“New Normal” has become a common expression in the past few years. It has emerged as analysts, reflecting on the deep transformation the world economy is going through, are endeavouring to identify a sense of logic binding together the various changes, or evolutions triggered by the 2008 financial crisis.
Whether “crisis” describes what we are witnessing, is the crux of this debate. It is too soon to assert whether we have shifted to a new paradigm. What is certain is that we have not seen all the ripple effects of the great financial crisis (GFC). What is equally likely is that the world economic order is unlikely to revert to the pre GFC era. Forces unleashed in 2008 and beyond, through the multiple attempts to circumvent the potentially disastrous effects of the financial crisis, have altered the path and the dynamics of the world.
New paradigms are in the process of shaping up but are very difficult to precisely identify at this juncture. The “New Normal” for now is likely to be constituted of a long transition predicated on the deconstruction of an old economic order but, as if still exposed to multiple aftershocks, the reconstruction of a new one is fragile, awkward and potentially temporary in many of its manifestations.
This should not prevent us from trying to understand where we are heading, and reflect on the potential impacts this transition will have on our business, and beyond to personal lives.
Old Economic Order
The 2008 crisis has marked a major inflexion point that should not be underestimated. From 1945 to the first decade of the 21st century, the post WWII reconstruction dynamics led to an unparalleled era of prosperity. First, amid the former belligerents who wisely built a tight dialogue and established common foundations and rules to foster trade and cooperation at every level. Then in the later part of the 20th century, the engine of growth was powered by the developed economies’ strength and interaction. In the 1990’s the developing world, took over the relay of growth. Predicated upon the demand of the developed economies at first, and then, gradually, fostered by the emergence of new middle classes, notably in Asia but also in South and Central America, developing countries morphed into “emerging markets”. North-South trade was complemented by a growing flow of so-called South-South trade: Emerging markets were taking over the helm of the world economy. Poverty receded, middle classes blossomed across all continents: The world’s urbanisation was in motion.
Working classes travelled the world, discovered markets, cultures, studied abroad and learnt languages, thus enabling the building of a truly global economy. Geographic boundaries faded. Industrial supply chains, bolstered by both efficient logistic and seamless communication channels, lengthened, spreading their wings across continents both to benefit from more efficient costs and be ever closer to a more geographically diversified population of urbanised consumers.
With longer and more sophisticated supply chains, trade of semi-finished product flows accelerated; with millions of people escaping poverty, demand for cross-border products gathered momentum. The combination of both resulted in trade steadily growing faster than the world GDP, notwithstanding the latter was turbocharged by the emerging market growth: a new world order was in the making, predicated on ever more exchange of goods and services. Nothing seemed to be able to challenge this. The virtuous growth circle was firmly set: developed countries pulling developing countries, themselves generating the formation of middle classes, thus becoming so-called emerging markets and turning themselves to other remaining lower income countries for cheap labour supply thus feeding the process.
However, if poverty receded by integrating more population into a globalised middle class, the bulk of this positive transfer occurred in the emerging countries. In the developed world, the middle-class income growth was slow at best and largely perceived as flat by the population. Revenue inequality rose to new heights across the “old” countries, from the US to Europe, thus building a silent yet growing frustration amid the populations.
A New disorder
Eight years after the crisis, and amid stagnating developed economies, this frustration is progressively turning into anger. Beyond economies lie populations; unhappy populations, jolted by stagnation of income, little perspective of improvement of their life standards, which translates into angry voters. Everywhere, voices are challenging the world order, the institutions that were personifying it and the dynamics that fostered globalisation. In numerous democracies, we are witnessing rejection of globalisation; trade agreements are challenged; laisser-faire and free circulation are disputed, and in many instances, protectionism is no longer seen as a danger but as part of the solution.
Trade is suddenly lagging world GDP growth, itself off its pre-crisis peak. More worrisome is the widening discrepancies between the largest economies’ performance. China has in a decade become the second largest economy in the world growing 2.5x faster than the United States; Japan has been marred in “wealthy stagnation” for 20 years now; European countries are bound together in a model whose ability to react to the new challenges looks to many increasingly doubtful. On the other hand, and besides the semi-developed economies – and maybe India - the pull factor on the developing world seems to have lost its momentum. The virtuous circle is broken.
Trade needs a stable political environment to thrive. Trade fosters peace, but to do this, it requires a shared vision amongst economies that it should be prioritized and prevail over selfish interests. The geopolitical environment however, has never been so tense since cold-war times, a period that nobody would have expected to live through again. Feeble democracies, with their disgruntled inward looking populations and relatively weak leadership in some parts of the world; more assertive rulers in others, either fostering nationalism by turning their backs to globalisation or through affirmed regional hegemonic strategies and swelling military budgets on the other... It should therefore not be a surprise that 8 years after the great financial crisis, protectionism is back in fashion.
