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Commodity finance
- Over 2 billion people are estimated to derive their livelihood from production and trade of commodities; - More than 50 developing countries and LDCs depend on three or less leading commodities for at least half of their export earnings.
Commodity trade and production is credit-intensive. Risks in commodity finance.
Through use of structuring techniques, financiers can control their level of risk
Without structured finance: financier Will the borrower reimburse? Potential borrower With secured finance: financier How to control collateral? With structured finance: financier Will the borrower produce? $
Financing Stages
Production / Processing
Trade / Export
Wholesale
Agri Players
Local Local producers & processors; producers & processors farmers; Commercial Commercial farmers input suppliers. International International input suppliers
Producers Processors Input financing; Working capital/basic cash Crop risk management weather insurance Structured finance: WRS/inventory based finance, etc..
Commodity Traders
Working capital/liquidity;
Buyers
Working capital; Trade finance; Price risk management; Structured finance: receivables-
Financing Needs
Structured trade finance and collateral management, etc.; Price risk management;
Foreign exchange.
Pre-shipment finance
Post-shipment finance
EXAMPLE: Financing
Receivable-Based
1. Underlying transaction: To trade naphtha and crude oil. 2. Lender: XYZ Bank.
Shipment
3. Facility Amount: US$ 50 million for credit facility. 4. Exporter: Oil company 5.. Importers: oil refineries worldwide. 7. Tenor: 30-90 days from B/L date. 8. Collateral: Outstanding account receivables. 9. Facility Period: 1 year. 10. Each transaction amount: Over US$5 million.
Exporter
Payment at shipment
XYZ Bank
Payment after 30-90 days from B/L date through an escrow account
This financing is given to the exporter once goods are shipped and repayment is done automatically by importer through an escrow account.
This creates an automatic reimbursement procedure. This enables exporters to use future trade flows to raise self-liquidating export-based financing at better cost and tenor. It also enables financiers to externalize country and credit risks by the assignment of export contracts and receivables, and by receiving payment in an offshore escrow account.
Example - revolving pre-export finance for fishermen and a fish processing plant
Local bank
Monitoring
Foreign bank
Loan used for buying oil
Diesel oil
Diesel
Reimbursement
Fisher men
Fish Fish
Foreign buyers
Local market
Farmer
1. Deposits products
Banks
Warehouse
Trader
Guarantee agencies
Approves Warehouse
Government regulator
Payment when goods enter into warehouse controlled by the collateral manager
Rice exporter
Warehouse
Warehouse
Rice Importer
Collateral manager takes full control from moment on that goods enter export warehouse, until release (as authorized by the bank) from the import warehouse. The bank will have recourse to him for most losses during this period.
Collateral manager
Commodities will increasingly become a financial asset any commodity will be like a currency. Financial markets will develop around these new currencies. Independent entities will be doing the leg work to convert commodities, as they move through the value change, into financial assets.
Commodities
Money
Paper
Technology will link it all together through a Global Commodity Receipt system.
WRS in Tanzania
- The CFC funded Coffee and Cotton marketing development project which was launched in 1999.
- Tanzania has passed a Warehouse Receipts Act (2005) and Warehouse Regulations (2006),
- and has designated a Licensing Board in the Ministry of Industry, Trade and Marketing -This has registered some 20 warehouses (12 for cashew, 5 for coffee, 2 for cotton and 2 for paddy rice), and plans to establish a fully-fledged licensing regime.
WRS in Tanzania
Commodities Finance includes: - Traditional crops (coffee, cotton) has expanded their loans portfolio at ground level.
The WRS has taken off with coffee since the latter 90s and 25% - 30% of the countrys exports are reported to pass through the system, much of it supplied by POs (farmer business groups, primary cooperative societies etc.) that bulk on behalf of their members.
- Non traditional crops such as Paddy (MF-linked approach, with upward of 10,000 tonnes being stored by farmers per year), Maize and sunflowers are recognized and getting finance from the bank.
