Issue 2 | May 2016

Inside this issue:

New trade rules How regulation is shaking up trade finance

Clever CLEVIS Lessons learned from this year’s exporter survey

SWIFT innovation What to expect from this transformative programme

Commodities conundrum Is an end to the slump in sight?

Insights from Deutsche Bank Global Transaction Banking

Corporate clients

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Banking on techBankable’s Eric Mouilleron on marrying FinTech with the banking sector

Elite treasury to power your growth

Deutsche Bank Global Transaction Banking

As a trusted and long-term partner to treasurers around the world, let our local expertise and global network support you to drive effi ciency, maximise value from new payment structures, and help your business succeed.

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This advertisement is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG and any of its branches and affiliates. The general description in this advertisement relates to services offered by Deutsche Bank AG Global Transaction Banking and any of its branches and affiliates to customers as of May 2016, which may be subject to change in the future. This advertisement and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG or any of its branches or affiliates. Deutsche Bank AG is authorised under German Banking Law (competent authority: German Banking Supervision Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority, and is subject to limited regulation in the United Kingdom by the Prudential Regulation Authority and Financial Conduct Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority and regulation by the Financial Conduct Authority are available on request. Copyright © May 2016 Deutsche Bank AG. All rights reserved.

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WELCOME

Firm foundationsThese are challenging times, of that we can be certain, and we are operating in an environment that demands banks closely examine their business models.

Banks and other financial institutions are reconfiguring their structures, culture and product offerings to ensure they are future-

proofed and equipped to meet the requirements of their clients. In that context, Deutsche Bank has been very public about its own plans to invest EUR1 billion in Global Transaction Banking, a clear endorsement of the strength and stability of our business.

It’s well known there are a number of hurdles facing the industry at present, not least the cost of regulatory compliance. Cyber terrorism and money laundering are also both on the increase, and we have to continue to invest in making our systems and security robust enough to deal with attacks from criminals.

We also have to be absolutely sure who our clients are, so our efforts around Know Your Customer (KYC) are being strengthened. These important elements of today’s business landscape represent some of our top priorities and those banks that successfully invest will be able to offer greater levels of security, efficiency and service to their clients.

Our industry is under close scrutiny and the very highest standards have become an absolute prerequisite, the bare minimum we should be striving to achieve. It is therefore essential our core offering is built on solid footings. Safety and soundness starts in our own organisation, but it can also make our contract with our clients even more compelling.

Werner Steinmueller, Head of Global Transaction Banking, Deutsche Bank

To learn more about Global Transaction Banking, visit

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Flow is published by Deutsche Bank Global Transaction Banking

Design and editorial concept by Wardour (wardour.co.uk)

Marketing: Christoph Woermann Editorial: Neil Fredrik Jensen, Janet Du Chenne (Deutsche Bank), Joanna Lewin (Wardour)

For more information about Flow, please email gtb.marketing@db.com

All rights reserved. Reproduction in whole or in part without written permission is strictly prohibited. Flow is printed on Edixion Offset paper, which is sourced from responsible sources.

Cover photography: Liam Bailey

This document is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG, any of its branches and affiliates. The general description in this document relates to services offered by Global Transaction Banking of Deutsche Bank AG, any of its branches and affiliates to customers as of March 2016 which may be subject to change in the future. This document and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG, any of its branches or affiliates.Deutsche Bank AG is authorised under German Banking Law (competent authorities: European Central Bank and German Federal Financial Supervisory Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and the BaFin, and to limited supervision in the United Kingdom by the Prudential Regulation Authority and the Financial Conduct Authority. Details about the extent of our authorisation and supervision by these authorities are available on request. Copyright© March 2016 Deutsche Bank AG. All rights reserved.

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This document is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG, any of its branches and affiliates. The general description in this document relates to services offered by Global Transaction Banking of Deutsche Bank AG, any of its branches and affiliates to customers as of March 2016 which may be subject to change in the future. This document and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG, any of its branches or affiliates.Deutsche Bank AG is authorised under German Banking Law (competent authorities: European Central Bank and German Federal Financial Supervisory Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and BaFin, and to limited supervision in the United Kingdom by the Prudential Regulation Authority and the Financial Conduct Authority. Details about the extent of our authorisation and supervision by these authorities are available on request. Copyright© March 2016 Deutsche Bank AG. All rights reserved.

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Flow is regularly updated online with news and industry insights and is also available twice a year in print. Please email gtb.marketing@db.com to register your interest in Flow.

Through our website and thought leadership magazine, Flow, we deliver timely insights about the world of transaction banking and our role within it. Whether it is an important piece of research, graphics that provide greater clarity on key issues or transaction case studies, our stories – written by both internal and external experts – are tailored for corporate and institutional clients worldwide.

We hope you enjoyed this issue of Flow and we welcome your feedback.

3

4 INFLOW

The latest developments from the global transaction banking sphere

6 IN NUMBERS: THE DISRUPTORS

Who are the new FinTech players and what should banks consider when forging partnerships?

8 FIVE THINGS WE LEARNED FROM THIS YEAR’S CLEVIS SURVEY

Simon Sayer, Head of Structured Trade Export Finance at Deutsche Bank, shares his views on the key findings

10 BEING BANKABLE

Eric Mouilleron, CEO of FinTech firm Bankable, talks innovative payments solutions and global aspirations

14 TRAFIN THE TRAILBLAZER Revisiting TRAFIN, the landmark deal that shows how trade finance as an asset class is gaining popularity

16 THE BUTTERFLY EFFECT

Exploring the ramifications of new trade finance regulations in Europe

20 CHANGING SANDS

Michael Spiegel remains optimistic about the lie of the undulating cash management land

22 NEW TOOLS, NEW RULES

A new platform is opening up the foreign exchange market and reducing costs

24 TIME FOR A CHANGE

Switzerland’s new interbank payments system is a landmark for the nation’s banking sector

26 PLAYING THE LONG GAME Why a sustained recovery in commodity prices could be on the cards

30 THE AGE OF FINANCIAL INNOVATION IS UPON US

How can banks make the most of a FinTech partnership?

32 THE NEVERENDING STORY

Basel III and PSD2 are charging forward. What are some of the latest developments?

34 SWIFT AND SURE

The Global Payments Innovation Initiative goes live at the end of 2016. How will it improve transactions?

36 FROM HERO TO BELOW ZERO

Anne-Katrin Brehm, Institutional Cash Management at Deutsche Bank, answers FAQs on negative interest rates

38 OILING THE PAYMENTS ENGINE

Why intraday limits are essential for a smooth-running payments market

41 ARE WE ROBOT READY?

Columnist Stephen Armstrong considers artificial intelligence in our business lives

“The US is our big target for 2017”Eric Mouilleron, CEO of Bankable

10

“The negative interest rate environment is not a business cycle expression – it is a structural one”Anne-Katrin Brehm from Institutional Cash Management at Deutsche Bank

36

CLEVIS Survey: What’s keeping exporters up at night?8

contents

54

Digesting the trends affecting institutions and corporates in the global transaction banking sphere

Money2020 opens eyes and ears

The leading financial technology conference, Money2020, reached Europe in April.

Normally held in the US, the conference this year was hosted in the Danish capital of Copenhagen – a reminder of the changing global business landscape.

The Financial Technology (FinTech) sector has commanded a lot of attention over the past couple of years. While some try to dismiss its rise as a bubble, it was clear from Money2020 that FinTech firms are already gaining significant client traction.

This was an eye-opener for the banks present in Copenhagen, but what was

equally clear from the conference was FinTech firms’ desire to work alongside banks. Regulators are also looking to link up with the sector in a bid to balance regulation and innovation.

Blockchain was never far away from discussion at Money2020. CEO of Digital Asset Holdings Blythe Masters, speaking at the conference, said Blockchain will be used by financial services companies within two years, and that the underlying technology will become mainstream within 5-10 years. Blockchain still has its hurdles to overcome, with some of the doubts driven by its connection to the sometimes-controversial cryptocurrency, Bitcoin.

Collateral mobility dichotomy addressed at SWIFT Business ForumApril’s SWIFT Business Forum in London saw topics range from UK settlement system CREST turning 20 to collateral mobility. An industry panel deemed that, with regulators advocating the increased protection of investors’ assets on the one hand and pushing for greater collateral mobility on the other, it should be up to service providers to find the structures that support both aims.

Mike Clarke, Director, Product Management, Global Securities Services at Deutsche Bank, moderated the panel with representatives from international central securities depositories. It addressed market concerns about whether the dichotomous nature of investor protection and collateral mobility regulations will allow for the benefits of TARGET2-Securities to be realised.

“The industry should be able to find structures that allow collateral mobility while still safeguarding client assets,” said Clarke.

EPC launches consultation on SEPA Rulebook amendments

The European Payments Council (EPC) has announced the launch of the Single Euro Payments Area (SEPA) Credit Transfer and SEPA Direct Debit (DD) rulebook consultations.

All stakeholders are invited to have their say in the evolution of the three existing SEPA scheme rulebooks published by the EPC. The SEPA Credit Transfer scheme, the SEPA DD Core scheme and the SDD Business-to-Business scheme will be subject to a public consultation until July 4 2016.

Suggestions that find broad acceptance in the overall payment community, and that are technically and legally feasible, will be taken forward. In November this year, the EPC will publish the updated rulebooks and implementation guidelines that will enter into force one year later. This is to ensure participants in the scheme have enough time to implement the necessary changes in their systems.

Survey finds 73% of US companies targeted for payments fraudNearly three quarters of all US businesses were targeted for payments fraud in 2015, according to new research by the Association for Financial Professionals (AFP). The 2016 AFP ‘Payments Fraud and Control Survey’ found that 73% of all US companies experienced payments fraud last year. That matches the largest percentage since 2009, and was up from 62% in 2014.

Business email compromise (BEC) scams are an increasingly common type of fraud that greatly affects wire fraud. In 2015, 64% of organisations were exposed to BEC scams. Though cheques continue to be the payment method most targeted by fraudsters, in 2015, 48% of organisations were exposed to wire fraud, an increase from 27% in 2014 and 14% in 2013.

inflow

72.5% The proportion of renminbi (RMB) payments processed by Hong Kong, the No. 1 RMB clearing centre[1]

Source: [1] SWIFT

For more Global Transaction Banking news, go to

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FinTechs have technical expertise, regulatory freedom

and no legacy issues

Banks bring knowledge, tried-and-tested infrastructure

and experience

FinTechs must consider a bank’s

client base in relation to what they can offer

66%think partnering

up is risky[3]

think FinTechs will reduce reliance on banks[3]

62%

Banks should see FinTechs not as

vendors, but equal partners

FinTechs must be aware of cultural differences within

banks

Banks should ensure their services are in line with the

FinTech’s objectives

What do CFOs think?What are the key things to consider?