The criticality and endurance of trade
All this makes a bleak and rather uncertain world. Economic leaders are not merely spectators however. It is their strategic visions which translate into the decisions that have a genuine impact on everybody’s life and, therefore shape the world future. Exploring a new market, investing in a new technology, fostering their business growth is directly responsible for jobs, wealth and, eventually for a peaceful world.
The current environment creates an incredible challenge in that respect. Schumpeter advocated a creative destruction to foster growth. However, when the environment itself is at stake, corporate leadership is tested more than ever to identify the safest paths, choose the right options to preserve and grow businesses.
For corporate leaders, “to do nothing” is not an option. They therefore need to understand and adapt to the new trade dynamics. Is trade collapsing? Is the world shrinking through reactivated boundaries? Not quite, but trade will follow new paths.
Relocalisation of large spans of the industry is already in motion, fostered by emerging robotics and relatively cheaper energy. This will contribute to reshape large parts of the world supply chains as we know them. Technologies like 3D printing will bring back many transformative processes closer to the consumers. Larger clusters of urbanised emerging middle classes will see their needs for safe and efficient supply burgeoning.
These deep changes will affect trade flows. Some of these flows will shrink but many others will thrive. Gradually we might witness the slowing down of semi-finished product trade (being gradually re-on shored). Conversely, commodity trade which represents some 25 pct. of trade flows will continue to thrive in sync with the combination of the world demography which will put the world population at over 9 billion people in 2040 and the pursuit of global urbanisation.
The financing of these trade flows will also be affected. Relocalised trade is the most likely to benefit from faster payments through decentralised ledger technologies and expose banks to new competition. Technologies will also affect longer haul trade by perfecting the control over goods in transit. This will be particularly interesting for the commodity industry which will remain intercontinental and a significant consumer of financing: banks will need more security over goods to optimize their large capital requirements and therefore it is paramount for bank practitioners to work with logistic suppliers to develop new solutions.
Trade finance will witness deep transformation in the next 5 years. Largely built to foster long haul trade amongst far away parties through letters of credits, the inception of regional clusters around large consuming areas will call for a vast simplification of risk protections and payment methods. The ability to know precisely where is what, in which shape or form, and what belongs to who, will greatly improve thanks to new solutions brought in by the development of “Internet of Things” technology. This knowledge should in turn foster more efficient payment and credit risk absorption capabilities, combining bank protection and insurance. Banks will have to overhaul their trade finance products, back-offices and processes to fence-off a new competition attracted by a business which requires less up-front investment and lighter overheads, notably through decentralised ledgers.
This is not to say that long supply chains will disappear: commodity supply chains for instance will still need to reach as far as needed to source strategic staples, oil, iron ore and other key raw materials. Such long-haul trade will still require more traditional trade finance instruments such as letters of credit, stand-by letters of credit and guarantees, combined with straight balance sheet financing and structuring capabilities. Commodity finance expertise will still be required with its must-have dedicated middle and back offices, a necessary evil to control the risks associated with this activity amid ever more demanding capital requirements.
One enduringly growing flow of trade will be made of services. In a world where communication is easy, where data are travelling at light speed across continents, services will continue to thrive. The bulk of job creation in the most developed countries will be service related, rather than linked to the production of goods. When measured in added-value terms, trade in services accounts for almost 50 pct. of world trade. This is an area which by-and-large escapes the banking industry: how to re-intermediate the financing of service flows? Yet the sheer importance of services will require banks to invent a new “trade finance” if they do not want to be disenfranchised by non-banking more nimble players. Here probably lies the biggest challenge for an industry which re-intermediates nowadays most supply chains trading goods, whether to finance them or to support the embedded payment process.
Banks and trade
Trade finance is probably one of the oldest forms of banking and one with a pristine track record over centuries. Financing trade flows of goods has always been considered a very safe activity by all practioners, across all continents. When revisiting the prudential guideline surrounding credit activities in the early 2000’s, the regulators asked a very simple question: “can you prove it?” Easier said than done and it took a great deal of joint effort (something that banks were not accustomed to – there was no such thing as a trade finance industry), support from multilateral organizations, such as the WTO to put forward a convincing answer to the Basel Committee. The GFC created a sense of urgency as tumbling trade required immediate attention. The impact of trade finance availability on trade flows was clearly established in the context of the crisis, but the evidence regarding its low risk nature were yet to be gathered. When not a single bank was able to provide satisfactory evidence of the safe nature of their trade finance activities (at least as per the regulators’ standards) under the stewardship of the ICC, a trade registry was put together, collecting data from the main “trade finance” banks. The collective data gathering millions of trade transactions passed muster: As the G20 was eminently concerned about the state of the world economy, the Basel Committee swiftly issued rather flexible guidelines around trade financing activities in a relatively short period.
