1. finance
2. investing
3. futures trading

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Commodity finance and risk
management
Frida Youssef
UNCTAD
Palais de l’ONU
Geneva, 18 Feb 10
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I.
Commodity finance
• Introduction
• Traditional finance vs Structured finance
• Examples
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Introduction: access to finance in
commodity trade and development
• Importance of the commodity sector for developing economies and
financial constraints:
- 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.
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• Traditional finance (balance sheet based)
vs Structured finance (transaction based)
Economics, and political events that have global implications, especially in emerging markets,
have compelled financiers to develop and adopt innovative, structured financing techniques to
mitigate their risks and adapt to globalization and privatization of commodity trading activities.
- Until the onset of the Latin American financial crisis in the mid-80s, banks involved
international commodity finance relied on balance sheet lending and government guarantee.
Structured finance, on the other hand, is based on the transaction for which the finance is
provided.
- Such techniques aim to transfer risks in financing transaction from parties less able to
support those risks to those more equipped to support them in a manner that ensures
automatic reimbursement of advances from the underlying assets such as inventory and
export receivables... This forms the pillar of structured trade finance.
Structured finance revolves around identify and mitigating risks associated with
transactions..and convert wealth, in the form of commodities, into ready cash.
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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?
Potential
Goods
borrower
With structured
finance:
financier
Will the
borrower
produce?
$
Potential
Offtaker
borrower
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Practical use of structured trade finance:
There are no distinct standardized types of structure trade finance
transactions since one essential principle of these transaction is the
ability to tailor a structure that will satisfy the needs and
circumstances of all parties involved, provided that perceived or real
risks are mitigated. We are going to present some basic forms of
structured finance, their concept, and transactions flow.
1. Export receivables-backed financing
2. Supply Chain finance
3. Warehouse receipts finance
Producers
Processors
• Input financing;
• Working capital/basic cash
Financing • Crop risk management
weather insurance
Needs
• Structured finance:
WRS/inventory based finance,
etc..
Pre-shipment finance
Manufacture/
Further
Processing/
Packaging
commodity traders
commodity traders
Commodity
Traders
• Local distributors
•F & m
Bultinationals
• Wholesalers.
Buyers
• Working capital/liquidity;
•
Structured trade finance
and collateral
• management, etc.;
Price risk management;
• Foreign exchange.
Wholesale/
Distribution
Wholesale
Trade / Export
•• Local
producers
& processors;
Local
producers
& processors •Small
•• Commercial
farmers;farmers
Commercial
•Large
•• International
input suppliers.
International
input suppliers
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Transport
Agri
Players
Production /
Processing
Commodity
Sales
Storage
Financing
Stages
Storage
AgriculturalAgricultural
Agri
Production
Value Chain Inputs
Transport
Success Factors Along The Value
Chain
• Working capital;
• Trade finance;
• Price risk management;
• Structured finance:
receivables-back finance,
pre-payment etc.
• Foreign exchange.
Post-shipment finance
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Export receivables-backed financing
This model entails the provision of pre-export loans or advance payment
facilities to an exporter, with repayment being obtained from the exporter’s
receivables resulting from the sale of the pre-financed exported
commodities.
Under this model, banks take the following combined measures:
(a) Taking security over the physical commodities in the form of a local-law
pledge or similar security interest;
(b) Assigning the receivables generated under the commodity export
contracts;
(c) Establishing an escrow account in a suitable (usually offshore) location
into which buyers of the commodity are directed to pay the assigned export
receivables.
EXAMPLE:
Financing
Receivable-Based
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1. Underlying transaction: To trade naphtha
and crude oil.
2. Lender: XYZ Bank.
Shipment
3. Facility Amount: US$ 50 million for credit
facility.
Letter of
Acknowledgment
4. Exporter: Oil company
5.. Importers: oil refineries worldwide.
7. Tenor: 30-90 days from B/L date.
Buyers (Oil
Refineries)
Exporter
Payment at
shipment
Letter of Undertaking
(remedial procedures in
case of non-performance)
8. Collateral: Outstanding account receivables.
9. Facility Period: 1 year.
Assignment of
contract/A/R etc..
XYZ Bank
Payment after
30-90 days from
B/L date through
an escrow
account
10. Each transaction amount: Over US$5
million.
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.
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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
Fisher
men
Fish
Processor/
freezing
Fish
plant
Fish
Local
market
Reimbursement
Foreign
buyers
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A simple warehouse receipt finance scheme - open to various depositors. This
can act as a model to reach farmers - who are often willing to pay high interest rates.