FinTech firms

Small startups Focus on payments

Technologically advanced

Digital ecosystems

Digital platforms Outside the payments space

Allow transactions within a marketplace

The estimated number of FinTech startups in Asia, the UK and the US combined[1]

The rise in FinTech investment in the first 10 months of

2015 vs 2014[2]

of payment startups will fail in their first four years[1]

c. 50%

1/3

6,500

IN NUMBERS

The disruptors

Sources: [1] Bobsguide; [2] Forbes; [3] Deutsche Bank

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Things are changing rapidly in the FinTech space and banks are looking to forge partnerships with new market entrants

Who are the new players?

See pages 30-31 for more on the opportunities for banks and FinTechs

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Each year, research firm CLEVIS surveys around 80 exporters to reveal some of the major trends within the export finance sector. Simon Sayer, Head of Structured Trade Export Finance EMEA at Deutsche Bank, shares his views on this year’s results

things we learned from this year’s CLEVIS Survey

1Exporters are mixed on whether Basel III poses a challenge to export

finance pricing

The survey said: “Exporters believing Basel III will have a strong impact on export financing prices suppose this will increase their future demand for services from [banks and] export credit agencies (ECAs).

“Many exporters are only moderately worried about the impact of Basel III due to the fact that a significant number of banks outside Europe are not affected by [the] regulations … resulting in a weaker global effect [of] Basel III.”

Simon says: “This is concerning but to some extent understandable. The full implications of Basel III have not yet fed through to the market, and therefore to exporters, as the adoption of Basel III reporting proceeds at different speeds at different banks – some are early adopters, others are not yet reporting under Basel III.

“There will certainly be pricing and capacity implications for export finance driven by the Leverage Ratio in particular. At the moment, there is still plenty of liquidity but we are starting to see changes in the market as some banks pull back. Only when pricing moves upwards will exporters start to be directly affected. It is going to happen – it’s just not clear when.”

FIVETRADE FINANCE

3Exporters are concerned about excess liquidity

The survey said: “There is a notion that pricing will keep decreasing due to high liquidity.”

Simon says: “This has been an issue for some time. There is a lot of cash ready to finance trade at the moment and that means there is more money chasing the deals. This has, naturally, forced pricing down and placed margins under tremendous pressure.”

4Emerging markets are coming to the fore again, notably

the continued rise of African markets

The survey said: “The interest from European ECAs in emerging markets is increasing … There are [big] differences among countries, some of which are still unstable and carry big risks.

“North Africa and sub-Saharan Africa are regions where economic growth will lead to enormous opportunities over the coming decades.”

Simon says: “Deutsche Bank is a mature player in the emerging markets but, like other banks with an established track record, carefully selects transactions with the right risk profile.”

2Risk considerations are still a major priority for exporters

The survey said: “[For deals in] India and the Middle East, and for long-term projects in general … the uncertainty level is significantly higher.

“ECAs are not allowed to insure deals related to certain countries, such as Ukraine, for risk that extends beyond two years.”

Simon says: “Export finance holds a number of specific risks for exporters. Right now, the conflict in the Middle East and Russian sanctions are of great concern, coupled with the rise of terrorism in recent months.

“Market risks include low commodity prices together with fluctuating exchange rates, the latter of which has increased the need for hedging export deals.”

5Banks continue to meet their clients’ needs against an

ever more challenging backdrop

The survey said: On measurements that included flexibility, understanding of business, breadth of product offering, customer services and risk appetite, not one of the export finance banks surveyed received a score lower than seven, which denotes ‘very good performance’.

Simon says: “Exporters know exactly what they want and need from their banks. This is a mature market and what banks offer their clients is largely appreciated. Banks aim to make life as simple as possible for exporters.

“To some extent, we, as a market, have undervalued the services that we provide – that includes the advice, knowledge, financing expertise and the deep experience that established market providers bring to the table.”

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For the banking industry, one of the priorities over the next few years will be the need to step up collaboration

with the fast-growing financial technology sector. With so much dynamism emerging from a broad range of companies across all geographies, it is clear that the future landscape will, to some extent, be driven by the symbiosis of traditional financial institutions and young, agile organisations free from legacy issues.

Deutsche Bank has already focused on building partnerships within the FinTech industry. Together with its broader digitalisation push, characterised by the establishment of innovation labs and various initiatives, the bank is winning mandates and forging partnerships with firms within this increasingly important client segment.

The push is not all one-way, either – some FinTechs have identified that cooperation and co-existence is a pragmatic way ahead. One such company is Bankable, an organisation that positions itself as a global architect of innovative payment solutions. Bankable was founded in 2010 by Paris-born Eric Mouilleron, who has a track record of presiding over fast-moving startups. Notably among these is the IT services consultancy firm Valtech, which Mouilleron eventually took public. He is especially proud of the fact Valtech had no venture capital involvement and was self-funded by partners and sundry investors until its market floatation.

Mouilleron’s ambition for Bankable is similar and he is confident he can make it a GBP 1 billion enterprise within a reasonable timeframe. Such optimism he bases on his experience of making Valtech a EUR 1.5 billion company within six years.

Cash outBankable was formed out of its founder’s desire to play a key role in building a so-called cashless society for consumers and corporates – something that has been championed by none other than Bill and Melinda Gates. It was an idea that came to Mouilleron at an industry conference on

It’s not just banks that are keen to tap into FinTech. FinTech firms are coming to banks. Neil Fredrik Jensen talks to Bankable CEO, Eric Mouilleron about his company’s innovative solutions

Being Bankable

CLIENT INTERVIEW

prepaid cards, during which he identified that this was an area of potential high growth. “I saw an opportunity to make life easier for consumers who really only need basic banking services and do not want to be burdened by hidden fees. I sensed, for example, that a prepaid-based bank account enables such services and empowers those who do not have bank accounts and sit outside the credit rating system.”

Mouilleron knew that he could build a company that didn’t need to be heavily capitalised and resourced to make an impact – Bankable is the epitome of lean, working predominantly from London’s Level39 Tech Accelerator in Canary Wharf. Certainly, Bankable’s profile has grown significantly over the past couple of years. It was named among KPMG’s Global FinTech 100 and was recently listed in the top three in the payments category in the European FinTech 100 Awards for 2016.

Bankable also made a contribution to the Open Banking Standard, a framework aimed at stimulating financial innovation and competition through the means of application programme interfaces (commonly known as APIs) at the request of the UK Government’s Treasury department. Furthermore, at the World Economic Forum in Davos earlier this year, Bankable formed part of the Innovate Finance delegation that represented the UK’s FinTech sector.

Bespoke banking The company’s mantra-like proposition is the provision of “banking as a service”, but what exactly does that mean? Mouilleron explains: “We are an enabler, allowing fellow FinTechs to take their proposition into the market with the infrastructure for transaction processing. Furthermore, we add financial services to companies with a new idea, delivering the payment part of their offering.”

Bankable’s core platform is available in white-label or via APIs, and allows financial institutions, corporates and other FinTechs to develop bespoke payment solutions that meet their business needs.

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‘Banking as a service’ is, essentially, a payment platform that can incorporate virtual accounts, B2B payments, B2C light banking, mobile payments, peer-to-peer transfers and remittances. Moreover, the white-labelled payment apps include virtual ledger management, real-time payouts, light banking, card management, corporate disbursement and virtual cards.

Bankable’s payment solutions are targeted at corporates, insurance companies, retailers,

telecoms companies and transaction banks. As part of Bankable’s target client base, Deutsche Bank made an ideal partner for the company. Mouilleron portrays Bankable as “the friendliest FinTech around to incumbent banks” and from an early stage, it was clear that Bankable and Deutsche Bank had common interests.

Mouilleron and his colleagues are firm advocates of the partnership concept, be it with banks or other clients. “We are not all about saying to our client, ‘we want to sell you as much as we can’,” he explains. “It’s about seeing what we can do together for our mutual benefit. We look to minimise the capital expenditure and maximise net revenue for our clients, and also for ourselves. And we do this in a very transparent and open way.”

Mouilleron is also very open about his outlook for the FinTech revolution. He’s obviously a huge advocate, but he does believe there will be some falling away within the sector. “There are a lot of interesting companies out there at present, and I hope they will all survive, but I sense the ‘fashionable’ items will disappear, while those that people really need – the ‘solid’ offerings – will thrive. Clients know the difference between the two, that’s for sure,” he insists.

Bankable’s unique selling point, according to Mouilleron, is its flexibility. “The technology we use allows us to build configurable and adaptable systems. This enables us to build platforms that can serve both large and small companies. This is an attractive aspect of our offering to larger organisations.”

The perfect partnerThe link-up between Bankable and Deutsche Bank underlines this flexibility. “We are proud of our close relationship with Deutsche Bank,” says Mouilleron. “We identified the bank as one that understood the changing markets and we could see they were well organised around the FinTech sector. It became very clear that Deutsche Bank wanted to work with us on a number of levels – as a client, a vendor and a partner.”

The partnership began with involvement from Emmanuel de Rességuier, Global Head of

It has been our ambition since day one to become global

It’s all about seeing what we can do together for our mutual benefit

Advisory and Solutions for Insurance, Public Sector and Pensions at Deutsche Bank Paris, and has subsequently expanded within the firm to include the likes of Andy Reid, Head of Cash Management Corporates EMEA, and Martin Runow, Global Head of Client Product Solutions. Pablo Melchiorre, Head of Cash Management Corporates in Spain, has also been appointed to extend Bankable’s relationship with clients across Europe.

Deutsche Bank fully audited the Bankable platform over 12 months and appointed the company as a globally approved vendor. The platform was comprehensively tested by EY almost two years ago.

Bankable’s virtual ledger technology operates on top of any bank account-enabling treasury management reconciliation. It allows corporate clients to mirror their organisation and create corporate users in the relevant entity with the right level of roles and permissions. The virtual ledgers permit credit and debit entries to be automated. They do this by using unique references or the manual assignment of funds entering or leaving the underlying bank account.

Then there is Bankable’s card management platform, which is flexible and allows distributors, corporates and cardholders to access their own portals for managing and using the card programme.