However, and as banks became increasingly constrained with additional capital requirements, they engaged into ever deeper reviews of their lending activities, focusing their commitment on their most valuable customers and core-markets. More demanding vetting processes were put in place. The society-at-large concerns about corruption and financial crime led most international banks to cull large parts of their correspondent banking networks, notably in and with low income countries, as the cost to maintain such networks and the perception of a higher reputational risk became incompatible with the revenues generated. Furthermore, a tougher geopolitical environment led to the implementation and strict enforcement of sanctions against several countries, companies and individuals.
Trade was the prime victim of these decisions and to-date, it is estimated that, notwithstanding countries affected by financial sanctions, there is a trade finance gap (where supply does not meet demand) of $1.6 trillion. This represent around 10 pct. of merchandise trade as calculated by the WTO.
Unintended consequences of global regulation
The Great Financial Crisis was triggered by investment banks in the US which inundated the whole financial system with securitized US debts and mortgages which were wrongly analysed by rating agencies as triple A risks. Almost overnight, no bank was considered as a safe risk anymore as the world’s most developed banks had bought into these structured assets and blended them into financial products sold to other banks and their customers. The massive liquidity gap was only quenched through massive public intervention. Once the most critical phase of the crisis was over, the whole concern of governments and regulators was to make the banking system safe again, ensuring such a systemic risk would never happen again.
Regulatory frameworks were overhauled, bank capital requirements against all forms of risk taking significantly increased. The Basel guidelines became more sophisticated, in fact so sophisticated that only specialized modelling teams in large organisations can validly claim they have a thorough understanding of the Basel two, then three and soon four guidelines.
Besides, since the world economy growth has slowed down vs. pre GFC times, the pro-cyclicality of the Basel rules is more evident than ever: when risk deteriorates, capital requirements increase. Conversely, when risk improves, they should decrease, thus creating a virtuous circle (more lending when safer the environment). However, since the crisis, the overall risk level has remained at best stable. When considering the degradation of the geopolitical environment, it is not likely to improve any time soon.
The combination of more demanding capital requirements rules (all things being equal i.e. merely ensuring that banks should put aside more capital to conduct their risk-taking activities) on the one hand and of a worsen risk perception on the other has led the banking industry to a massive de-risking exercise, leading to tens of thousands of accounts closure, notably affecting small companies and low income countries debtors. As unintended as it may be, the banking industry’s flight to quality under tighter constraints is de facto slowing down the world economic recovery.
We have probably reached a tipping point where the sole focus of regulation which was to make the banking industry safer and suppress any systemic risk stemming from the collapse of large institutions, is going to be questioned. Have we gone too far? Have we, for the sake of too much safety, compromised the growth momentum of the economy? Never before have we heard so many voices amid governments, openly challenging the Basel guidelines. The Dodd Frank act is now openly questioned by the new US administration. Even the sacrosanct fight for criminal crime and money laundering, which has led to the impounding of heavy constraints on each individual bank, is now entering a phase where the pooling of data and the creation of KYC (know your customer) repositories is no longer disregarded by the regulators.
The overhaul of the regulatory framework surrounding banking activities has certainly been a very positive outcome of the crisis. But as often, the pendulum towards a safer world has swung too far to the detriment of the dynamism of the world economy and financial inclusion. How long before and how far can the pendulum swing back? No one knows – and it is likely that the regulatory environment will remain much more stringent than pre-crisis anyway. But the sheer acknowledgment that too much regulation can become detrimental and a defeat to its purpose is a first and welcome step towards reason.
To-date, however, banks are still de-risking their balance sheets and trimming their cost base to compensate for the formidable increase in compliance costs they have to shoulder. A low interest rate environment has added more pressure on the sector, this has led to the burgeoning of non-bank lending, particularly to smaller companies. Many trade finance funds were created to take advantage of higher returns which, unlike in the banking industry, are not penalised by the Basel guidelines. This is not to say that funds are not regulated. They are tightly so to protect investors, but when it is almost impossible for a bank to keep a “risky” asset on its balance sheet because of the unbearable level of capital to maintain it and the negative profitability this entails, funds have a different philosophy and more manageable constraints. Investors, looking for alternative investments, support this move. Nevertheless, compared to the amount of de-risked assets by the banking sector, funds represent a mere drop in the ocean. This is entirely logical: Investing in investment grade rated assets is one thing, supporting a SME in its trade endeavours is another. How to assess the risk? How to manage it? Is a fund as equipped as bank to effectively do so?
