Data mining: Investors beware

A growing number of investors in trade finance funds complain that low default risk trade data provided by the ICC Trade Registry is being used out of context to pitch high risk fund offerings.

The ICC Trade Register is in its sixth year and collects data to measure potential credit risks in the trade finance sector. The register for 2016 confirmed the low credit risk for banks dealing with trade finance – it did not confirm that all financing in the trade sector comes with low default risk.

That distinction is not always finding its way into marketing presentations from trade finance funds. According to a number of investors contacted by TXF, some self-sourced funds within the trade finance space have begun referring to the ICC data in their investor presentations – in effect implying that anything associated with trade finance is low risk. The problem is that many of these funds tend to be high risk/high return and are making inappropriate use of ICC data collated from and aimed at banking institutions involved in low risk flows.

An investor source tells TXF: “What these companies are doing is taking the ICC data and using it as an umbrella, climbing under it and saying ‘we’re also low risk trade finance’. The ICC is aware of this, but it’s very difficult to police.”

Another trade investor adds: “There are always going to be defaults in trade finance - that’s why it is so important to have a diversified portfolio. But what some funds are doing is associating themselves with low default risks categories, such as trade finance, to make it easier to attract investors.”

The ICC’s deputy head of the executive committee, Alexander Malaket, tells TXF: “I’ve become aware of this very recently, just before the end of the year. If there are people in the market who are somehow distorting the risk profile of their investment activities by using the work of the ICC, that’s clearly inappropriate.”

More information was included in the 2016 Trade Registry on defaults and transaction risks – a bid by the ICC to create a point of differentiation and make the misuse of its data in fund marketing presentations more difficult. But the practise does not appear to be diminishing.

The problem is potentially very damaging for the overall trade finance industry. Fallout from trade scandals can be wide ranging. For example, the Qingdao port scandal in May 2014 sent ripples across the trade sector.

The fraud involved the multiplying of a receipt five times over on a single copper shipment in the Chinese warehouse. This was not a typical trade finance transaction as there was no collateral monitoring function in place for copper deals in China at the time. However, it still caused China’s copper imports to drop 7.9% the month after news of the scandal broke.

As an investor source concludes: “There is the real risk lurking out there of direct lending platforms scouring the landscape for any opportunities, and if, seemingly, they’re covered by ICC data, investors will follow.”

Many in the trade finance industry claim the sector can only protect itself and trade flows if investors are educated about the mechanics of trade finance. As Ian Henderson, senior portfolio manager at Gulf International Bank says: “You have to make sure people are saying the correct thing. In many cases, in marketing to potential investors the letter of credit (LoC) default rate is stated as the default rate in trade finance. This is obviously a bit misleading.”

The ICC is not at fault, but potentially more accuracy is needed to refine the alternative risks involved. The average non-performing loan ratios on lending for banks is 3-5%, which are between 0.3 and 0.4% for short term on a 90 day cycle. Extremely low risk.

Some funds are shrewd in their approach to using ICC data – using very low default rates surrounded by LoC cash flows to put aside any question of high risk. The ICC has put out figures quoted by trade finance type, region and recovery probabilities. The figures are there, but as Henderson adds: “I think it’s more about whoever is doing the marketing – they are getting a certain portrayal out to investors, but not always telling the full story.”

Many funds claim they use ICC figures because there is no other concise, objective data available on trade finance. Henderson agrees, only citing e-con analytics as another option, although it does not track default or re-structuring rates.