Bankable’s Corporate Disbursement solution, meanwhile, offers a white-labelled self-service cloud-based platform that banks can offer to their corporate clients to issue prepaid debit cards to employees for expenses, purchasing, payroll and other incentives. Deutsche Bank selected Bankable to implement and operate a Deutsche Bank-branded Corporate Disbursement Programme – full turnkey solution that includes a white-labelled corporate card management platform, card issuing, manufacturing and delivery, and transaction processing.

An evolving relationship“We are actually best known for our relationship with Deutsche Bank,” says Mouilleron. “There is the potential to distribute our solution to a significant corporate client base. Working closely

Clients know the difference between the fashionable offerings and the solid ones, that’s for sure

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with Deutsche Bank, we were able to roll out innovative card services such as real-time transaction notifications and SMS alerts, receipt management and self-servicing for clients. And the combination of our solutions and the Deutsche Bank brand really works.”

Reid says the partnership is still in a relatively early phase and, at present, around 50 clients are benefiting from the Bankable solution. “The relationship is growing all the time and there is enormous upside,” he says. “The prepaid cards sector is in the ascendancy and this solution can be a very compelling proposition for a broad range of our corporate clients.”

As well as a partner and a vendor, equally important for Deutsche Bank is Bankable as a client. In this case, the bank has provided a trust account on behalf of Bankable’s clients, across various currencies. “Deutsche Bank’s position as a leading FX house is also something that brings big benefits to the relationship,” says Mouilleron.

Deutsche Bank is not the only big name client for Bankable. A major European-based global insurance company has selected Bankable to operate its ‘click-and-collect’ programme for real-time payments.

Worldwide ambitionAlthough Bankable appears to be Euro centric at present, the company’s aspirations are absolutely broader. “It has been our ambition since day one to become global,” insists Mouilleron. “We currently serve our European clients on a global basis as well as all organisations with a legal entity in Europe. So in a way, we are already in the US. However, we see the US as a big target for 2017.”

Bankable’s global ambitions, aligned to the network offering that Deutsche Bank can bring to the partnership, can only enhance a relationship that is something of a poster child for the bank’s Trade and Cash business. “The cooperation between Bankable and ourselves can be a template for the way FinTechs and banks can come together successfully,” is how Reid phrases it. “The really exciting thing about this is that we are achieving good things, but we are only just at the start.”

Eric Mouilleron is the CEO and Founder of Bankable. Paris born, Mouilleron started Bankable in 2010. He previously ran Valtech, an IT services consultancy he eventually took public.

For more on the opportunities for banks and FinTechs, visit

cib.db.com

In addition, there are now greater origination responsibilities, such as more stringent proprietary credit processes.

The assets in TRAFIN are short term, which brings with it administrative challenges. “The term of the deal is five years, so for the life of TRAFIN, we have to continually replenish the assets,” adds Brooks. “So, we have to be confident in our pipeline and our ability to originate business over the course of the transaction. Some other firms have had replenishment issues on their deals, but this is not something we have experienced.”

A sign of things to comeBrooks sees further deals of this nature coming to market – they help the issuers with balance sheet management and they are also regulatory friendly. “We can expect greater demand coming from investors who are now much more aware of trade finance assets and their qualities, which means pricing will become more competitive for deals like TRAFIN,” says Brooks.

He also sees the success of TRAFIN as an indication of the strength of Deutsche Bank’s Trade Finance business: “This clearly demonstrates that investors have confidence in our business and risk management capabilities. With this model, we were able to tap into an investor base that would not usually consider trade finance as an asset class.”

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insurance companies and hedge funds, bought into the deal. “People have a better understanding of trade finance than they had in the past. They see that trade finance investments offer them diversification, non-correlation and relatively low risk. Furthermore, if you look at the default rates on trade assets they are very low and the recovery rates are good,” insists Brooks.

Handle with careNevertheless, the distribution of trade finance assets, especially to new investors, requires some expertise. Brooks considers it as a specialist asset class in need of careful handling, not least because trade finance loans, for example, are invariably structured to mitigate key risks.

Surely, as a CLO, there were perception barriers to overcome? After all, the acronym is deeply associated with the 2008-09 financial crisis. Brooks explains that a trade finance securitisation is significantly different from the infamous sub-prime mortgage-backed securitisations.

“The market is more regulated today and rightly so. And CLOs continue to play a major role for institutions wanting to manage debt. One of the things that is different today is that regulators insist on the issuer – in this case Deutsche Bank – retaining some of the risk. In the past, this was not necessarily required.”

Although it was the third synthetic Collateralised Loan Obligation (CLO) transaction to be carried out

under what has been heralded as a highly innovative structure, Deutsche Bank’s TRAFIN 2015-1, launched last November, was something of a milestone. It underlined the growing demand for trade finance assets from institutional investors.

As well as appealing to these investors, the transaction also helped strengthen Deutsche Bank’s balance sheet in the form of risk-weighted asset relief. This type of structure is not simple to achieve and not every financial institution can bring it to market.

Guy Brooks, Head of Distribution & Credit Solutions at Deutsche Bank’s Global Transaction Banking, explains: “The barriers to entry for a deal of this kind are high for a number of reasons. First, you need the system infrastructure. Second, the internal dynamics of your organisation need to be aligned and able to work alongside each other seamlessly. For example, we have an in-house team that looks at securitisation and repackaging within our trade finance team, which is quite unusual.”

Brooks and his colleagues compiled a USD 3.5 billion portfolio of trade finance assets, including flow business, short-term trade finance, letters of credit, supply chain finance and documentary credit business.

“We place them all into a reference portfolio, so obviously we have very strict eligibility criteria that we must adhere to,” explains Brooks. “We agree with the investor(s) the type and the concentration caps of the products that can go in and those that cannot. And that is when we settle on the appropriate ratings.”

Securing buy-inWhere the TRAFIN structure differs from other regulatory capital transactions is that it is a pure trade finance portfolio, which facilitates optimal pricing.

Equally, one of the big differentiators of this transaction is that it allows Deutsche Bank to hedge the portfolio via the sale of a first loss tranche, which the bank structured, arranged and placed in the market. Seven investors from Europe and the Americas took the deal.

“Given you are selling the riskiest piece of the deal – the first loss – it naturally has an inflated yield, which appeals to a broad range of investors. So, it was important to reformat the risk, slice up the capital structure and sell off different pieces. The response in the market has been impressive,” says Brooks.

With interest growing in trade finance assets, a broad range of investors, including family offices, pension funds,

TRADE FINANCE

TRAFIN the trailblazerWhen Deutsche Bank launched its trade finance securitisation, TRAFIN 2015-1, it was unveiling one of the largest deals of its kind in the market. Neil Fredrik Jensen talks to Guy Brooks about a landmark that shows the growing appetite for this asset class

USD 3.5bnworth of trade finance assets

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For more content on trade finance, visit

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Eventually, the Basel Committee on Banking Supervision (BCBS) announced a carve-out for trade finance.

Despite these positive developments, banks specialising in trade finance, in particular commodities finance, still face significant regulatory concerns. In the initial Basel II proposition, for example, there was an interesting window of opportunity for commodities finance: the possibility to use so-called Supervisory Slotting Criteria (SCC) (detailed criteria for assessing the credit risk of different types of specialised lending) as a substitute for the probability of default under the SA for credit risk. These are detailed in Annex 6 of the Basel II text.

Concise and well received These slotting criteria allowed banks that were active in commodities finance to do business with counterparties that had a weaker balance sheet but a good track record. They also recognised that lenders take security over commodities and/or commodity flows, and that some flows are more ‘strategic’ to any given borrower, or indeed country, than others. Furthermore, the slotting criteria allowed for degrees of response to any highlighted risk considerations: ‘Strong, Good, Acceptable and Weak’.

In fact, the SSC were such a concise and well-received risk summary that many commodity finance specialists in Internal-Ratings Based (IRB) Approach banks used them in an attempt to encourage their Credit departments to recognise that this view of commodity finance risks was already accepted by the Basel authorities.

The big commodity banks, however, were all using IRB, so the SSC did not apply. Meanwhile, some of the smaller banks that were using the SA struggled when control departments could sometimes take a

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short-term instruments, was just 0.021%. In the face of this data, the one-year maturity floor was removed.

An ongoing challengeBut with every iteration of the Basel framework come new challenges for trade finance – and Basel III is no exception. Granted it retained the favourable 20% credit conversion factor for trade finance, inherited from the various earlier national regimes

across Europe, which survived into Basel II for Standardised Approach (SA) banks. But against the backdrop of the financial crisis, which saw over-leveraged banks shoulder much of the blame, Basel III introduced a flat 100% leverage ratio for all off-balance sheet instruments. Initially, LCs fell into the scope of that leverage ‘tax’, essentially cancelling out the favourable 20% capital treatment they had been afforded.

With the help of the World Trade Organization, however, the trade finance community was able to prove that LCs weren’t being used to leverage balance sheets – and, more compellingly, that the major victims of such a move would be poorer countries that have to pay by LC for their food and energy imports.

Today, it is almost impossible to discuss the impact of prudential regulation on trade finance without mentioning the

phrase ‘unintended consequences’. Looking at some of the most significant changes and proposed updates to the Basel framework in recent memory, it’s easy to see why.

Over the past few decades, the regulatory pendulum has swung from supporting trade finance to imposing much stricter requirements – which either seem to misinterpret the business of financing trade, or inadvertently impact on trade finance, while actually targeting other, riskier forms of finance.

Take Basel II for example. As part of a wider attempt to minimise systemic risk in the financial system, the regulators introduced a one-year maturity floor for letters of credit (LCs), meaning that banks had to capitalise every LC for 360 days, even if it had a 90-day maturity. Understandably, putting up four times as much capital as was actually necessary didn’t sound like a compelling proposition for the banks.

Hugo Verschoren of ING Wholesale Banking is Senior Technical Advisor for the International Chamber of Commerce’s (ICC’s) Short-Term Trade Register, which was formed in reaction to the Basel II proposals. He says: “When Basel II was proposed, the parameters for the treatment of trade finance were so high that the industry could not have continued to function properly.”

At the time, no aggregated data from across the market was available to help the regulators understand the average maturity of LCs and their risk profile. By bringing together data from the world’s largest trade banks, originally over five years, the ICC’s Trade Register was able to provide evidence of the average maturity of LCs (90 days), and determine that the loss, given default of

TRADE FINANCE

The butterfly effect While any attempts to make the trade finance industry safer and more robust are welcome, the ramifications of broad-brush regulation on business practicalities remain a cause for concern – not least in the commodities finance segment, says Eleanor Hill

100%leverage ratio introduced under Basel III for all off-

balance instruments

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very literal interpretation of the language. For example, some insisted that one leg of any trade finance must involve an exchange in order to qualify for the category ‘exchange-traded commodity’. This led to the SSC falling out of favour.

