Felaban Congress of Foreign Trade – CLACE 2010 Closing Remarks John Ahearn, Global Head of Trade
Basel 2. 5 – Impact on Trade
Basel II Impact: Basel I vs. Basel II The Trade business has become more challenging due to credit tightening, changes in accounting regulations and stringent capital reserve requirements, namely through Basel II will have a more comprehensive approach to calculating risk capital than Basel III tightens up on contingent instruments Basel I – Standardized risk weighting by simplistic categorization of obligor (i. e. corporate vs. bank) and product type (Banker’s Acceptance vs. Commercial Letters of Credit) – Established a minimum ratio of required Tier 1 capital to Risk Weighted Assets (RWA) – RWA assigned only for credit risk Basel II – Basel II allows several methods for calculating RWA for each of the three risk types it recognizes: § Market Risk: enhanced standards to model default risk § Credit Risk: formula-based calculation utilizing an institution’s internal risk parameters associated with each facility, such as Probability of Default (PD), Loss Given Default (LGD), etc. § Operational Risk: new internal simulation model incorporating estimates of the frequency and severity of operational losses – Basel II is designed to be more risk sensitive than Basel I as the RWA is now aligned with actual economic risk and a bank’s internal measurement of economic capital 1 5 – Impact on Trade
Drivers of Trade: Basel II’s Impact on Trade Basel II will likely call for much more capital than Basel I. Investments deferred by Banks during the down cycle need to be re-started to support regulatory changes from Basel II. Wholesale Exposures – 35% LGD/ELGD 5 Year Maturity 2 5 – Impact on Trade
Capital Requirements – Looking Forward As banks roll out implementation of Basel II, continued regulatory reforms are expected in the next few years Looking forward – Initial discussions on significant Basel II amendments demonstrate the on-going importance of achieving industry standards for capital allocation of trade assets – LGD calculations will continue to be an important driver as economic capital and regulatory capital begin to converge – Improved information among trade banks can give the industry leverage in explaining operational efficiency of trade products to regulators and the wider banking community – Increased capital requirements continue to influence the importance of risk distribution strategies Status of Basel II Amendments – In July 2009, Basel II reforms were approved to raise capital requirements for trading books and complex securitization exposures – Reforms are expected to be fully implemented by the end of 2010 – Further reforms were announced at the end of last year and endorsed by the Financial Stability Board and the G 20 leaders at the Pittsburgh Summit – Consultative Proposals on “Strengthening the Resilience of the Banking Sector” and “International Framework for Liquidity Risk Measurement, Standards and Monitoring” were published in December 2009 with comments expected by April 16, 2010 – Initial impact assessments of the proposal are to be carried out in the first half of 2010 before the reform program is finalized – A final, full set of standards is expected to begin phase-in by the end of 2010 with an aim for full implementation by the end of 2012 3 5 – Impact on Trade
Basel II and Basel II Amendments (2. 5) – Impact on Trade The Basel II 5 key amendments focus on ensuring the resiliency of banks at a micro level, while taking into account system wide risks and the potential for pro-cyclical amplification of risks. Basel II and its latest amendments outline new regulations that may have a significant impact on trade finance and the amount of capital allocation required for short-term credit and trade One-year maturity floor for short-term self-liquidating trade transactions does not reflect the majority of trade assets, which are typically 180 days or less – ICC Banking Commission estimates that removal of the maturity floor could cut capital requirements for 90 day trade finance obligations by 20 -30% Application of key risk attributes for trade finance assets do not reflect industry expert judgment – Currently lack of historical data on “loss given default” and “credit conversion factor” model inputs to promote industry benchmarking – Working Group was put together by the ICC and Asian Development Bank to set up an International Trade Finance Loan Default Registry to address this issue through appropriate data collection Latest Basel II amendments would change the credit conversion factor for off-balance sheet operations to 100% from 20% – Would impact credit allocation requirements for SBLCs and similar off balance-sheet trade bills – When used for the purposed of calculating a leverage ratio, may encourage a diversion of capital to higher risk/higher return products rather than highly documented and short-term, self-liquidating trade instruments Leaders in the trade finance space, including Citi, as well as Trade Ministers and the WTO are actively involved in discussing possible re-thinks to trade finance restrictions Industry concern is that trade lending, especially for smaller firms, will be adversely affected by current regulatory proposals Source: Mark Auboin, International Regulation and Treatment of Trade Finance: What are the Issues? WTO, February 2010 and internal Citi sources 4 5 – Impact on Trade