- Cashew nut WRS initiative emerged in 2007. More than 168 primary cooperative societies in cashew nuts sub sectors are financed in in the business of raw cashew nuts. Total loan portfolio in cashew nuts WRS finance exceed U$50 million.
Hedging
Market used for risk management is divided in two part
Commodity exchange
Over-the-counter market
Although the basic ways to use these tools can easily be learned, hedging strategies can become quite complex. Even with a good mastery of these instruments, some difficulties exist, due to:
The need to pay margin deposits/guarantees Margin calls, which could be required, and which can be high The fact that in some countries, intermediaries do not really exist, or even use of these markets is banned
Futures
Futures are kind of standardised contracts for future delivery of an asset (that could be commodity). There are: Useful for some marketing strategies
Initial position can easily be reversed Delivery is not necessarily implied No need to negotiate contract specifications
These kinds of contracts are regulated by exchanges authorities, and there execution are guarantee by clearing houses.
Can be tailor-made to match specific Have standardized contract terms hedging needs Require cash transfer only at maturity of Require initial transfer for margin contract payments and may require daily settlements to adjust margins to adverse price movements Involve a high degree of counterparty risk Imply very little counterparty risk because no clearing house facility exists because the clearing house guarantees the fulfillment of contractual obligations Contain delivery the expectation of physical Only a small fraction of futures contracts result in actual delivery of the underlying commodity
Options
Options contracts give the right (but not the obligation), to purchase or sell a specific asset at a predetermined price on or before a specified date. There are two kinds of options contracts: Call option US call: the right to buy at any time during the period. European call: the right to buy, but only at the end of the period. Put option US put: the right to sell at any time during the period. European put: the right to sell, but only at the end of the period. Main use are for: Obtaining short-term finance
An over-the-counter financing
Swaps
A swap is a purely financial instrument under which specified cash-flows are exchanged at specified intervals.
It should be noticed that swaps are purely financial tools, which means that no delivery of physical are requested.
Role of UNCTAD
UNCTAD has been a pioneer in helping commodity-developing countries address the commodity problematique including by advocating the importance of increased access to, and diversified sources of finance. One recent example, UNCTAD as part of its technical capacity activities (funded by the EC All ACP project), been looking at financing tools such as Factoring (discount of receivables) that would enable the integration of small scale farmers into the supply chains, such as of the tourist industry (the mainstay of many Caribbean territories economies) and supermarkets. Yet, nowadays, the problematique extends beyond the commodity sector and its traditional issues to cover other cross-cutting concerns, such as food insecurity, water shortage, climate change impact, energy security, and more broadly, sustainable commodity sector development. In other words, the challenge for UNCTAD and for all relevant stakeholders is of a greater magnitude today than it has ever been. To address the challenge, concerted and considered efforts are required at all levels, national, regional and international and from both the public as well as the private sector (including financiers, insurers, research, academia, enterprise, civil-society, etc).
Role of UNCTAD
UNCTAD activities targeted to both public and private sectors include: Building perspectives on broad trends in financing and pinpointing the implications for development of commodity sectors and the institutions that serve them. Advising on the structuring of financing mechanisms Engaging in institution- and capacity-building and policy advice to implement new commodity financing and risk management schemes. Organizing large awareness-raising and networking workshops and highlevel conferences on financial techniques. Arranging tailored training programmes
Thank you
frida.youssef@unctad.org
Commodity exchanges
Commodity exchanges are financial organised market where commodities are traded on standard contract. There exist a several commodity exchanges around the world, each place trading a certain part of commodities. Commodity exchanges provide Standardised contracts Main Commodity Exchange around the world: Chicago Board of Trade (CBOT) New York Mercantile Exchange (NYMEX) Coffee Sugar and Cocoa Exchange (CSCE) New York Commodity Exchange (NYCE) London Metal Exchange (LME) International Petroleum Exchange (IPE) London Commodity Exchange (LCE) MATIF (Paris)
Good international benchmark prices for the traded commodities Secured trade
Nevertheless, it should be paid attention to the following fact: this market is not transparent