Rethinking commodities financeHowever, a December 2015 consultative paper (updating the 2014 edition), entitled ‘Revisions to the Standardised Approach (SA) for credit risk’, has given the trade finance industry cause to revisit the concept of slotting criteria.

In it, the BCBS proposed the reintroduction of external ratings for specialised lending exposures: “In particular, the Committee proposes to use issue-specific external ratings for project finance, object finance and commodities finance. The applicable risk weight would be determined by the same risk-weight look-up table that would apply to general corporate debt exposures.”

The challenge here is that in the world of commodities finance, unless you are dealing with one of the biggest players, there are no external ratings available. And according to the regulator’s proposals, in the absence

of an external rating, a flat risk weighting of 120% would apply. This seems quite high when project finance only attracts a 100% risk weighting in the operational phase.

Given that project finance deals typically have little or no track record and last anywhere from 7-15 years, compared to a much shorter timeframe in commodities and a significant track record, it seems that the current regulatory environment is not tipped in favour of commodities finance.

The finer detailWhere issue-specific external ratings are either not available or not allowed for regulatory purposes in a jurisdiction, the BCBS proposed:• a flat risk weight of 120% (irrespective of the

counterparty’s risk weight) for object and commodity finance exposures; and

• a 150% risk weight for pre-operational project finance and a 100% risk weight in the operational phase.

In fact, some industry observers believe that if the banks do not ‘wake up’ to the current consultation process around the ‘Revisions to the Standardised Approach’, the commodities finance business risks disintermediation. Many short- and long-term deals may end up being financed by commodity traders, who are not hampered by Basel III or are not made less agile by having to comply with prudential regulation. Many deals have already gone that way.

Regulatory overspillElsewhere, elements of Basel III are leading banks to focus on Return on Assets (RoA) as a key performance indicator. This is inadvertently causing them to take on more risk when it comes to credit insurance for commodities deals, says John MacNamara, Global Head of Structured Commodity Trade Finance at Deutsche Bank.

“Basel II introduced banks to using insurance to improve RWA outcomes. Looking at Basel III, the RWA treatment of insurance is still good, but it tails off beyond a certain point.

“Meanwhile, the more insurance you take out, the less likely you are to make the RoA target because of the cost eroding the return while the asset remains the same.”

Broadly speaking, it is “now more or less uneconomic to insure anything over 65% of most commodities finance deals. In the past we would have typically looked to insure 90%. So, for any given USD 100 million transaction, banks are taking an extra USD 25 million dollars of risk,” he adds.

Basel III has also made it more difficult for European banks to compete in certain product areas and regions. “If a bank has an unfunded commitment,” says MacNamara, “Basel III stipulates that it has to be capitalised as though it is cash. Since the American market is particularly focused on liquidity, customers like to have credit headroom: unutilised committed facilities.”

Previously, the banks have provided that for a commitment fee, but under Basel III, it has to be at full margin. “This has made it far more difficult for the European banks to compete in the US as the American banks

were, and are until June 2016, still under the requirements of Basel III. So those types of facilities have essentially become loss leaders for European banks.”

Additional headachesBasel III isn’t the only regulation that is causing commodities and trade financiers to scratch their heads, however. “Take the recently promulgated Securities Financing Transactions (SFTs) regulations, for example,” says Nick Grandage, Partner at global law firm Norton Rose Fulbright LLP. “These are designed to bring securities repos within the ambit of financial regulation, and they extend to commodities repos as well. There is no reason why that shouldn’t be the case, but the wording of the regulation is clearly based around securities financing.”

The result, says Grandage, is that there is “some activity which, according to a purposive test, seems as though it should fall under SFTs, but according to the strict wording of the regulations, it does not.” That will only lead to confusion among firms attempting to apply the regulations.

Grandage adds: “The recent Bank Recovery and Resolution Directive (BRRD) introduces new requirements around contracts that banks must sign, known as the ‘contractual recognition of bail-in’. The wording is mandatory and requires an acknowledgement from a counterparty.

“This is fine for most types of finance, but with an LC, the requirement for an acknowledgement makes little sense.”

With examples such as this, Grandage says: “It does sometimes seem that trade finance is something of a regulatory afterthought.” And although no one within the commodities and broader trade finance industry would argue for a complete exemption from regulation as a solution to this challenge, the volume of regulatory initiatives that still fail to fully take into account the nature of trade finance is a genuine hurdle.

“What we would ideally like to see is regulation that enforces a level playing field and sets rules to which we can all

subscribe,” says MacNamara. “These rules need to be consistent across the market, but at the same time recognise that trade finance wasn’t the cause of the global financial crisis and is, by and large, one of the lower risk products.”

Grandage, meanwhile, emphasises the need for greater clarity around regulation. “Of course banks want regulation that draws the right balance between regulatory oversight and achieving commercial and business practicality,” he acknowledges.

“But what is really important is that regulation is clear. I would say that if banks were given the choice between too much crystal clear regulation and a smaller amount of unclear regulation, most would opt for the former.” After all, non-prescriptive regulation means banks have to spend time working out what the regulation means for them, rather than putting in place processes to ensure compliance.

A joint approachTo that end, Verschoren believes:“The industry needs to maintain an ongoing dialogue with regulators, since the Basel framework will continue to evolve and new consultation papers are frequently being issued for discussion.” Global banks should engage with their local banking associations to respond to these papers, he adds.

As representatives of the trade finance industry, banks must also do what they can to educate regulators in the nuances of trade finance. “Ultimately, this will help regulators to accurately estimate the risks involved with the business. This will help to ensure that any control mechanisms are commensurate with that low level of risk.”Im

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FinTechs may depend on evidence that their business is stable, secure and robust. And this is where he sees continued value being added by banks. “We have a key role to play in adding certainty and stability and solid activities like financing and distribution to the equation.”

Regulation reverberationsTraditionally, the environment has been created by regulators and infrastructure providers. Spiegel considers that there have been a lot of unintended consequences from some of the regulations being tabled. “In my view, the regulations have been so focused on banks that they do not always seem to fully consider the effects on the economy, in particular the flow of goods and services,” he says.

“Globalisation is irreversible and it is in the best interests of all players to create a safe, sound financial system. But this needs to support the economy rather than create more barriers. So, the industry needs to ensure regulators become an integral part of the new eco-system between banks, clients and FinTechs. This is something we have to find a way to achieve.”

Committed as everWithin that framework, Deutsche Bank is committed to making client onboarding better and more thorough. While it may be a frustrating process for some, Spiegel underlines its importance. “Know your client processes have to be strong enough to deal with the issues we are all facing – fraud, money laundering and others. But we are making significant investments in improving our systems.

Trade Finance and international corporate banking are both core to our strategy – it has always been the case for Deutsche Bank and it is integral to our future growth,” says Spiegel. “Nothing has changed. We are as committed as ever to our clients, and our business model is intact.”

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why Spiegel believes the treasurer has undoubtedly moved centre stage.

Then there’s the remarkable upward momentum of FinTech firms, which is very much on Spiegel’s mind. “These companies, some of which are significant in size, are bringing a new dynamic to the payments industry. They have certainly raised expectation among service users.”

He is adamant, however, that the banking industry must ensure it is part of the dramatic change that is just beginning and becomes a driver rather than a passenger. “We should be under no illusion that these new market entrants could assume some of the functions that have traditionally been carried out by banks,” he cautions.

Enabler of innovationSpiegel’s goal is for FinTech firms to become the Bank’s clients, partners and vendors, as well as competitors. “Partnering with these companies should be a priority, as they bring a fresh and agile approach to the table. The role of banks in the future may change, but we can be in control of that change and could, for example, be the provider of basic infrastructure or perhaps the enabler of innovation,” he says.

It’s clear where Spiegel’s preference would be – in the direction of banks as ’change agents’. Spiegel sees the combination of the global strength of a big bank – such as Deutsche Bank – and a nimble FinTech creating a very workable and fruitful partnership. From Global Transaction Banking’s perspective, there are already good examples of partnerships being built.

Harnessed properly, and with the client uppermost in the process, Spiegel envisages a new eco-system emerging from this time of disruption – one that includes FinTech firms. While there can be no doubt about the invention coming from this segment, Spiegel cautions that investment in some

Regulatory demands, geopolitics, increased competition, digitalisation and the rise of the Financial

Technology (FinTech) sector are all adding to a set of new and renewed challenges for banks. Bankers, among others, could easily be downcast about the outlook.

But not everyone is having sleepless nights about how to maintain profitability and relevance with clients. In April, the Money2020 conference in Copenhagen highlighted the opportunities – and need – for further innovation in the banking industry. Attendees came away very aware of the change underway and the need for banks to respond, something that Michael Spiegel, Head of Deutsche Bank’s Trade Finance and Cash Management Corporates, has been advocating for some time.

“I believe we are still at an inflection point in the Trade and Cash industry,” he says. “One that demands that we ensure our business is run better, that it covers all risks and also embraces the changes in the marketplace. If we get all of those things right, we will emerge from this period of transition with a stronger, more compelling client offering.”

Moving centre stageSpiegel is only too aware of the challenges facing Deutsche Bank and, more broadly, the sector, but he believes that the Bank’s Global Transaction Banking arm is coming from a position of relative strength. The inflection point he talks frequently about is based on two key trends: increased corporate treasury complexity and the rise of FinTech firms.

“The role of the corporate treasurer is becoming more complicated on many levels: geography, client demands, liquidity and risk management, to name but a few,” says Spiegel. Add to that the need for greater working capital solutions, such as FX, trade finance, cash management and short-term lending, and you can see

TRADE FINANCE/CASH MANAGEMENT

Shifting sands Change is underway in the banking sector, so it’s no surprise that the Trade Finance and Cash Management industry is feeling the pressure. Michael Spiegel, Head of Deutsche Bank’s Trade Finance and Cash Management Corporates, talks to Neil Fredrik Jensen about why he remains optimistic

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Hedging is only part of the story, however. FX is an integral part of GTB’s Cash Management offering to clients. This really comes to the fore around cross-currency payments and collections. Paying beneficiaries in their operating currency, while leaving FX conversion to the beneficiary’s bank, and paying in local currencies through individual currency accounts can be inefficient for our clients from a cost perspective. “FX4Cash provides another way – paying beneficiaries in local currencies and funding payments from a single operating currency account.”

