they serve have responded accordingly.
With the advent of real-time payments from customer to customer, now business to business and between businesses and their customers, we are seeing an acceleration of the real-time-payment revolution.
Various markets in Asia were early adopters followed by Europe, but we’ve seen an acceleration in Latin American and North America on the domestic level. The next major innovations will be in real-time cross border payments.
PATEL: Where is the payments space in terms of adopting best practices and standards?
SINHA: Some elements of best practices – such as straight-through rates, payment times, reporting, and digital deployment, offer competitive advantages, so firms are constantly driving towards what they believe is best practice.
At BAFT, we focus more on standards and best practices for functions that are common and necessary for a healthier ecosystem, such as interbank transactions and risk management.
In that regard, our members are very active in collaborating through our committees and working groups. The community is very engaged in driving towards new standards such as ISO 20022 and working with providers such as SWIFT and other payment service providers that offer technology solutions that improve on current practices.
PATEL: What are your missions and objectives at BAFT over the coming months?
SINHA: First on my list, as well as an ongoing goal, is to be at the forefront of new payments capabilities as they develop, as well as the policies and regulations that guide them, and be able to disseminate that to our members as quickly as possible.
My goal is to assist our members in achieving optimum productivity by leveraging technology and industry best practices in operational efficiency.
I also want to entrench myself as a subject matter expert on the challenges that our members are facing in the area of financial crimes, policies and regulations that govern them, and how to tackle those challenges head-on, with new developments and solutions in technology to prevent financial crimes before they happen, and to solve for them when they do.
CBDCs should complement, not replace, existing forms of money, according to leading officials at BAFT’s 2022 Global Annual Meeting.
As central bankers in advanced economies consider launching their own digital currencies, top officials have warned that CBDCs should not replace existing payments systems entirely.
“The legacy system has been worked at diligently and hardened for decades,” Robert Bench, Assistant Vice-President at the Boston Federal Reserve, told a BAFT (Bankers Association for Finance and Trade) conference on 3 May.
“What we want to do is understand what are the costs or the benefits [of a CBDC], but not disrupt anything happening in the steady state, because so much work has gone into making the money system so secure.”
The Boston Fed has partnered with the Massachusetts Institute of Technology to investigate the technical feasibility of a digital dollar in an initiative dubbed Project Hamilton.
Bench said he was not yet confident that a digital dollar was technically possible.
“There’s no higher stakes than the US dollar. So to understand technical feasibility, the level of hardening you have to do so that institutions are comfortable offering these services to clients, that’s a long way away,” he said.
Tom Mutton, Director of Fintech at the Bank of England, said the Bank would be agnostic on potential use cases and business models for any CBDC.
“We should be in the infrastructure game, rather than the product game,” he told the conference.
The Bank has also partnered with MIT, entering into a one-year research agreement with the university to look at the technical challenges and opportunities of CBDCs.
In most advanced economies, central banks are either exploring or are in the early stages of developing a CBDC. Some 89 countries accounting for 90% of global GDP are currently looking at developing a CBDC according to the Atlantic Council, a Washington-based think-tank.
In April, the Bank and Treasury announced a CBDC taskforce to better coordinate research into a digital pound.
The increased attention around a CBDC does not mean one is on the horizon, however; the Bank has said not to expect a digital pound before 2025.
Both the Fed and the Bank are still in the research phase, and both central banks have said they would require approval from elected officials before moving onto the design phase.
A major concern that central banks have raised when discussing CBDCs is the potential of undermining the traditional systems fractional reserve banking and commercial money.
Mutton said the goal of the Bank’s potential digital pound is not to become the dominant form of money, but to serve as another payment option for consumers as cash use continues to decline.
“What we don’t see is a world in which a [CBDC] is the only form of money we use,” he said. “The predominant form of money we use to buy our groceries and go on holiday and anything else is currently commercial bank money. As we have a more digital economy and as we have lower levels of cash use, we continue to explore the case — or not— for making central bank money available in digital form.”
But while the Fed and Bank continue with their research, other jurisdictions are pressing ahead.
China’s e-CNY has been piloted in a number of cities around the country and was given a high-profile test run at this year’s winter Olympics. The People’s Bank of China reported that during the two-week sporting event, around $315,000 worth of e-CNY transactions were processed everyday.
European Central Bank president Christine Lagarde said the advanced stage of China’s CBDC project has spurred the ECB to move faster on its own digital euro project.
Lenders, banking associations and trade finance users are lobbying the European Commission, European Parliament and member states to scrap planned amendments to the treatment of off-balance sheet instruments such as technical guarantees, performance bonds, warranties and standby letters of credit.
Proposed changes to the treatment of trade finance in the EU’s capital requirements regulations could push up financing costs for businesses and allow insurers a bigger slice of the guarantees market, banks and borrowers claim.
The European Commission published the final text of its proposed changes to the Capital Requirements Regulation (CRR) in October last year, part of the bloc’s implementation of the Basel III banking reforms.
Lenders, banking associations and trade finance users are lobbying the Commission, European Parliament and member states to scrap planned amendments to the treatment of off-balance sheet instruments such as technical guarantees, performance bonds, warranties and standby letters of credit.
