What is structured trade finance?
Structured Trade Finance (STF)
Structured trade finance is a type of debt finance, which is used as an alternative to conventional lending. It is regularly used in developing countries and in relation to cross border transactions. The aim is to promote trade by using non-standard security; it is usually used in high value transactions in bi-lateral trading relationships.
Structured Trade Finance (STF) is a specialist and more complex type of finance, which is usually associated with commodity trading or other high value underlying products or large quantities. We usually see these types of finance set alongside the supply chain and able to be structured to work around terms agreed in large structured bilateral trading relationships.
It is most prevalent within the commodity sector and used by processors, producers, traders and end-users. However, the types of finance and security packages vary widely; as there is warehouse financing (stock), borrowing base financing (revolving finance based on underlying assets), processing or tolling (converting products) and pre-export (prepayment) finance along with reserve based lending.
It is important to note that many of these facilities are self-liquidating; thus they pay themselves back via the sale or export proceeds of the underlying product; so in many cases funding mirrors the underlying trade cycles.
STF structures look at cross border product flows and are backed by limited recourse trade finance lines. However, the structure aims to provide an enhanced security mechanism, to act as an improvement on the borrower’s position when viewed in isolation.
Why are structured trade finance facilities used?
STF structures are put together so that trading in different jurisdictions and specific country risk may be mitigated. Looking at a transaction together with these structures in place adds resilience to the trade; when compared to looking at financing individual elements of a trade. It also allows payment times to be lengthened, diversification of funding, strategic procurement and increases the ability for clients to increase facility sizes.
The reason that STF is also attractive; is that the strength of the borrower in the transaction is not looked at as closely when compared to a vanilla loan. Instead, more focus is placed on the structure and underlying cash flows.
What is important in a structured trade finance transaction?
Structured trade finance is a term used for a number of types of lending. Financings are structured in various ways with the usual ultimate aim to have an independent structure that sits alone. For this to happen there are many mechanisms that are put in place and these may include an escrow agent, insurance and a collateral manager when we look at products in warehouse.
Agreements are key in relationships; which must be governed by clear contracts and underlying covenants. Clauses will need to enforceable, roles of parties defined and governing law clauses clearly set out. Security documents will be the main focus of these agreements; with charges on property, asset charges, guarantees, SBLCs and debentures along with the priority ranking clearly set out.
We sometimes see the above structures put into a special purpose vehicles; so they can act as standalone structures. Other tools that are used in these structures are price mitigation tools. Examples of these are fixed price contracts, forward contracts, futures etc. This is along with commodity swaps and options that are sometimes used.
We usually see structured commodity finance (SCF) in relation to soft commodities, mining, energy and metals. This funding mechanism is also used mainly by traders, producers and financiers. The ultimate aim is the efficient deployment of capital to mirror trade cycles; which focuses on the producer to the re-payment from the end buyer.
Various structures are used to manage cash flows and mitigate risk throughout the transaction cycle. The commodities financed make up the main or the whole body of the underlying security.
What types of STF are there?
These are usually referred to as:
- uncommitted trade facilities;
- receivables finance;
- inventory finance;
- pre-export finance;
- tolling financing; and
- accounts receivables financing.
The ultimate aim of these more structured type-financings is to trade with emerging markets with the intention of receiving repayment by the liquidation of the underlying trade cycle or ‘commodities flow’.