FX4Cash brings many benefits to the client, not least improved treasury and risk management in FX transactions. It also consolidates accounts and eliminates the need for minor currency accounts. Corporate and financial institution clients that are attracted by its flexibility gain innovation and efficiency.

A clear distinctionRobert Wade, Head of Electronic FX Sales at Deutsche Bank, says there is a marked difference between the needs of the two client bases. “Institutions are more concerned with execution capabilities, while corporates are more focused on workflow and treasury solutions. We can provide exactly what both sets of clients need.”

Clients can also benefit from the expanding partnership between GTB and the Sales & Trading FX business. “These departments can really leverage this client-focused joint venture to good effect,” insists Wade.

Mueller adds that the interaction between GTB and the FX business continues to grow and reap rewards for both the bank and its customers. “Our FX franchise is world class and enables our clients to manage risk, while also meeting the growing requirement from treasurers to execute cross-currency and cross-border payments,” he says. “These are both major priorities for our clients and we have the tools and expertise that they require.”

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Hedging, quite naturally, features among these requirements and the FX team has developed a product that is ticking many boxes for clients – Deutsche Bank Automated Rolling Collars, or ‘dbARC’. This tool, explained below, is especially useful in emerging markets (EMs), says Jeremy Monnier, Global Head of FX Structuring, Deutsche Bank. “Hedging EM exposures is a necessary exercise but can be costly if done through traditional hedging instruments such as forwards,” he explains. “However, a collar-based strategy – which restricts certain market activities – can allow clients to hedge risks without locking in the cost of the carry.”

Given local interest rates in emerging markets, this cost of carry – the difference between the cost of holding an asset for a specific timeframe and the financial benefit of doing so – can be high. It affects both forward and cross-currency swaps pricing, which weighs on profit and loss in the longer term. EM currencies can also have wild mood swings, appreciating steadily, before depreciating very rapidly when things go wrong.

Attractive featuresThis has prompted some corporates to turn to collar-based solutions such as dbARC. “It combines all the necessary ingredients of a hedge – collar-based, rolling short-term hedges and preset collar strikes at trade inception,” explains Monnier. “But the difference between dbARC and other dynamic collars is that it locks in all market parameters to a given maturity.”

The benefits for clients are manifold. First, they can lock liquidity rather than be at the mercy of prevailing market liquidity. Second, clients can lock market levels regardless of how the market develops, an attractive feature, as the carry can materially worsen in EMs in times of crisis.

Providing an antidoteSo, which clients benefit from this hedging tool? Mueller explains: “Trade finance and structured trade export finance business relies on FX hedging, especially in markets where risks can surface quickly. The introduction of dbARC has proven to be a win-win for our clients in this space.”

An example of how dbARC can be used as an antidote to volatile markets came earlier this year when heightened concerns around China, and the possibility of contagion, troubled the global economy.

MACRO & MARKETS

New tools, new rulesA new platform for hedging foreign currency exposure risk is reducing the historically high costs of doing so and opening up the market, writes Neil Fredrik Jensen

Deutsche Bank has long been among the world’s leading Foreign Exchange (FX) houses and, for nine consecutive

years, was voted No.1 in Euromoney’s prestigious FX poll.

Having stood astride the market for so long, the bank’s stance has modified, turning its attention to more structured and integrated transactions. No longer does it strive to be a market behemoth that devotes its energy to the accumulation of volume and mass – instead, it has a more focused approach that homes in on big deals and sizeable clients.

Furthermore, Deutsche Bank has developed a broad offering for its target clients, leveraging its renowned FX4Cash platform and developing solutions that address a

wide range of issues for both corporates and financial institutions.

Optimising FX flowsThe Bank’s Global Transaction Banking (GTB) arm provides its clients, across cash management for corporates and institutions, trade finance and investor and issuer services, with access to the bank’s market-leading FX franchise. “Closer connectivity is key to ensuring we really leverage what is a powerful business,” says Eric Mueller, Head of GTB FX, Deutsche Bank. “As business becomes more global, international corporates and financial institutions have a broad range of FX needs, including structured products. Our aim is to deliver the solutions they need to optimise their foreign currency flows.”

Hedging EM exposures is necessary but can be costly

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LANDMARKS

Time for a changeIn a bold statement of forward-looking, pared-down banking, Switzerland has introduced an entirely new interbank payment system (SIC). In April, the nation waved goodbye to its current system, which had been in operation for 30 years, and embarked on an ISO 20022-based messaging standard alternative, which will provide a variety of new services to corporate firms and institutions.

Market operator SIX worked with the Swiss National Bank and the Swiss financial centre to transform the system, which, with the ISO 20022 technology, will reduce the number of interfaces between users. This way, says SIX, it will simplify the payments platform, which had become highly complex over three decades.

SIC boasts 350 participants and processed more than 440 million large value and retail transactions in 2015. The amount handled in these transactions is equivalent to about 75% of yearly GDP.

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The world is drowning in oil. That’s what is being reported by news publications the world over – and, for

the moment, proving hard to challenge. Oil behemoth Russia, together with members of the Saudi-led Organization of the Petroleum Exporting Countries (OPEC), is resisting calls to cut production levels to remedy the current chronic oversupply. These nations are pumping oil at record rates and major banks are predicting varying but altogether worrying price estimates – some dipping to as low as USD 10 per barrel (bbl)[1]. That’s despite the recent uptick in oil prices to around USD 40 bbl[2]. But research by Deutsche Bank posits that placing any long-term certainty on either the sudden turnaround in the oil price or the underlying low level seen throughout the first months of the year is misguided. While there could

be a further slump in the price of oil and with it steel, nickel and others, Deutsche Bank analysts say there’s just as much evidence to suggest prices will sustainably rebound in the near-ish future.

Radical response Although there is a great deal of surplus oil floating around, when looking at barrel numbers, the widely advertised oversupply looks rather more modest. Global production in 2016 is 96.44 million barrels per day (bpd)[2]. But the world struggles to guzzle more than 94.85 million bpd[1], resulting in a surplus 1 million bpd. In 2015, though, there was an overhang of 1.2 million bpd, so this year’s figure is an improvement.

As for steel, the recent and severe rebalancing in the real-estate sector and investments in China triggered a 3.5%

TRADE FINANCE

Playing the long gameWhile recent upticks in commodities prices may not be the recovery institutions are waiting for, the longer-term picture is less flooded with oil and steel. Joanna Lewin explores the commodities landscape

decline[3] in demand by Chinese construction and manufacturing firms in late 2015. Let’s not forget, China accounts for about half of the world’s steel supply. It has the capacity to produce 1.1 billion tonnes[4] of metal per year. China has sold its resulting surplus to nations around the globe for a markedly cheaper price than many other steel exporters could possibly afford.

It doesn’t take an economist to conclude that the reverberations of this situation for the world’s primary steel producers are fairly catastrophic.

Analysts see few signs of the oversupply abating without a radical response from the world’s commodities suppliers, or, if they don’t play ball, more severe tariffs on commodities imports, such as those imposed by the US, of around 260%.

1mThe number of surplus barrels of oil produced

each day[1]

Sources: [1] The Telegraph, Jan. 16, 2016; [2] US Energy Information Administration, March 9, 2016; [3] World Steel Association, March 10, 2016; [4] HKTDC

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their research, global demand is healthy, especially when the price is low. The excess supply should therefore drain off within the next few years.

Absorbing supply Pointing to the US’s tight oil production, for example, the pair cite encouraging figures that indicate supply absorption. Output is already well below its mid-2015 peak of 5.5 million bpd and will likely fall to 4.2 million bpd by the end of the year. This has allowed them to forecast medium-term prices rising towards USD 50-55 bbl by next year, more than the amount needed for many US producers to break even.

If oil prices really do fall to lows of USD 10 bbl, Sporre and Hsueh say that, for example, planned capital expenditure (capex) might be “ratcheted so low as to engender a greater likelihood of a V-shaped recovery in prices over three to five years”. Before it even got to firms shelving capex, OPEC nations would get involved, they add.

EIU analysts agree with this logic. The group’s central scenario is for a sustained pick-up in the oil price as soon as the second half, and particularly the final quarter, of 2016. And Marlier thinks that Russian production is bound to drop at some point. “Russian producers will have trouble sustaining their current production levels. Dwindling investment and growing cash restraints have made it difficult.”

The Brent Crude price is currently around USD 40 bbl – a step in the right direction. However, Marlier believes this current upturn will be short-lived, given the

The EU, so far, has not imposed tariffs. Efforts are being made to impose anti-steel dumping laws on China, but these are taking time to materialise.

Sebastien Marlier, Senior Commodities Editor at the Economist Intelligence Unit (EIU), says that a material response is necessary before any plateau in oil and other commodity prices can be reached. And as yet, that hasn’t been forthcoming. “It seems major suppliers are still pumping out record amounts of oil and producing significant amounts of metal,” says Marlier.

A March 2016 meeting for oil makers to discuss a production freeze was mooted, but then called off once it became apparent Iran would likely not agree to a deal. And an OPEC meeting in April ended without a deal.

Resisting calls to cutMaintaining market share is one big reason why OPEC countries seem to be turning a deaf ear to suggestions of cutting oil production, and why China isn’t responding to appeals to lower its metal output. But there’s a more fundamental reason too, believes Marlier. “Cutting production is costly. You might need to close down a whole operation.”

There is also the effect on employment to consider. “Closing down aluminium smelters in China has a strong impact on jobs and on local government revenue, so you see local and even central government being very wary of pushing for closures.”

The World Trade Organization states that countries have the right to protect their businesses’ interests and many Chinese firms are benefiting from the lower prices – an argument put forward by the Chinese Minister of Commerce, Gao Hucheng. He added that the steel situation was “purely market behaviour, not the behaviour of the Chinese or EU governments”. So, until there is a substantial and sustained response from suppliers, there will continue to be substantial oversupply.

But as Grant Sporre, Head of Metals Research, and Michael Hsueh, Head of European Natural Gas and Thermal Coal Research at Deutsche Bank, point out in

broader prevailing conditions. “When you consider that shale oil producers have been so slow to reduce production, the recent recovery isn’t really what we mean by a material recovery – we are expecting that later on in the year,” he says.

