The Unexpected Regulatory Threat to Global Trade
EU has included trade finance instruments in list of bank liabilities that could be at risk if a bank goes under
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A new regulation threatens European trade finance. Shipping containers in Hamburg, Germany. Photo: Sean Gallup/Getty Images
Banks and commerce bodies are increasingly jittery about the potential effects of European Union regulation on the short-term financial instruments that connect buyers and sellers of goods across countries.
EU authorities have included trade-finance instruments, such as letters of credit, in the list of bank liabilities that could be written down if a bank goes under. This decision, the banks say, creates an enormous compliance headache and a competitive disadvantage, and could leave unsuspecting parties holding the bag if foreign buyers fail to pay their bills.
The spat comes amid a challenging backdrop. The World Trade Organization warned in a report this month that a “trade finance gap” is hurting global commerce, especially for smaller companies. The Bank for International Settlements estimated that “reduced trade finance could have accounted for as much as two-fifths of the fall in export volumes” between the 2008 financial crash and 2014.
“Every bank is squirming, thinking about how they can avoid [the regulation],” said Geoffrey L. Wynne, London-based partner at American law firm Sullivan & Worcester. But banks and trade associations don’t have high hopes of getting a last-minute opt-out.
A spokeswoman for the European Commission said members would be “considering these concerns,” among other issues, when the results of a consultation on the new financial regulation are published at a date yet to be confirmed.
The new rules are designed to shield taxpayers from bailing out distressed financial institutions again, shifting the brunt to a “bail-in” by investors instead.
All EU bank contracts that fall outside the bloc’s jurisdiction are now mandated to include a clause obliging liability holders to accept the possibility of a bail-in. This regulation, introduced in January, was intended to stop creditors seeking the protection of foreign courts.
Trade credit is usually provided by a long chain of financial institutions across different countries, meaning each of those banks needs to hold another’s liability. EU banks worry that a “bail-in stamp” would put them at a disadvantage relative to U.S. banks.
U.S. trade credit faced its own uncertainty last year, when the U.S. Export-Import Bank’s charter was allowed to expire for five months before finally being renewed in December. A lobbying effort by business groups, and the vocal complaints of large exporters including General Electric Co. and Boeing Co. , eventually overcame opposition to the Ex-Im Bank from congressional Republicans who insisted that its existence unfairly put taxpayers at risk.
Deutsche Bank AG ’s global head of trade finance, Michael Spiegel, warned “there’s a possibility that non-EU counterparties would be reluctant to accept such clauses, because many of them won’t understand them.”
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Banks also argue that logistical complications are insurmountable, as these decades-old contracts don’t operate under any specific law. Furthermore, they are usually transmitted over the Swift network, which banks use to send information to one another in a standardized way, making them difficult to amend.
Commerce bodies are highly critical of the regulation, as well, saying it could especially hurt smaller companies with less access to trade credit.
“It’s a poorly thought-out regulation that will hurt EU businesses,” said Emily O’Connor, senior policy manager at the Paris-based International Chamber of Commerce.
Letters of credit guarantee a seller will get paid even if the buyer fails to make good, which enables unknown parties in different countries to trade by putting their faith in banks rather than one another.
A bank issues the letter of credit against a promise by the importer that it will pay up and then sends it to a confirming bank, which is the one the exporter uses. A specified time after presenting proof the product was shipped, the confirming bank will pay the exporter.
While sellers are promised payment by both buyer and confirming bank, the latter—more often a chain of them—is directly exposed to the risk of the issuing bank going under. Even though this risk was there before, traditional bankruptcy procedures used to be protective of trade finance, whereas the new regulation pinpoints it as liable to be written off.
People familiar with the matter say banks across different EU countries are testing the waters and slowly starting to phase in these rules in some trade-finance instruments, while still intensively lobbying European regulators. But there is little sign it has affected their corporate clients.
“We aren’t aware of these new regulations,” said Aner Garmendia, general manager at EGA Master SA. For this Bilbao, Spain, industrial manufacturer, which exports 85% of its sales, trade finance is essential, Mr. Garmendia said.
