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7/30/2019 Commodity Finance Risk Mgt FYoussef.ppt
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SPECIAL UNIT ONCOMMODITIES
Commodity finance and riskmanagement
Frida Youssef
UNCTAD
Palais de lONUGeneva, 18 Feb 10
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SPECIAL UNIT ONCOMMODITIES
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 andfinancial constraints:
- Over 2 billion people are estimated to derive their livelihood fromproduction and trade of commodities;- More than 50 developing countries and LDCs depend on three orless 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 involvedinternational 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 tosupport 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 financier
Potential
borrower
With structured
finance:
Will the
borrower
reimburse?
financier
Potential
borrower
With secured
finance:
How to
control
collateral?
$
Goods
Will the
borrowerproduce?
Potential
borrower
$
Offtaker
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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
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ProducersProcessors
CommodityTraders
InputsAgricultural Agricultural
Production
Storage
Production /
Processing
Local producers & processors;
Commercial farmers;
International input suppliers.
Local producers & processors Commercial farmers International input suppliers
Input financing;
Crop risk management weather
insurance
Working capital/basic cash
Structured finance: WRS/inventory
based finance, etc..
Storage
Transport
Trade / Export Wholesale
AgriValue Chain
FinancingStages
AgriPlayers
Financing
Needs
CommoditySalesSales
Transport
Manufacture/Further
Processing/Packaging
Wholesale/Distribution
Small commodity tradersLarge commodity traders
Local distributors F & Bmultinationals Wholesalers.
Working capital; Trade finance;
Price risk management;
Structured finance: receivables-
back finance, pre-payment etc.
Foreign exchange.
Working capital/liquidity;
Structured trade finance and
collateral management, etc.;
Price risk management;
Foreign exchange.
Buyers
Success Factors Along The Value Chain
Pre-shipment finance 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 exporters
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.
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Exporter
EXAMPLE: Receivable-BasedFinancing
1. Underlying transaction:To trade naphthaand crude oil.
2. Lender : XYZ Bank.
3. Faci l i ty Amount:US$ 50 million for creditfacility.
4. Expor ter :Oil company
5.. Importers:oil refineries worldwide.
7. Tenor:30-90 days from B/L date.
8. Collateral:Outstanding account receivables.
9. Facil ity Per iod:1 year.
10. Each transaction amount: Over US$5million.
XYZ Bank
Payment after
30-90 days fromB/L date through
an escrowaccount
Letter of Undertaking(remedial procedures incase of non-performance)
Shipment Buyers (OilRefineries)
This f inancing is given to the expor ter once goods are shipped and repayment is done
automatically by importer thr ough 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 exportcontracts and receivables, and by receiving payment in an offshore escrow account.
Letter ofAcknowledgment
Payment at
shipment
Assignment of
contract/A/R etc..
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Fisher
men
Processor/
freezingplant
Foreign
buyers
Local
market
Diesel oil
Foreign
bankLocalbank
MonitoringLoan used
for buying oil
Reimbursement
Fish
Diesel
Fish
Fish
Example - revolving pre-export finance for fishermen and a fish
processing plant
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A simple warehouse receipt finance scheme - open to various depositors. Thiscan act as a model to reach farmers - who are often willing to pay high interest rates.
Farmer
Trader
Banks
Warehouse
1. Deposits
products
2.Issues
receipts
3.Lodges receipts with bank
4. Provide credit
5.Signs sales
contract
6. Reimburses credit; in return, bank transfers receipts
9. Deliversreceipt;
warehouse
makes delivery
Guarantee
agencies
Government
regulator
Approves
Warehouse
Guarantee, insurance,
etc.
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Rice
exporterWarehouse
Rice
ImporterWarehouse
An example of using a collateral manager to finance
South-South trade
Collateral
manager
Bank
Collateral management
agreement
Payment when goods enter
into warehouse controlled by
the collateral manager
Acceptable payment will
allow rice to be released
from import warehouse
Collateral manager takes full control from moment on thatgoods enter export warehouse, until release (as authorized bythe bank) from the import warehouse. The bank will haverecourse to him for most losses during this period.
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SPECIAL UNIT ONCOMMODITIES
Commo-
dities
Paper
Money
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.