So there is good and bad news. The price increases seen of late are unlikely to last, but a more meaningful recovery is on its way. “While it’s too soon to say ‘we’ve seen the worst’ we can already say, ‘it could be worse’,” says John MacNamara, Global Head of Structured Commodity Trade Finance at Deutsche Bank. He notes that Brent Crude and West Texas Intermediate were both about USD 27 bbl back in the depths of last winter – and are now pushing USD 40. Iron ore has been floating around the USD 50s when at the start of 2016 it was in the USD 30s, and zinc is now heading towards USD 1,800 per metric ton, up from USD 1,500.

Efficiency gains While financial institutions are taking a broadly doom-and-gloom attitude and gravitating to low commodities price estimates, corporates are far more upbeat.

On a recent trip to the US, MacNamara was struck by a comment made by someone at a Houston oil corporation. “We’ve never been this efficient,” they said. MacNamara explains this stance: “When oil is USD 100 bbl, everyone focuses on growth and the ample cost-base cover means no one looks too closely at the bills. At below USD 30 bbl, they check every nickel and dime to be sure they don’t spend what they don’t have.”

In any case, for many European corporates, the advantages of low commodity prices actually outweigh the disadvantages. A price recovery may offset some of these benefits.“For the majority of European

corporates, energy and oil are a cost, rather than a revenue, consideration,” says Marlier. “At the end of the day, the benefits will likely exceed the costs.”

But there are also risks for corporates. “Stock prices and market sentiment have moved in line with oil prices, which could affect corporates negatively. So, for those who were expecting a boost to European markets as a result of lower oil prices, this hasn’t really been as clear as in previous commodity cycles.”

As for financial institutions, Marlier says: “The exposure for European financial institutions is far less than for US ones. And even for them, they have very diversified portfolios and relatively limited exposure to the energy sector.”

Uncertainty reigns During all of this discussion, commodity prices are still fluctuating. Oil prices are likely to continue to yo-yo as short-term factors cause short-lived spikes. But what is clear is that the response from OPEC nations and Russia will be key to oil prices settling, and Chinese economic stability will underlie metal prices rising.

With Russia likely to be forced to cut production due to cash considerations, further OPEC discussions to freeze output will probably be slated. And if prices really do dip to levels predicted by some of the big banks, then OPEC is likely to impose a freeze anyway.

While it wouldn’t be wise to say with any certainty that prices have hit a floor and can only go up, it is fair to predict that the oil price is far more likely to rise. And as oil is the great driver in market sentiment for metal prices, and therefore inescapably tied, it’s looking all right for them too.

It’s too soon to say ‘we’ve seen the worst’ but we can say, ‘it could be worse’

1.1bnChina’s yearly steel production capacity

in tonnes

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The world’s top 5 oil producing nations

1 US: 13,973,000 bbl/day

2 Saudi Arabia: 11,624,000 bbl/day

3 Russia: 10,853,000 bbl/day

4 China: 4,572,000 bbl/day

5 Canada: 4,383,000 bbl/day[5]

Source: [5] U.S. Energy Information Administration, 12 September 2015

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TECHNOLOGY

The age of financial innovation is upon us Banks and FinTech firms are taking tentative steps to partner up. Neil Fredrik Jensen takes a look at some of the highlights from Deutsche Bank’s white paper on the topic

What is driving the FinTech market phenomenon? What are the possibilities of partnerships

between banks and FinTech firms? And how can innovation be applied in the real world? The paper, ‘FinTech 2.0: Creating new opportunities through strategic alliance’, sets out to answer all this and more.

The banking industry has become accustomed to dealing with competition, so it realises it has to be more innovative, flexible and nimble in order to retain its market-leading position among new market entrants. Many FinTechs have focused on the payments industry, often homing in on a niche element of the transaction process. Invariably, this has resulted in more efficient and user-friendly alternatives to traditional bank products. Needless to say, these new players have not only created some anxiety, but also revitalised the spirit of innovation within the banking community.

Bank technology officers talk constantly about the need to collaborate rather than compete. While recognising these new market entrants bring something different to the table – at a time when the traditional structure of financial services is being questioned – banks are acknowledging they also bring a vast pool of expertise to any budding relationship with a FinTech firm.

For FinTechs themselves, entering into equal partnerships with traditional banking providers is a simple way to address a lack of payments-market experience or regulatory expertise, leveraging synergies and creating a stronger proposition by fusing the core competencies of both sides.

Successful implementation Banks and FinTechs have different attributes to bring to a relationship. FinTechs have the skills, mindset and regulatory freedom to be innovative. They also contribute technological expertise and are not hamstrung by siloed thinking or legacy system issues. This enables them to be relatively fleet-footed and quick to market with new ideas.

Banks, however, bring experience of compliance and long-established infrastructure. Banks also have the operational power needed to excel in clearing, settlement, straight-through-processing, liquidity and FX functions. Major banks also have the global reach that many FinTechs have yet to build.

Partnerships are already being formed, but the most successful ones will be those that centre on well-balanced mutualism – two parties bringing complementary core competencies and resources together to

innovate and offer a new value proposition that benefits both, while addressing a clear market need.

Key to any partnership involving banks and FinTechs has to be mindset alignment. Although it is important that both sides adopt an adaptable attitude, banks will need to accept that a new business paradigm is taking root and that time and resources need to be invested. After accepting that the rise of FinTechs is at the forefront of this market shift, banks will gradually see that digitalisation can become a key differentiator for them. Existing business models will need to change and could even be cannibalised through new alliances with FinTechs. There will be failure in some areas, but also the opportunity for success to offset any shortcomings.

Culturally, banks will possibly have to change their view on their own structures. Leadership and talent will become more important than management, although senior management will need a strong vision to lead the transformation into the digital age. Selecting the ideas that are worth pursuing will be of paramount importance and empowering staff to be innovative should be a priority. Decision-making, often hampered by bureaucracy and organisational structures, will also need to improve. Above all, banks must focus on execution capabilities – solution delivery will have to be faster than ever.

Potential obstacles It would be misguided to believe there are not hurdles in the way of innovation. Regulation is weighing heavily on the banking industry and can be seen as both a burden and a protective force. Some regulation has resulted in circumstances more conducive to innovation, such as the Single Euro Payments Area, which has advanced technological developments and encouraged other points of differentiation.

For banks, the post-crisis cultural mindset has also, to some extent, stymied innovation. Banks have developed a lack of tolerance towards failure, a crucial ingredient for creativity and innovation. FinTechs, by contrast, have evolved in a more creative environment, free of bank regulation and expensive legacy systems. Two of the greatest difficulties FinTechs face – particularly in the B2B market – are access to a sufficient client base and the ability to successfully scale up a functioning solution for mass use.

Technical compatibility will be one of the biggest obstacles to overcome when establishing a partnership. While most banks use outdated communication protocols, going forward, they will need to embrace application programme interfaces in the treasury and corporate space. But banks are only in the early stages of this process. Ultimately, they will need to convert their data from being unstructured to structured in order to leverage the potential of Big Data, an area in which many FinTechs are way ahead of banks.

Partnerships between banks and FinTechs The industry has seen a number of micro-payment services that have sprung up from collaborations between technology companies and established banks, such as Cringle-DKB, Simple-BBVA and Earthport-Bank of America Merrill Lynch. There is already momentum in this direction, but as digital structures change, they will transform almost every industry. The treasurer’s world will also shift towards a more transparent, interlinked and real-time manageable system.

There’s no denying that market players that want to safeguard their position have to develop a strategic plan that enables them to remain competitive. At the same time, this plan must adhere to a rapidly changing regulatory environment.

So, banks have some challenges, but so too do FinTechs, which have to find a way to meet regulatory, investment and risk needs.

The combination, however, of banks plus FinTechs has the rousing potential to create a more dynamic payments industry, and, ultimately, this will position financial institutions at the forefont of the digital age. What’s more, it should also create a win-win scenario for banks’ customers, who will derive multiple benefits from the pooled expertise of all parties involved.

Banks have a lack of tolerance towards failure, a crucial ingredient for creativity

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Eight years on, the banking industry is still feeling the after-effects of the global financial crisis. Ben Poole examines two pieces of this year’s regulatory pie – PSD2 and Basel III

REGULATION

The never-ending story

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that it uses to verify the identity of the payer. These factors could be knowledge, possession and inherence.

“Part of the authentication discussion, and a broader trend beyond Europe, is around the levels of protection of client data and the security levels that banks are required to implement as part of their systems,” says Fletcher.

“This will mean changes to risk processes and, potentially, to systems and exception-handling that PSPs are going to have to look at introducing.”

PSD2 allows payment initiation service providers and account information service providers access to customer bank accounts for different reasons. Some providers will be able to initiate payments, while others will be able to provide their customers a ‘virtual wallet’, allowing them to see a history of their payments.

“This is good for customers. They should get access to more innovative services,” says Fletcher. For banks, however, this creates concern about how they ensure that the third-party providers linking to accounts have the correct authorisation. If fraudulent transactions occur, then the bank is liable for refunding the customer.

“This shifts the liability somewhat,” says Fletcher. “It remains on the bank, but this opens the process up to a new set of parties that banks will have to manage.” This change in the rules should make new types of products and services available to the customer. For banks, however, an increased workload and new risks could potentially arise.

PSD2: What’s new?Following the Payment Services Directive (PSD), PSD2 came into force in January 2016. EU member states have two years to implement its provisions. PSD2 contains notable additions, including changes to geographical scope and currency. It also addresses business requirements such as authentification of payments and the granting of access to customers’ bank accounts to third-party payment providers.

The change covers transparency of terms and conditions and information requirements that payment services providers (PSPs) will need to provide for their transactions. The original PSD demanded levels of transparency when both PSPs were in the EU.

Now, PSD2 demands the same level of transparency even when only one PSP is in the EU. This also applies to all currencies where those payments are being made as they arrive in the European Union.

“This is a significant move and, from a customer point of view, it is probably quite a good thing,” says Angus Fletcher, Head of Market Advocacy, Global Transaction Banking at Deutsche Bank. “They will get to see greater levels of transparency around the payments they make.”

PSD2 also calls for two-factor customer authentication. This requires banks to look at the payments that are being made, determine whether they are comfortable with those payments and confirm the payments aren’t fraudulent.

The key here is that a bank can combine different elements to form two factors

Basel III: Overcoming implementation issues While PSD2 only came into force this year, the Basel III standards have been a talking point for much longer. As they are standards, they must be enshrined in national or jurisdictional law. This implementation process is undergoing phased rollout, which began in 2015 and is planned to run through to 2018.

