Pacific Life spurs possible trade finance sea change

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The National Association of Insurance Commissioners (NAIC) is developing guidelines for regulators that would eventually allow insurance companies to become major investors in trade finance, according to two sources at the industry group that declined to be named.

The shift, which would be a first for the trade finance industry as a whole, comes at a time when new regulations arising from “Basel III” threaten to constrain the lending ability of banks, which have traditionally been the only source of trade finance. And with roughly USD 6.5 trillion in assets under management, the US insurance sector could become major players in the trade finance space. However, these changes are not a direct response to the banking regulations coming into place.

Discussions at the NAIC, a research and support organization comprised of insurance regulators, began last year after Pacific Life Insurance reached out to a state regulator about permitting trade finance assets as an investment for the major California-based life insurer as well as the insurance industry.

Pacific Life CFO and CIO Khanh Tran said the insurer became aware of the opportunity that trade finance as an asset class presented nearly a decade ago, when one of its subsidiaries enjoyed great success in that line of business. Returns were good and there were no defaults, he said, even through the market crash in 2007-2008. After several years of monitoring this business, Pacific Life launched a pilot program for the life insurance business around the end of 2009 and beginning of 2010, Tran said.

“Most people think of trade finance as perhaps lending to less than high quality borrowers,” the executive said. “The program we developed here is geared toward investment grade obligors.”

Trade finance can be loosely defined as the funds that enable the movement of goods and services across international borders. For example, a US company that is owed USD 5m for a large shipment of machinery to Brazil can receive an upfront payment of USD 4.8m from a bank for the accounts receivable. The company takes a discount on what’s owed to it but has immediate access to cash, while the bank waits for the buyer to make good on a the payment depending on the length of the contract.

This system is widely-expected to be disrupted by the above-mentioned Basel III banking industry regulations which will be phased in from next year. Traditionally, a bank would hold the trade-related debt on its books until it is paid off. However, the new regulations could make it more costly for banks to do so.

“If what we think is happening in the regulatory environment continues, then banks will scale back lending and by doing so it could potentially impact global trade,” said Robert Miller, a managing director for specialist investment manager Conning & Company. “In many ways, trade finance is a necessary enabling vehicle”

Conning has been active in providing comments to the NAIC regarding trade finance, said Miller. The firm has roughly USD 80bn in assets and has about 110 insurance clients that have expressed a great deal of interest in investing in trade finance, Miller said. Its aims are to expand its role as a third party asset manager and credit researcher for insurance companies.

Insurance companies ‘ideal’ trade finance investors

Insurance companies would be ideal investors in trade finance, Miller said. Trade has historically low default rates with annual yields comparable to investment grade corporate debt, Miller said. Trade finance is also usually lent on a floating rate basis, providing interest rate risk protection, and does not have the trading volatility of liquid corporate debt, he said.

While the NAIC is an organization comprised of insurance regulators, it is not a governing body. The insurance industry is largely regulated at the state level, but the federal government also has rules that the industry follows. That said, the NAIC has a lot of governing bodies to work with before it makes a formal recommendation. The group’s next annual meeting is in March, but it may make progress before then, said the two NAIC sources.

The response from the industry has so far been positive and the NAIC continues to make progress on developing recommendations and guidelines, the sources said.

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