The Commission has proposed that those products be categorized as medium risk for determining the credit conversion factor, which is used to calculate what a bank might have to pay out under those instruments – taking into account the likelihood the payout obligation will materialize – and therefore the risk they represent on its books.
The planned change would hike the required credit conversion factor for those off-balance sheet trade finance products to 50%, from the 20% under the current CRR.
The lobbying campaign has stepped up in recent weeks. Lenders, corporates and trade groups have sent a flurry of written submissions to the Commission arguing that the increase is incongruous with trade finance’s relatively low risk profile and high rates of recovery in the event of defaults.
In a position paper published in December, the International Chamber of Commerce (ICC) says it is “deeply concerned” that the two amendments “may have severe unintended consequences for the provision of cost-effective trade finance to the real economy”.
According to BAFT (Bankers Association for Finance and Trade), default rates on technical guarantees are only 0.24%. Upping the credit conversion factor to 50% “is therefore excessive and does not seem justified or appropriate”, the association said in a submission to the Commission last week.
“European banks are likely to price technical guarantees at higher rates to clients” if the change goes ahead, BAFT argues. “The effect will be to discourage these business activities and make it more costly to offer trade finance for banks and their corporate clients,” the submission says, disadvantaging small and medium enterprises and making European companies less competitive when bidding for major infrastructure projects.
The proposed changes will increase the capital charge on the trade finance instruments by 150%, according to a joint submission from banking associations in Denmark, Finland and Sweden.
Under the proposal, the cost of a €10mn performance guarantee for a corporate customer would rise from €50,000 to €125,000, the submission says.
Technical guarantees are frequently used by infrastructure, energy and defense companies fulfilling large contracts. Governments can call on the guarantees if the company fails to deliver or meet its performance goals, and often require firms to enter bid bonds when taking part in tender processes.
Engie, the French utilities giant, says in a submission that it has exposure to bank guarantees amounting “to several billions” and that “the proposed revision would imply a severe cost increase for Engie and potentially difficulties to get access to those guarantees, as banks may decide to prioritize activities with higher return on equity”.
It adds that “some banks have already alleged the potential revision of Basel requirements to justify an increase of existing guarantee line[s] that have recently matured”.
Airbus estimates its financing costs will increase by “several millions” per year if the changes go ahead, including the corporate undertakings its parent company makes with its subsidiaries.
The aircraft manufacturer says in a submission that the possible drying up of credit lines due to steeper capital requirements could hinder its ability to meet contractual obligations when its customers request technical guarantees and put its supply chain “at risk”.
“It is very important to underline we are in the real economy,” says Christian Cazenove, group head of trade oversight at Société Générale. “The things that we are dealing with are goods and services…. We are dealing with what allows corporates to succeed abroad.”
“The additional capital costs may lead the banking sector to some extent to disengage from the guarantee business,” Cazenove, who has rallied other banks and clients to campaign on the issue, tells GTR. “Trade finance by nature is still a paper-based industry and not extremely profitable – we, together with clients, really don’t need these additional costs that we would charge to our clients.”
Banks are also wary that the changes will benefit insurance companies at the expense of banks. Baft says its members are concerned that the “excessive pricing of credit risk… will accentuate the current outflow of guarantee business from banks to insurance companies” which are allowed to internally model guarantee risk.
The ICC agrees that the mooted revisions to the law could create “an uneven playing field” between banks and insurers.
Those lobbying the Commission are also concerned that a second proposal under the update of the CRR will increase the costs to EU banks of providing letters of credit and other trade finance instruments.
They say ambiguities in the draft text concerning credit risk rating approaches will effectively force financial institutions to treat key trade finance instruments such as letters of credit as having a 2.5-year maturity when they are provided to large corporates.
Currently the CRR exempts trade finance from a maturity floor in recognition that instruments in the sector mature relatively quickly. Most trade finance products have average tenors of under 130 days, according to ICC data.
“Applying an average 2.5[-year maturity] to this kind of transaction will create a significant price increase for European corporates – the main users of trade finance – putting EU exporters in a weaker position than their competitors outside the EU,” the ICC says in its submission.
Banks in the Nordic region fear that adding costs to their trade finance businesses will add further pressure to already expensive correspondent banking networks that underpin global trade.
Michael Friis, a senior adviser on banking regulation with Finance Denmark, tells GTR that the group’s members are concerned that a loss of performance bond businesses and more expensive letters of credit will mean “that some of the volume will go out of the business and make it more sluggish and more expensive”.
The Commission’s proposal will be the subject of negotiations with the European Parliament and member states through the European Council. The trade finance measures are only a small part of a much broader Basel III package being put forward by the Commission and are unlikely to come into effect until around 2025.
A spokesperson for the Commission says that its draft will not be altered following the submissions received since October, but they will be used to inform the talks with the Parliament and Council.
Industry groups are also lobbying EU lawmakers and member states, Friis and Cazenove say. The French finance minister Bruno Le Maire has been made aware of the industry’s concerns over the proposed legislation, Cazenove says.
© 2024 BAFT (Bankers Association for Finance and Trade)