“I think we will see adjustments and national interpretations go beyond 2018,” says Fletcher. “The phased-in process is all about tweaking and changing the different ratios to get the best fit. On the one hand, banks need to be as safe as they possibly can. On the other, it is important that these ratios are not introducing burdens on organisations that force them to stop doing certain business, or create unintended risks to banking services.”

Another concern for banks continues to be the treatment of deposits, especially non-operational (those deposits not attached to business/payment flows). These have a significant balance-sheet effect under Basel III, as they must be held at central banks. Many corporate and institutional customers, however, want to be able to hold large balances with banks and have the ability to take those out at any point.

“It’s important for banks and their clients to really understand each other’s models, and to try to come up with something that works for all,” says Fletcher. There are several ways of doing this, for example through offering certain balance sheet efficient deposit products, such as call and/or rolling time deposits. Offering off-balance sheet products is another option for banks – products such as money market

funds, which allow cash to be stored in a relatively safe place for customers. Reverse repurchasing agreements (repos) are also a possibility. The client can usually make a return on the cash as well, despite negative interest rates. However, there is still a capital effect felt when using reverse repo products, which may negate any return.

Basel III also affects trade finance. Banks use a number of core trade finance products, such as guarantees and letters of credit. These are off-balance sheet items – so-called contingent liabilities. This means that they will only be called on in certain agreed circumstances.

“Under some of the Basel consultations being carried out this year, in particular those focused on the net stable funding ratio and the leverage ratio, these products are being effected,” says Fletcher. “The end rules could change these tools and therefore affect the ability of banks globally to support what we see as real-world economy activities.”

Of course, the ongoing implementation of Basel III presents an opportunity for banks and their clients to understand how their strategies affect each other.

When a corporate requires services such as deposits or a line of credit, knowing how and when this will affect a bank’s balance sheet is important, as it will highlight possible overpricing or availability challenges, for example. For multinational corporates, it presents an opportunity to examine ways of making internal processes, account structures and balance sheet moves more efficient and cost-effective. Im

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It’s important for banks and their clients to understand each other’s models, and come up with something that works for all

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the initiative to go fully live at the end of 2016, although not all banks may be ready by then. Overall, the GPII is intended to “dramatically improve” the cross-border payments experience for banks’ corporate clients, and bring significant efficiencies and reductions in cost.

Geert Matthys, Head of Digital Product Development at Deutsche Bank’s Global Transaction Banking arm, says of the Bank’s involvement: “We envisage a smart integration of GPII whereby we make it easy for our clients to do business.”

Matthys says that Deutsche Bank aims to provide corporates certainty of the status

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experiencing the irksome inefficiencies in tracking and transparency – on a frequent basis.

Future proofing paymentsThis is where GPII aims to bridge the gap – to bring the cross-border payments business fully in line with current customer expectations, and also to build it out in such a way that future expectations are also easier to fulfil.

Essentially, GPII will look to build on existing correspondent banking foundations and provide an overlay of new global business rules. The initiative will be built on a strong basis of compliance, global reach, co-operation and proven standards. Together with the industry, SWIFT is creating a new service level agreement (SLA) rulebook for cross-border payments, which will deliver a range of benefits (see box out).

Dramatic improvementPiloting the SWIFT system are 21 banks, with 51 due to take part overall. The results will be announced at the Sibos conference in September 2016. “Banks are not just piloting to test the system,” says Wim Raymakers, Global Head of the Banking Market and Project Lead for the initiative at SWIFT. “They are really starting to develop a plan to automate things.” The aim is for

Cross-border payments between corporations are what make international trade go round. For

these payments to be efficient, businesses rely on the services of their banking partners. But some banks may not necessarily have a presence in any given country and so they, in turn, depend on the services of their correspondents.

These interbank relationships – collectively termed ‘correspondent banking’ – are supported by embedded technology, processes and controls. Much of this is currently contingent on SWIFT messaging. SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication, and supplies secure messaging services and interface software to wholesale financial entities. The correspondent banking process is based on an infrastructure that has been built up over the course of the past 40 years and has proven to be stable and resilient.

But the model is increasingly coming under pressure. Transaction banks are already facing persistently low interest rates and stuttering global growth, as well as regulatory demands around capital requirements, anti-money laundering and new non-traditional competition – for example, as a result of the latest Directive on Payment Services 2 changes.

Additionally, society as a whole is becoming more demanding – unsurprisingly, given the incredible speed at which technology advances. With the increasing use of smartphones and mobile technology, people expect real-time services, transparency and utmost convenience as a given. These expectations are now spilling over into wholesale commerce.

Expectation gapThere is currently a mismatch of expectations when it comes to individual demands, or commercial activities, and cross-border payment capabilities. This mismatch can be understood using the following simple example.

Suppose you live in Oxford, UK, and you go on holiday to Los Angeles. You have booked a rental car, but when you arrive at the customer counter you realise you’ve left your driver’s licence at home. You call UPS, and ask them how long it will take to deliver your licence. At the same time, you call your neighbour and inform him that UPS is coming to your house to pick up the troublesome licence. UPS promises to deliver door-to-door within 36 hours. Not only do you know the exact price to pay, you also know exactly where your license is. UPS provides you with tracking that allows you to see your licence’s journey from Oxford, via New York, to Los Angeles.

Compare that clearly efficient process to a dollar-denominated payment made by a corporate, again from Oxford to Los Angeles. Although the firm may know the price it has to pay (but not necessarily), and despite the clearing of the payment taking seconds, there may be an issue with one correspondent further down the chain. The firm does not have full transparency on the payment or the ability to track the payment. It may be the case that the beneficiary does not receive the payment for several days.

In our technology-driven world, these inadequacies are simply no longer acceptable. Yet corporate treasurers are

PAYMENTS

Swift and sureLike many other aspects of transaction banking, the cross-border payments business is changing. The Global Payments Innovation Initiative (GPII), which aims to streamline the payments process, is due to go live at the end of 2016. Hannah Tautz explores its potential

of payments and details of the cost of transactions at any point in time, in a way that is easy to implement and use.

To this end, Matthys’s team is looking to integrate an array of technology. This will include application programming interfaces to support service and status requests; digital documents and digital signatures; data visualisation to provide insight and foresight; and, potentially, blockchain technology. Existing popular Deutsche Bank payment applications, such as the autobahn cash inquiry app, will also be in the mix.

Multiple benefits“We love the fact that there is a global payments innovation initiative because we believe that it will create benefits for many parties in the cross-border payments ecosystem,” says Matthys. However, he cautions that, as things stand, many corporates are unaware of what GPII can do. He says banks need to fully understand the problems facing corporates and ensure that these are properly addressed.

Raymakers is also optimistic about what GPII can do to support global trade. “This initiative creates a great experience for payments,” he says. “Ultimately, it may mean that we will no longer need such a big network of [correspondent] banks.”

Four ways cross-border payments will change

SWIFT’s new SLA rulebook for cross-border payments will aim to deliver the following:

1 Same-day availability of funds

2 Transparency and predictability of fees

3 End-to-end payments tracking

4 Transfer of rich payment information

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51Banks are due to take part in the new SWIFT system

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&

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Q Why have central banks cut interest rates to below zero?

A Generally speaking, it is standard procedure for central banks to cut

interest rates when economies face times of low inflation. That in itself is nothing unusual. What is new though is the decision by several countries to cut rates below zero almost simultaneously, catapulting financial markets into a new environment and challenging the architecture of those markets, despite not fundamentally being in crisis. To interpret the full implications of these actions, it is important to understand the different reasons for taking the unknown path into the negative interest rate territory. For the eurozone and Sweden, the main rationale was to raise inflation and boost the economy. In Denmark and Switzerland, the primary objective has been to prevent a steep currency increase. Japan and Hungary also recently joined the ‘negative interest rates club’.

Q What are the implications for transaction banking?

A The banking sector, with its underlying payment system architecture, is

clearly affected as negative interest has a fundamental impact on underlying transaction flows. Commercial banks normally hold deposits at their central banks as settlement balances for clearing purposes in order to facilitate payments on behalf of their clients. They now face costs for holding balances with their central banks overnight to follow up with their operational behaviour. But why does the move from close to zero to below zero rates make such a big difference? In a ‘normal’ positive market environment, central banks pay interest on excess deposits above minimum reserves. Financial institutions usually minimised these excess levels as central bank deposit rates were typically below market rates – there was no incentive to hold excessive cash balances with central banks as investing funds in the market was more profitable. This changed in the low interest environment as the spread between rates diminished and arbitrage opportunities increased due to risk aversion. As soon as official interest rates hit zero, one of the main ways in which banks make money – net interest margins – gets squeezed.

Q How widespread are the effects?

A It is evident that more and more banking businesses are placing the

negative interest rate topic on their agenda and attempting to analyse its impact. It is not only transaction banking’s core activity that is affected. The official cut in rates also affects money markets, with fewer investment opportunities for their market participants. The pension and insurance industry, for example, may struggle to meet their long-term liabilities offered at fixed nominal rates. Furthermore, there are differences in how market participants are affected. Financial institutions have to absorb the cost or at least have to find ways to share the costs with their depositors. This is no trivial decision. At the same time, liquidity is fundamental as it is imperative for financial institutions to execute on their transaction flows to enable global economic business. Global bank deposit levels have not fundamentally changed. However, in the long run, interest margins will diminish. This has not been fully apparent so far as the decrease in interest margins was partially offset by the decrease in risk provisions. But this may change in the near future. Therefore, financial institutions will have to find new ways to offset declining interest revenues with higher lending volumes. This too may become limited when interest rates further decrease – something banks cannot actively manage.

Q How low can central banks go?

ACurrently, most rates are in the range of between zero and -1%. If central

banks push rates too far into negative territory, there is a danger that the financial sector could face a new type of systemic risk. This could lead to a situation in which banks increase their lending rates to limit their profit and loss downside. The idea of storing cash in vaults and reducing fiat money to limit and avoid negative interest rates would also contradict the intention of the European Central Bank. This would question the constitution and sense of financial markets. The uncertainty about actual implications has reinforced the need for tighter communication among market participants and the need for forecasting cash flows to enable a smooth transaction flow and a cost-limited use of funds.

