Fraud, rules and thin margins putting global banks off commodity financing

Singapore

SINGAPORE'S reputation as a trusted commodity trade financing hub has taken a hit of late, with the industry rocked by the recent spate of high-profile fraud scandals the likes of Hin Leong and Zenrock, said industry watchers.

Revelations of fraud were likely the last straw that led to the pullback of European banks from commodities trade financing here, they added.

Among them is French bank Societe Generale, which is shutting its Singapore trade finance unit. Others that are said to be scaling down their trade finance operations or exiting this line of business altogether include ABN Amro and BNP Paribas.

But this comes as longstanding issues such as tightening regulations, falling commodity prices, and the opaqueness of the industry have led to the present malaise in commodity trade finance, said observers.

Among the biggest contributing factors that have led to the winding down in commodity finance is the Basel IV banking reforms from 2017, aimed at strengthening the banking system. The reforms require banks to allocate more risk and capital to support commodity trade finance - this will have the biggest impact on European banks.

Annie Koh, professor of finance, Singapore Management University said that the decision to pull out then became a "no-brainer". Asia is an important market, but these European banks are accountable to shareholders back home.

"There were a lot of ancillary factors like Covid-19 and falling oil prices, but the main reason why these European banks decided to pull out has to do with where they can put their equity capital to get the highest risk-adjusted returns," she said.

"Basel IV was the trigger, then there was also the big Hin Leong fraud case, and they all came together like a perfect storm."

The collapse of Hin Leong was the biggest scandal in the industry this year, with over 20 banks owed more than US$3 billion - among them are ABN Amro and Societe Generale. The oil trading giant had admitted that US$800 million in losses from futures trading had allegedly been hidden.

George Lee, chief operating officer of trade-finance fintech Capital & Credit Risk Manager (CCRM), concurred that the exit of major trade banks is symptomatic of a much broader issue and not specific to Singapore as a commodity trading hub.

"It isn't a case of these banks moving their desks to other hubs, but rather the fact that they are making a strategic decision to exit a business or limit themselves to their home markets," he said. "In some ways the cliché 'go big or go home' rings true," he said. "The reality is that commodity trade financing was already under threat for many years with impending reforms under Basel IV."

Beyond regulation, Kevin Kwek, managing director of Asian Financials, Alliance Bernstein, noted that general commodity prices and volumes have been falling since 2011.

"Events like Hin Leong and falling oil prices were the last straw but the trend goes back further," he said. "It isn't so much a case of Singapore losing competitiveness in the space, but overall falling demand."

The Covid-19 pandemic also did not help the situation - global commodity trade finance revenues for banks fell 40 per cent year on year in the second quarter of 2020, showed figures from research firm Coalition.

Some rebound to long-term normalised growth rates post Covid-19 is possible, but time is needed for sentiments to recover, said Mr Kwek.

As commodity trade is a thin-margin business, it will be unsustainable for the European banks to maintain their businesses here unless prices go up substantially, said analysts.

Mr Lee said banks are faced with the choice of either exiting, running a loss-making product in the hope of having a larger share of customers' wallets in other areas, or distributing financing to other institutions.

Industry watchers are in agreement that trade finance cannot carry on in its present state. Already, the Republic and the financial industry here are taking the lead to set global standards and improve transparency, they pointed out.

But even as changes are on the way to overhaul the age-old practices in trade finance, banks that are unable to sustain will have to reduce their exposures to this sector, even if they do not exit completely.

Ivan Tan, an analyst at S&P Global Ratings, said the financial failures of some commodities traders have heightened risk aversion in this sector.

"Capital preservation and loss minimisation have become the key priorities of financial institutions as the economy grapples with the impact of Covid-19," he said. "Underwriting standards have been tight, and banks are circumspect in granting new loans particularly to vulnerable sectors or borrowers."

There remain questions on whether smaller businesses would be penalised by higher borrowing costs, especially as more banks exit. Prof Koh thinks that other banks will fill these gaps left by global lenders, including local banks.

There are still pockets of trade that are growing, with e-commerce a key driver. She pointed out, too, that non-bank lenders such as private companies in the commodities space could also close this gap as they already have the expertise in this area to provide lending to buyers and sellers in their value chain. Digital banks are another option as they do not have legacy issues and have alternative ways to assess credit risk.

Similarly, Mr Lee noted that it is not all doom and gloom for Singapore. Trade fundamentals are still in place and Singapore will still have a strong role to play as both production and consumption become increasingly Asia-weighted, he said.

"It is important to remember that Singapore's position as a global trading hub is not due to banks alone - a whole ecosystem has been built up," he said.

This includes major credit insurers, legal and regulatory frameworks, companies all along the value chain, representing producers, consumers, traders, logistics, risk management, sales and marketing.

There is also a "vibrant pipeline and pool of talent being churned out" by higher institutes of education here, he said. Mr Lee noted: "Singapore has a good foundation to build from, and I am a firm believer of the saying that one should never let a good crisis go to waste."

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