Commodity finance (CF) is the term used for funding the trade of commodities. CF is a type of trade finance, often split into metals and mining, soft commodities and energy. Commodity finance is used by many companies, including producers, traders and commodity lenders.
Commodities have always been difficult and complex products to finance. They typically have low margins and goods are traded cross border in jurisdictions where there may be a lack of trust between counterparties. This means that many financiers are hesitant to work with new or growing companies, as there is knowledge in the fact that if there is a sudden difficulty, shipment problem, quality issue or a counterparty acts incorrectly then it means that a previously profitable trade may cause major and disproportionate difficulty for the company. This is intensified as trades are larger and commodities are more specialised.
Commodity finance has historically been a specialist financing type. The reason for this perceived risk and enforcement. In the event that a lender is required to enforce security over goods and sell them – it is much easier to re-sell a shipment of toys than it may be on-sell scrap metal with low margins. This specialist knowledge has led to specialist funders who have a knowledge and ability to re-sell the underlying commodity, being the ones who are actually financing these types of commodity trades.
Trade Finance Global has extensive expertise in the structured trade and commodities market and clients can be confident that we work with the best and most appropriate funders in the market to serve your business needs. Given the volatility and low margins, commodity finance is complex and difficult to secure in comparison to other asset classes.
What will a funder look for?
- The standing and strength of the borrower
- Company set up
- Cash cycles
- Concentration risk of suppliers and end buyers
- Credit standing of counterparties
- Insurance limits
- Spread of trade
- Products and perishability
- Country risk and diversification
- Terms of sale and purchase
- Finance instruments used
- Existing funding structure
Many parties across the value chain may be a beneficiary or user of commodity finance and this could be a producer, processor, distributor or traders.
Types of Commodity Finance
- Pre-export finance
- Inventory finance
How is commodity finance changing?
In recent years we have seen more banks work with funders in order to make these trades possible. This is because some funders are now comfortable with the transaction cycles of commodities due to security placed around a number of the elements above; even when they may not have a branch or department that is able to sell or purchase commodities. In either case, the funder needs to feel secure that in a default scenario they are able to enforce security and release capital from the goods.
Commodity finance is an industry that usually has structures in place in relation to lending. An example of this is deposit or pre export financing. Commodity finance is a type of lending that fits into trade finance and is actually split into three groups of commodities, which are metals and mining, energy and soft commodities. SCF is a financing technique which are used by many primarily producers, lenders and trading houses.
Commodity producers may use these finance structures in order to receive capital and make sure that cash flow is available for the optimum output. There will be an aim to provide repayment of the financing when exports commence. There are risk mitigation factors involved with these financings; with the aim of reducing risk exposure to a single country or commodities. Being in a stand-alone structure means that there is mitigation in relation to any volatility in demand, supply or pricing.
Commodity producers may be opened to new markets when lending is advanced to them. Liquidity and risk mitigation elements are provided to produce, buy or sell product. A way of doing this is by looking at assets in isolation with predetermined receivables. Other elements such as prices, history and future value are all looked at. In the event that structures or trades break down; usually assets are sold in order to repay any facility. Commodity finance makes trades possible by using alternative and innovative financing structures.
Trade Finance Global were able to restructure and come up with a smart funding solution which banks had previously been unable to do. The commodity finance team worked closely with our CFO until the deal was completed, and we continue to use TFG.