MACRO & MARKETS

Moving below zeroNegative interest rates have gone from being a theoretical curiosity to being enshrined in major global economies’ central bank procedure. Negative Interest Rate policy is bringing nominal target interest rates below zero. Anne-Katrin Brehm from Institutional Cash Management at Deutsche Bank answers some important questions

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Collaboration among central bodies, commercial banks and their clients will be key to handling the new situation that the entire financial market finds itself in. It is not only a question of analysing and understanding the implications of macroeconomic and financial market fundamentals. It is also a question of validating the technical plumbing of systems and banking products, to see whether they are compatible with negative rates. Contractual arrangements as well as practice and investment guidelines may also have to be adjusted under the new lens of negative interest rates. The scope of the implications on the transaction banking business have not yet been fully explored as the negative interest rate environment is not a business cycle expression – it’s a structural one.

Anne-Katrin Brehm ispart of the Institutional Cash Management business at Deutsche Bank AG in Frankfurt. Brehm focuses on Liquidity, Interest Rate and Balance Sheet Management, as well

as Intraday Liquidity Management. Prior to her current role, she worked in Deutsche Bank’s Asset & Liability Management team in Singapore

The negative interest rate environment is not a business cycle expression – it’s a structural one

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Intraday exposures, and the intraday limits that banks provide their clients, play a crucial role in keeping global payments

flowing efficiently. For the uninitiated, intraday (put simply, within the day) limits are placed on a dealer’s currency positions by their bank to reduce the risk of exposure.

They permit the dealer to make payments without necessarily holding the funds needed to fully cover the payment. For a client to be given one of these limits, they first have to fulfil certain risk criteria set out by the bank.

Koral Araskin, Institutional Cash and Liquidity Management at Deutsche Bank, has a pleasant way of looking at it: “If you imagine the payments landscape is an engine, the liquidity is the fuel for that engine and intraday limits act as the oil that keeps it running smoothly,” he says.

Without intraday limits, a payment could only be made if a client has the funds to match it fully. This might not sound like a big issue. But it would cause significant obstacles that would slow down the entire payments landscape. For example, in institutional cash management businesses, banks carry out payments on behalf of other banks’ clients. Often, an initial payment will be made on the basis that a second payment will be made later. The cash required to make the second payment, however, may stem from a transaction that has not yet happened, but is due to be carried out later in the day.

The institutional client knows that these two transactions will balance out over the course of the day. But without an intraday limit, the client would not be able to make the initial payment. Instead, it would have to wait until the funds arrive later. Multiply this scenario across the whole payments landscape and the process would become hugely inefficient.

“The intraday limits in place today are on an uncommitted and unadvised basis, but they are really essential for keeping payment flows running efficiently,” says Araskin.

Risk considerationsOne could say that a risk develops if the exposure balance has not cleared by the end of the day. But this is generally not an issue, as most payments will settle within a few hours and so the flow of payments remains uninterrupted. There are, however, times when this wouldn’t be the case, which is why banks often have overdraft positions with clients at the end of the day.

“The client may do a great job of managing their account, but they may have unforeseen expenses or make unexpected inflows,” says Araskin. “That is why they will have either credit or debit benefits on their account. The client may never be able to square these off completely by close of business, even though in theory it would be their aim to do so. You need to expect the unexpected.”

Things can be made more complicated when corporates and institutional clients have international business, meaning they are bound to the opening and closing times of a variety of currencies. “This is a sensitive consideration for many banks in terms of their foreign exchange settlements,” explains Araskin. “Banks have to process urgent payments in the early hours when an international market comes online, but they’ve not had the opportunity to raise funds from other sources up until that time.”

So, intraday exposures are crucial for commercial payment flows and have so far not attracted any risk-weighted assets, unless they have not been settled at the end of the day. To avoid disturbing the payment and settlement processes, the Basel Committee on Banking Supervision (BCBS) has published, in the supervisory framework for measuring and controlling large exposures (BCBS 248), that intraday interbank exposures are not subject to the large exposures framework, either for reporting purposes or for application of the large exposure limit.

Transparency requirements from regulatorsIn today’s payments climate, however, there is a trend towards increased

INSTITUTIONAL CASH MANAGEMENT

Oiling the payments engineThe exemption of intraday exposures from general exposure calculations is vital for maintaining global payments market efficiency, writes Ben Poole

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regulatory control and making payments less risky. If the perceived risk of intraday exposures leads regulators to require banks to hold additional capital against this risk, the result would likely be far higher costs. It could also affect the efficiency of bank services. “We talk about real-time payments becoming more efficient and getting even cheaper,” says Araskin. “Well, this would go in the opposite direction of becoming more expensive and less efficient.”

What’s more, without the possibility of intraday exposures, it would be far more difficult to manage payments in – or close to – real time, keeping in mind the interconnectedness of the payments landscape. “In this scenario, you would need to prefund any payment you make,” says Araskin. “This would slow down the system and make the payment landscape cumbersome. It would probably also increase costs – any inefficiencies will naturally increase the cost of a certain service as they require more resources and capacities, from a balance-sheet and operational perspective.”

The BCBS’s current recommendation is that regulators and central banks increase the intraday reporting required by banks in their main currencies (BCBS 248). When this eventually comes into law, it will mean that major banks have to give intraday reports on their liquidity position and, for example, the biggest users of this liquidity.

This would provide regulators with transparency, allowing them to see clearly

which banks and corporates are dependent on which for certain lines of financing.

“In market stress situations, regulators could see the different behaviour patterns of certain client participants and attempt to avoid a bigger impact by isolating a single participant at a very early stage,” says Araskin. “This is something we won’t see this year, but perhaps in 5-10 years.”

A more transparent approach to intraday liquidity could mean regulators have a comprehensive view of intraday exposures. Understanding the interconnected nature of the global payments landscape is vital if this landscape is to retain, and indeed enhance, the levels of operational efficiency.

Technology and industry collaborationNone of the major regulators have yet published exactly what they want to see in terms of transparency on intraday exposures, but financial institutions are preparing. All of the major banks, as well as euro and dollar providers, are either working on a solution or have a solution at hand to provide their clients transparency on their liquidity positions.

On the other side of the coin, banks are also working on ways to best provide regulators with this information.

“Providing information about liquidity levels on an intraday basis in certain currencies is, from a technology perspective, something that is relatively easy for us. To a large extent, this is information that we already

have,” says Araskin. “But it would become more complicated if we have to provide our institutional clients, for example a bank that holds a variety of currencies with us, the transparency the regulators desire on an intraday basis.

“What’s more, that bank’s regulator will then ask them for their intraday reports, which might include details of their highest usage or lowest overdraft position and how they ensure they have the appropriate funding. It becomes very complex. This cannot be something that just Deutsche Bank thinks about and provides to its clients, it has to be an industry-wide shift.”

Of course, the industry could benefit from a standard to ensure that future potential regulation is interpreted the same way among all banks. Corporates and institutional clients receive services from a mixed portfolio of providers, from a risk and diversification perspective.

If banks and corporates can achieve true intraday transparency through reports or a system that allows access to different

organisations’ intraday positions, it should mean that organisations are able to provide this information directly to the regulator without any additional work. But it is currently difficult for banks to build a system to report on intraday positions independently for their clients, as any such solution would need to be relevant to how others in the market move.

“Right now, there is a lot of industry consultation on this subject,” says Araskin. “It is being discussed at association level and in working groups from a technical perspective, in terms of how intraday transparency can be made as a standard. In one working group, Deutsche Bank is working with the Society for Worldwide Interbank Financial Telecommunication (SWIFT) to build a common technical standard and ensure that transparency can be provided through the SWIFT platform.”

Where to go from hereIn the supervisory framework for exposures, the regulators have explicitly exempted intraday exposures from the calculation of overall risk-weighted asset exposures. This is positive for both corporate firms and institutions, as it removes additional costs to payment flows.

In order to fully unlock the potential of more transparent intraday liquidity flows, Araskin concludes: “As an industry, we must continue collaboration to make individual intraday liquidity solutions and metrics an industry standard on how to measure and report intraday liquidity.” Im

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As an industry, we must continue collaboration to arrive at an industry standard for reporting intraday liquidity

Liquidity is the fuel for the engine and intraday limits act as the oil

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42

The beauty of the market is in its inception as the perfect way for us to meet human need – and thus

create prosperity. As the Scottish philosopher Adam Smith first argued: I have a need and you have what I need. How can I persuade you that meeting my need is in your self-interest?

At its philosophical core, the market is a human endeavour. We invented it and it reflects us as accurately as any work of art. Across the financial world, however, markets are becoming increasingly inhuman – robots dealing with robots, thousands of trades per second, trades faster than thought, hedging positions taken. One third of all European and US stocks were traded by algorithms in 2006, with estimates of 60% in 2015[1].

And it seems there’s a strong future in artificial intelligence-run algorithm trading. FinTech firms are offering a suite of robotic services – from algorithms that monitor banks’ liquidity to apps that allow high-net-worth individuals to day trade from their smartphones.

On the one hand, what’s not to like? Democratisation of the financial markets, increased hedging and machine learning. Robots don’t get drunk, deal on wild adrenaline jags or – in theory – take and then defend unsustainable positions in a market. These machines can shore up a bank’s balance sheet while the C-suite sleep. You still need to keep an eye on things, though.

For a start, it’s an arms race out there. If your robots fall behind, you’re the sucker at the table. So invest. But do a little more than just kick the tyres on innovation.

Algorithmic market-makers, for instance, strive to balance supply and demand. They move buy-and-sell quotes up by a cent when someone buys and down by a cent each time someone sells. Each time it moves price, it cancels all buy/sell orders and submits new ones. Add in the feast of other data flooding into these bots and an alarming number of orders can end up being cancelled.

Interestingly, the legal defences mounted in recent spoofing prosecutions, including

British stock market trader Navinder Singh Sarao’s arrest last year over the 2010 flash crash, are essentially: “It wasn’t me, it was the machine.”

The point is that any market traded solely by machines isn’t the market as we know it. It’s not even a version of it. It’s something entirely new. It might, in principle, work by our rules, but it works without any inbuilt human need.

In this world of hair-trigger regulation – the next US election will almost certainly usher in fresh ultra-high frequency trading rules – it’s useful for senior staff at large financial institutions to understand these differences ahead of treasury departments.

It might be cheaper to hire robots, but as Warren Buffett once said: “Never invest in a business you can’t understand.”[2]

Stephen Armstrong writes for The Sunday Times,

Wired and The Daily Telegraph and appears on

Radio 4 occasionally

last word

Are we robot ready?Stephen Armstrong reckons we need to get our heads around artificial intelligence in our business lives, and fast

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Sources: [1] PlusAtForex, August 5, 2015; [2] Forbes Magazine

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