4. Provide credit
3.Lodges receipts with bank
Farmer
5.Signs sales
contract
2.Issues
receipts
Trader
Banks
1. Deposits
products
Warehouse
9. Delivers
receipt;
warehouse
makes delivery
Guarantee, insurance,
etc.
Guarantee
agencies
Approves
Warehouse
Government
regulator
6. Reimburses credit; in return, bank transfers receipts
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An example of using a collateral manager to finance
South-South trade
Bank
Acceptable payment will
allow rice to be released
from import warehouse
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 management
agreement
Collateral
manager
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Commodities will increasingly
become a financial asset – any
commodity will be like a
currency.
Commodities
Money
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.
Technology will link it all
together – through a Global
Commodity Receipt system.
“Paper”
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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.
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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 country’s 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.
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II. Price risk management
• Describing briefly organised and over-thecounter markets
• Hedging tools
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Hedging
Market used for risk management is divided in two part
Over-the-counter
market
Commodity
exchange
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
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Tools for Commodity Risk Management
• Specification of price or minimum price in
contracts for sale of commodities by farmers or
processors at future date
• Forward and futures contracts
– Forward contracts negotiated on individual basis
– Futures contracts specified on commodity exchanges
– Options is right and not obligation to purchase or sell
a commodity at a a ”strike” price on or before a
specified date – pay a premium at time contract
signed
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Concept of price risk management
Financial markets provide possibilities to hedge against price risks. These
hedging instruments are:
Futures
Options (put, call)
Swaps
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Futures
Futures are kind of standardised contracts for future delivery of an asset (that could be
commodity). There are:
Helpful to
hedge price risk
exposure
Useful for some
marketing
strategies
Lock-in a future price
Initial position can easily be reversed
Protect the value of inventories
or finance storage
Delivery is not necessarily implied
An ideal
benchmark
price
Give a good benchmark
price to barter
No need to negotiate contract
specifications
These kinds of contracts are regulated by exchange’s authorities, and there execution are guarantee by
clearing houses.
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Differences between Forward and Futures Contracts
Forward Contracts
Futures Contracts
Most are traded OTC
Are traded on organized
through clearing houses
exchanges
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
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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:
Put option
Call option
US call: the right to buy at any time
during the period.
US put: the right to sell at any time
during the period.
European call: the right to buy, but
only at the end of the period.
European put: the right to sell, but only
at the end of the period.
Main use are for:
Obtaining
short-term
finance
Part of
marketing
strategy
An over-the-counter
financing
In regard of longer-term
trade relationships
Protection against
unfavourable
price movements
Limits the size of the maximum loss but
do not eliminate the opportunity to take
advantage of favourable price movements
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Swaps
A swap is a purely financial instrument under which specified cash-flows are exchanged
at specified intervals.
Guarantee
income streams
From financial operations or
new investments
Obtain easier
and cheaper
access to capital
Lock in longterm prices
No or less-strict margin calls
Long term instrument
Low administrative costs once
structured
Combination of price
hedging and investment
securization
Tailor-made
It should be noticed that swaps are purely financial tools, which means that no delivery of physical
are requested.
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Coffee Cooperative in Tanzania
• Multiple payments to farmers throughout the
year
– Minimum price when deliver coffee
– Supplementary payments based on price at which
coffee sold on world market
• Risk to cooperative of setting initial price
– Too low, farmers sell elsewhere
– Too high, lose money
• Mitigated through hedging in futures market
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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).
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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
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Thank you
[email protected]
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The practicalities of
risk management: the
markets
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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)
Strict controlled financial streams
Efficient market (due to the
normally great volume of trade,
clear information, control...)
Good international benchmark
prices for the traded commodities
Secured trade
As shown, main commodity exchanges are located in USA
and UK. There are the most efficient and can therefore
provide good international benchmark prices for the
commodity they trade.
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Over the counter market
The need for more sophisticated and specific hedging instrument has lead the over-thecounter market to be more and more used. This is mainly due to the fact that this kind of
market provide:
direct interaction between client and intermediary (bank,
trade house, brokerage firm…)
contract uncontrolled by a clearing house
tailor made contract
long term hedging instruments
Nevertheless, it should be paid attention to the following fact:
this market is not transparent
once entered into a transaction, it is very difficult to reverse
margin are not about to decrease, since contracts are not
standardised (i.e. intermediaries try to keep contract highly
tailor made then not competitive).