Implementation of the EU directive is dependent on each country’s regulators. There, results have been uneven.
In the U.K., regulators have suggested letters of credit could be exempted from the European directive because they “may not be practicably amendable by firms.” The final decision will be made public later this month.
In France, amendments to national legislation to allow the rule to be applied in a “proportionate” manner have been proposed, but the timing is unclear.
But other major EU countries have taken no such actions. This means British and French banks would have little reason to cheer, even if their own regulators exempted them from the rules, because different measuring sticks in every country would pose hefty complications.
“It’s just a huge documentation nightmare,” said Adam Cull, director of financial policy at the British Bankers’ Association. “Trade finance is about certainty.”
Write to Jon Sindreu at jon.sindreu@wsj.com
Corrections & Amplifications
The EU has included trade-finance instruments in the list of bank liabilities that could be at risk if a bank goes under. An earlier version of this article incorrectly stated that it was the U.S. that had included such instruments in a list of liabilities.
U.S. trade credit faced its own uncertainty last year, when the U.S. Export-Import Bank’s charter was allowed to expire for five months before finally being renewed in December. A lobbying effort by business groups, and the vocal complaints of large exporters including General Electric Co. and Boeing Co. , eventually overcame opposition to the Ex-Im Bank from congressional Republicans who insisted that its existence unfairly put taxpayers at risk.
Deutsche Bank AG ’s global head of trade finance, Michael Spiegel, warned “there’s a possibility that non-EU counterparties would be reluctant to accept such clauses, because many of them won’t understand them.”
ENLARGE
Fred Hochberg, chairman and president of the U.S. Export-Import (Ex-Im) Bank, at a House Financial Services Committee hearing in June 2014. The bank’s charter was allowed to expire for five months before being renewed in December 2015. Photo: Bloomberg News
Commerce bodies are highly critical of the regulation, as well, saying it could especially hurt smaller companies with less access to trade credit.
“It’s a poorly thought-out regulation that will hurt EU businesses,” said Emily O’Connor, senior policy manager at the Paris-based International Chamber of Commerce.
Letters of credit guarantee a seller will get paid even if the buyer fails to make good, which enables unknown parties in different countries to trade by putting their faith in banks rather than one another.
A bank issues the letter of credit against a promise by the importer that it will pay up and then sends it to a confirming bank, which is the one the exporter uses. A specified time after presenting proof the product was shipped, the confirming bank will pay the exporter.
While sellers are promised payment by both buyer and confirming bank, the latter—more often a chain of them—is directly exposed to the risk of the issuing bank going under. Even though this risk was there before, traditional bankruptcy procedures used to be protective of trade finance, whereas the new regulation pinpoints it as liable to be written off.
People familiar with the matter say banks across different EU countries are testing the waters and slowly starting to phase in these rules in some trade-finance instruments, while still intensively lobbying European regulators. But there is little sign it has affected their corporate clients.
“We aren’t aware of these new regulations,” said Aner Garmendia, general manager at EGA Master SA. For this Bilbao, Spain, industrial manufacturer, which exports 85% of its sales, trade finance is essential, Mr. Garmendia said.
Implementation of the EU directive is dependent on each country’s regulators. There, results have been uneven.
In the U.K., regulators have suggested letters of credit could be exempted from the European directive because they “may not be practicably amendable by firms.” The final decision will be made public later this month.
In France, amendments to national legislation to allow the rule to be applied in a “proportionate” manner have been proposed, but the timing is unclear.
But other major EU countries have taken no such actions. This means British and French banks would have little reason to cheer, even if their own regulators exempted them from the rules, because different measuring sticks in every country would pose hefty complications.
“It’s just a huge documentation nightmare,” said Adam Cull, director of financial policy at the British Bankers’ Association. “Trade finance is about certainty.”
Write to Jon Sindreu at jon.sindreu@wsj.com
Corrections & Amplifications
The EU has included trade-finance instruments in the list of bank liabilities that could be at risk if a bank goes under. An earlier version of this article incorrectly stated that it was the U.S. that had included such instruments in a list of liabilities.