Basel: Impact on Trade (est. ) • A Global Trade portfolio with a concentration of SME obligors and Emerging Market bank risk will most likely demand higher capital reserves • Banks will have margin pressures and potentially could be non-competitive in this space Basel 1 Basel II S&P/ Moody’s Rating Tenor of loan Obligor Risk Weight Facility Risk Weight (CCF) Total Risk Weight AA+/AA 1 Corporate 1 year 100% AA+/AA 1 Corporate Sight L/C 100% 20% AA+/AA 1 OECD Bank 1 year 20% 100% AA+/AA 1 OECD Bank Sight L/C 20% BBB-/Baa 3 Corporate 1 year BBB-/Baa 3 Corporate BBB-/Baa 3 Facility Risk Weight (CCF) Total Risk Weight 100% 6. 1% 20% 1. 2% 100% 6. 1% 20% 6. 1% 100% 6. 1% 20% 4% 6. 1% 20% 1. 2% 100% 6. 1% 100% 46. . 5% 100% 46. 5% Sight L/C 100% 20% 46. 5% 20% 9. 3% 100% 46. 5% Bank 1 year 100% 46. 5% 100% 46. 5% Bank Sight L/C 20% 4% 46. 5% 20% 9. 3% 100% 46. 5% BB-/BB 3 EM Bank 1 year 20% 100% 20% 127. 3% 100% 127. 3% BB-/BB 3 EM Bank Sight L/C 20% 4% 127. 3% 20% 25. 5% 100% 127. 3% BBB+/Baa Sovereign 1 year 0% 100% 0% 22. 2% 100% 22% 5 – Impact on Trade Obligor Risk Weight (LGD based) Basel 2. 5 BBB-/Baa 3 5 Type of obligor Proposed 6. 1%
Trends in Trade
Sovereign Events At SIBOS 2009, GTS Trade highlighted our concern over the potential for near-term sovereign events Budget and competitiveness problems in the so-called PIIGS – Greece, Ireland, Italy, Portugal, Spain – have born out this prediction and heightened our awareness of the shifting risks and opportunities facing the Trade business Despite generally strong performance in Emerging Markets, the risk of contagion remains – Emerging Markets global debt markets have performed better than in developed countries – Public debt profile of emerging economies is also projected to remain stable and at lower levels than developed economies Overall sovereign ratings downgrades (both developed and developing countries) have increased significantly in the past year European Bank CDS Spreads Potential for credit spreads to widen, especially for small countries, small enterprises, and countries in the European periphery Public Debt 11 Source: Citi Emerging Markets Macro and Strategy Outlook Trends in Trade May 2009, Sept 2009, and May 2010 Fitch Ratings Actions Source: Citi Emerging Markets Macro and Strategy Outlook
Sovereign Credit Crisis Budget Deficits as % of GDP Sovereign Default Risk Bank Exposure Remains Elevated (5 yr CDS) EU “Limit” Note: All shown CDS is USD denominated Source: Bloomberg Eurozone GDP by Country(1) Source: Bloomberg Source: Bank for International Settlements Observations Risk aversion rose sharply last week as global investors expressed a strong reluctance to support the Greek bailout However, the situation reversed this week, when the Eco. Fin announced their commitment to lend up to € 500 bn to the most-indebted countries, in conjunction with € 250 bn from the IMF The funding package incorporates both government-backed loan guarantees and a commitment by the ECB to buy European sovereign debt in the secondary market The market has responded positively to the funding announcement: - The Euro strengthened against the yen by the largest amount in 18 months - European stocks rallied the most in 17 months - Credit default swaps tumbled Despite this positive reaction, uncertainty about the long-term solution to the sovereign debt problem remains, with some suggesting potential debt restructuring in several peripheral countries Contagion has spread far away from the epicentre of the crisis, although it still feels more like risk reduction related market activity as opposed to definitive economic/ financial linkages at work 12 (1) Includes 16 countries using Euro currency Trends in Trade Source: 2009 CIA World Factbook
Global Trade Flows 10 Year Trend Global Trade Flows Between 1999 to 2009 (in $T) -22% Source: International Monetary Fund (IMF) – Direction of Trade Statistics Online (DOTS) Data as of Oct 2009 – FY 09 is based on 3 Q YTD actual data + Oct 09 x 3 World trade dropped sharply starting in Q 3 2008 and continued to fall throughout the first half of 2009 The steepest decline in export volumes occurred among manufacturing exporters in Asia. As industrial production rebounds, developing Asia is also leading the up-turn Prospects for international trade will be led by the pace of recovery in developed economies. Current forecasts for growth in world trade volume in 2010 are between 5 -9% Trade flows have so far not been directly impacted by the sovereign crisis in Europe; however, there are concerns that trade financing spreads will increase sharply for the affected economies and may spread to second tier corporates and FI’s in emerging markets 9 Trends in Trade
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