Technology will link it all
together through a Global
Commodity Receipt system.
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WRS in Tanzania
- The CFC funded Coffee and Cotton marketing development project whichwas 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 andMarketing
-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 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 primarycooperative 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-the-
counter markets
Hedging tools
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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
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:
Market used for risk management is divided in two part
Commodity
exchange
Over-the-counter
market
{
Hedging
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Tools for Commodity Risk Management
Specification of price or minimum price incontracts 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 sella commodity at a a strike price on or before aspecified date pay a premium at time contractsigned
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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:
These kinds of contracts are regulated by exchanges authorities, and there execution are guarantee by
clearing houses.
Helpful to
hedge price riskexposure
Useful for some
marketingstrategies
An ideal
benchmarkprice
Initial position can easily be reversed
Delivery is not necessarily implied
No need to negotiate contract
specifications
Lock-in a future price
Protect the value of inventories
or finance storage
Give a good benchmark
price to barter
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Differences between Forward and Futures Contracts
Forward Contracts Futures Contracts
Most are traded OTC Are traded on organized exchanges
through clearing houses
Can be tailor-made to match specific
hedging needs
Have standardized contract terms
Require cash transfer only at maturity of
contract
Require initial transfer for margin
payments and may require daily
settlements to adjust margins to adverse
price movements
Involve a high degree of counterparty risk
because no clearing house facility exists
Imply very little counterparty risk
because the clearing house guarantees thefulfillment of contractual obligations
Contain the expectation of physical
delivery
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:
US call: the right to buy at any timeduring the period.
European call: the right to buy, but
only at the end of the period.
Call option Put option
US put: the right to sell at any timeduring the period.
European put: the right to sell, but only
at the end of the period.
Obtaining
short-term
finance
Protection against
unfavourable
price movements
Part of
marketing
strategy
Limits the size of the maximum loss but
do not eliminate the opportunity to takeadvantage of favourable price movements
An over-the-counter
financing
In regard of longer-term
trade relationships
Main use are for:
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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
Obtain easier
and cheaperaccess to capital
Lock in long-
term prices
No or less-strict margin calls
Low administrative costs once
structured
From financial operations or
new investments
Tailor-made
Long term instrument
Combination of price
hedging and investment
securization
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 theyear
Minimum price when deliver coffee Supplementary payments based on price at whichcoffee 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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SPECIAL UNIT ONCOMMODITIES
Role of UNCTAD UNCTAD has been a pioneer in helping commodity-developing
countries address the commodity problematique including byadvocating the importance of increased access to, and diversifiedsources of finance.
One recent example, UNCTAD as part of its technical capacityactivities (funded by the EC All ACP project), been looking at financing
tools such as Factoring (discount of receivables) that would enablethe integration of small scale farmers into the supply chains, such asof the tourist industry (the mainstay of many Caribbean territorieseconomies) and supermarkets.
Yet, nowadays, the problematiqueextends beyond the commoditysector 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 sectordevelopment. In other words, the challenge for UNCTAD and for allrelevant stakeholders is of a greater magnitude today than it has everbeen. To address the challenge, concerted and considered efforts arerequired at all levels, national, regional and international and fromboth the public as well as the private sector (including financiers,
insurers, research, academia, enterprise, civil-society, etc).
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Role of UNCTADUNCTAD activities targeted to both public and private sectors include:
Building perspectives on broad trends in financing and pinpointing theimplications for development of commodity sectors and the institutionsthat serve them.
Advising on the structuring of financing mechanisms
Engaging in institution- and capacity-building and policy advice toimplement new commodity financing and risk management schemes.
Organizing large awareness-raising and networking workshops and high-level conferences on financial techniques.
Arranging tailored training programmes
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Thank you
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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.
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)
As shown, main commodity exchanges are located in USAand UK. There are the most efficient and can therefore
provide good international benchmark prices for the
commodity they trade.
Commodity exchanges provide
Standardised contracts
Strict controlled financial streams
Efficient market (due to thenormally great volume of trade,
clear information, control...)
Good international benchmark
prices for the traded commodities
Secured trade
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Over the counter market
The need for more sophisticated and specific hedging instrument has lead the over-the-
counter 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