Structured Trade Finance

Commodity traders selectively provide financial inter-mediation services to their most important and long-standing counter-parties. These services often take the form of structured trade finance (“STF”) transactions that incorporate funding, trade credit, risk management with trading-related services like supply, off-take, storage, processing and shipping. STF transactions are a natural extension of the underlying physical trading relationship between buyer and seller which is self-liquidating in nature.

Overview of STF transactions

STF transactions are increasingly a feature of longer term supply and off-take contracts. Compared to traditional trade finance, STF transactions are typically longer-dated, more complex in structure and require more in-depth understanding of the underlying assets and counter-parties. In addition, banks and trade credit insurers are generally a few steps removed from the trader-producer relationship, and generally have to depend on traders to obtain credible track record information. It is therefore no surprise that the STF transactions undertaken by traders are well-supported by a plethora of banks, insurers and other non-bank financial institutions in the major trading centres around the world.

Benefits of STF transactions

To Producers

■   Provides additional working capital buffer to optimise cashflows

■   Such structures usually attract greater lending appetite because risk profile predominantly shifts from being the credit risk of producer to production risk of producer

■   Offers flexible and tailored financing terms

■   Requires giving away less securities as compared regular bank financing

■   Financing can also be done with full recourse to the stronger counter-party in the transaction chain, so as to achieve better pricing compared to unsecured/corporate loans

■   Possible to achieve a positive balance sheet impact subject to internal accounting policy, notably on debt component of the producer

To Traders

■   Creates a more sticky relationship between producer and trader, resulting in higher barriers to entry for competitors to break into the relationship

■   Mitigates credit risk through the ability to set-off proceeds from underlying payment obligation

■   Provides an avenue to extract more value out of the trading relationship

■   Possible to achieve a positive balance sheet impact subject to internal accounting policy, notably on debt component of the trader

Drawbacks of STF transactions

To Producers

■   Dependent on trader’s ability to lay off risk, which introduces an element of uncertainty

■   Harder to switch trader once producer is dependent on funding from the STF transaction

■   Transaction costs are typically higher versus a vanilla off-take/supply agreement, and are usually borne by the producer

To Traders

■   Working capital intensive, as banking lines designed for regular trading activities have to be stretched to fund STF transactions that are full-recourse to the trader

■   Success of the STF transaction is dependent on the ability to syndicate credit risk to banks and trade credit insurers e.g. Lloyd’s market

■   Labour-intensive, as it requires joint efforts from many functional areas outside of trading like legal, tax, compliance, accounting policy, trade finance and other specialised areas

Pre-export Financing (PXF)

■   Buyer and Seller enter into a Commercial Contract and a Prepayment Agreement

■   Bank provides a limited recourse financing facility to the Buyer, who assigns its rights under the Commercial Contract to the Bank as security

■   Bank advances Seller a percentage of the total approximate contract value on day 1

■   Advance is attached to periodic cargo deliveries under the Commercial Contract

■   Repayment of advances done by the Buyer to the Bank after delivery of product by the Seller

■   Buyer and Seller agrees a discount on the initially agreed commercial price of the cargos

Commercial Prepayment

■   Buyer and Seller enter into a Commercial Contract and a Prepayment Agreement

■   Bank provides a full recourse financing facility to the Buyer, which makes the loan to the Seller

■   Buyer advances Seller a percentage of the total approximate contract value on day 1

■   Advance is attached to periodic cargo deliveries under the Commercial Contract

■   Repayment of advances done via set-off of Buyer’s payment obligations for each delivery of product

■   Buyer and Seller agrees a discount on the initially agreed commercial price of the cargos

■   Buyer may enter into a trade credit insurance policy without notifying the Seller, with Bank appointed as loss payee or co-insured under the insurance policy

Extended / Deferred Payment Terms

■   Buyer and Seller enter into a Commercial Contract which includes extended /deferred payment terms (e.g. 90 days instead of 30 days) to alleviate Buyer’s working capital requirement

■   Seller may require a corporate guarantee from the Buyer’s parent or ultimate beneficial shareholder as a credit mitigation measure

■   Seller may also require a controlled bank account to be set up between Buyer and Seller to ensure the Buyer’s end customer pays into that specific controlled account

■   In some cases, Buyer may offer a reverse discounting facility to the Seller to enable Seller to discount its long-dated receivables with Buyer’s relationship bank on a non-recourse basis

Sleeving

■   Buyer and Seller into a Commercial Contract

■   Seller enters into a back-to-back Commercial Contract with the Buyer’s end supplier

■   Seller buys cargo from Buyer’s end supplier, holding title and financing shipment upon delivery to the Buyer, eliminating the need for the Buyer to bear working capital

■   Title can be passed to specialised commodity financing firms and certain commodity traders

Stock Financing

■   Bank funds working capital requirements against security over stock

■   Transaction typically involves a tripartite storage agreement with Bank, the borrower and the storage facility owner

■   Title over goods are pledged to Bank

■   Storage facility owner issues Holding Certificates in favour of Bank as evidence of possession

■   In terms of control, goods cannot be moved without Bank’s approval

■   Deal subject to legal, operational and financial DD but involves physical segregation of pledged/financed goods within a bonded area

■   Holding certificates/warehouse receipts must also be countersigned by inspector and/or collateral manager

■   Haircuts applied to financing value depending on price volatility of underlying goods and tenor

Repo Structures

■   Initially involves a purchase contract between the Borrower and the Bank with title passing to the bank within an approved storage location

■   Bank signs a storage agreement with the storage facility owner, or in some cases, a contractual assignment of an existing storage agreement with the Seller

■   When Borrower needs to sell the goods, Bank sells back the goods to Borrower for the latter to on-sell to its counterparty under a sale contract

■   Deal subject to legal, operational and financial DD as well

Synthetic Swap

■   Netting off payment obligations due under sales of feedstock and purchase of finished products with a refinery or a smelter

Tolling Agreement

■   Seller and processing plant (“Plant”), which may be an oil refinery or a metals smelter, enter into a tolling agreement

■   Seller sells feedstock to Plant at an agreed market price

■   Seller holds title and risk of the inventory work-in-progress and finished goods at Plant

■   In return, the Seller pays a processing fee/tolling charge to the Plant

■   Seller off-takes the product from Plant at an agreed market price