A limited success for now, alternative funding of trade finance is probably going to last nevertheless: the banking industry, will remain, at least for the foreseeable future, under tight constraints for capital and therefore are likely to focus more of their activities on their immediate environment, trimming large international networks and repositioning their resources on their domestic or immediately regional markets (in line with the reshaping of trade). In certain sectors, the reliance on banks to finance trade flows is simply overwhelming. Commodity supply chains for instance hinges on trading houses expertise, pivotal players between production and the end users, whose activities are almost entirely supported by banks. This over-dependence on the “new normal” has become a risky bet.
The need for alternative finance therefore is not going to wane anytime soon. However, to grow to a meaningful level, investors need to understand the nature of the risks they invest in. How? This question is critical. Trade assets are the focus of alternative funds and their investors, but with a very narrow perspective and expectation: high risk assets calling for high return prospects. Since funds have taken a space vacated by banks because of their incapacity to maintain such risk profile on their balance sheet, they have invested in the higher risk bracket of trade finance.
Trade finance however, is a much larger proposition, with a pristine track record. With lower risks, expectations should be driven down toward lower returns, providing investors understand the asset class better. They will not do so if not supported by the industry. Trade supply chains, if properly managed are relatively safe and financing them is often less risky than outright financing to individual companies. Delivering on a contract, with the expected quality of goods and timing is critical for any company, even if this requires stretching repayments of its debt on time.
Trade finance is an asset-class deserving dedicated modelling and rating, without which investors will never go beyond current alternative finance expectations and appetite. With banks reprioritizing their activities and less appetite for business, it will become critical to develop such a model and successfully diversify the sources of funding for a critical economic activity.
The economic political and geopolitical worlds as we knew them are undergoing major tectonic shifts. It is much too soon to foresee how the world will eventually shape-up. It is critical during this phase of transition which might last several years, to be alert and aware and let go of our “old normal” reflexes. New paradigms will gradually emerge and they are bound to shake our understanding of the world as we know it.
The ripple effect of the great financial crisis will linger. Behaviours are already changing, expectations of worried middle classes allied with a dawning new era of technical breakthroughs will deeply modify the scope of globalisation and affect the nature of trade and relations between countries. Banking will need to further adapt and regulators should accompany this process rather than slow it down by shifting their focus from preventing systemic risks largely taken care of by now, to encourage the financial sector to play its role of key intermediary in the economy more effectively. Liquidity is still largely abundant in the world and it is necessary in these uncertain times to channel it towards trade which has historically been the most effective booster for openness, wealth and stability.
 The size of the “global middle class” will increase from 1.8 billion in 2009 to 3.2 billion by 2020 and 4.9 billion by 2030. The bulk of this growth will come from Asia: by 2030 Asia will represent 66% of the global middle-class population and 59% of middle-class consumption, compared to 28% and 23%, respectively in 2009 (http://oecdobserver.org/news/fullstory.php/aid/3681/An_emerging_middle_class.html#sthash.9eorDjxX.dpuf)
 south-south trade grew from c.$700 billion in 2000 to $4.2 trillion in 2014, topping south-north trade which amounted to $3.6 trillion in 2014 – source WTO 2016 trade statistics
 Between 1985 and 2007, trade volumes grew at twice the speed of GDP (source The Economist – WTO). In 2016, trade was expected to grow by 1.7% vs a 2.2% growth for the world GDP (sources WTO sept 2016)
 From 2004 to 2007 on average, world GDP grew by 4.25%. From 2010 to 2015, it grew by 2.97% (source World Bank data)
 For 2017, the IMF forecast a 2.3% growth for the US and a 6.5% growth for China i.e. a 2.8 factor. (http://www.imf.org/external/country/)
 calculation of share of commodity trade varies widely (from 12 to 33pct.) depending upon the definition of commodities and the strength of the USD.
 Sources UN https://esa.un.org/unpd/wpp/DataQuery/
 By 2014, 63 per cent of countries were more than half urban and one-third was more than 75 per cent urban. By 2050 more than 80 per cent of countries in the world are projected to be at least half urban and just under 50 per cent will be at least 75 per cent urban. (https://esa.un.org/unpd/wup/Publications/Files/WUP2014-Report.pdf)
 refer inter alia to “Off the Cliff and Back? Credit Conditions and International Trade During the Global Financial Crisis, Davin CHOR, Manova LINA” http://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=2164&context=soe_research
 seven years of data, a full disclosure on the specific recovery process and outcome of trade facilities