The future for commodity trade finance

21 December 2020
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Commodity trade finance leaders discuss how the events of 2020 have impacted issues including credit availability, counterparty risk management, and digitalisation across the global commodity markets.

The global spread of Covid-19 and its impact on commodity demand, a spate of fraudulent activity in the Asian commodity trading space and a precipitous drop in oil prices in April 2020 has led to a significant shake-up in the commodity trade finance sector this year.

The collapse of multiple Asian trading companies earlier this year triggered a widespread re-examination of the business by many banks, after tightened credit conditions amid the global pandemic revealed ongoing fraudulent activity in the region.

While French bank Societe Generale and Dutch lender Rabobank are reportedly reviewing their commodities operations as a result, others made the decision to leave the space altogether. Last August, for example, Dutch bank ABN AMRO announced it would end all trade and commodity business and scale back its global operations to focus on northwest Europe. This was followed by a similar announcement from French lender BNP Paribas about the closure of its Swiss commodity trade finance business in September.

Banks have traditionally been involved in financing the entire commodity value chain and large diversified commodity traders such as Mercuria and Glencore. Short-term financing from these banks funds the purchase, transportation and storage of raw materials for use in production, refining and distribution.

A tightening of financial regulations in the wake of the 2008 Financial Crisis had already squeezed market participants in this space – the events of this year have only added to these pressures. According to figures from research company Coalition, banks saw a 40% year-on-year drop in revenues from commodity trade finance in Q2 2020 and a 29% decrease during H1 2020.

With even those banks that remain in the market re-examining systems and processes, how will this impact the availability of credit in the sector?

Pointing to Swiss trader Mercuria’s ability to close an oversubscribed USD $1.5 billion revolving credit facility in June, Fabio Vernillo, Business Development Manager APAC at Vitol-owned storage provider VTTI, says: “Here in Singapore, lenders’ appetite for medium to large traders in the sector remains, so I don’t think there will be a huge issue for those [types of organisations] to get funding.”

Although banks will now be more selective about who they will lend to, he believes larger, more diversified commodity traders will continue to be able to access finance. In addition to trading large volumes, their asset bases attract lender interest.

Christine McWilliams, Global Head of Commodity and Energy Trade at Citi Treasury & Trade Solutions, agrees: “Owning midstream assets typically provides a more predictable cash flow from term contracts, with lower transaction risk and cost than an asset-light player.  Diversification done well can tend to lower risk compared to a more niche trader that is focusing on one particular geography or commodity type.”

“More generally, 2020 has seen a re-examination of systems and processes across the commodity trade finance space, particularly in relation to risk management and client due diligence.”

However, all is not lost for smaller players. Vernillo says new liquidity providers could also enter the market to fill the vacuum left by this year’s exits. “Crises or events like these present opportunities for new types of liquidity providers such as credit funds – especially in a world where interest rates are currently close to zero in developed countries,” he says.

More generally, 2020 has seen a re-examination of systems and processes across the commodity trade finance space, particularly in relation to risk management and client due diligence.

For Citi clients, McWilliams says, there will be little change when it comes to the bank’s solutions and scope, but more time will be taken for due diligence. “We are looking a little closer [than usual], but the areas [we fund] and the conversations we have with clients haven’t changed,” she says. “Our product suite certainly hasn’t changed – we are offering the same products and will continue to do so.”

At ABN AMRO Bank, Nydhal Elmahfoudhi, Team Head – Energy and Metals Commodities – EMEA, says governance has become more of a focus – both internally and externally. “We conduct client audits, rating them on their risk management systems and so on,” he says. “But these kinds of checks are becoming [even more] important.”

Elmahfoudhi adds that banks will use more third-party services from now on. “I think over the years we relied too much on clients’ input, for example relating to collateral for inventory finance,” he says. “There is a growing trend today to rely more on third parties.”

He also believes technology could play a greater role here by enabling banks to constantly monitor inventories remotely, for example. “New systems today are more efficient and can be plugged into banks’ risk management systems to send signals about inventories and so on. This frees people’s time to do more “added-value” work. Banks need these processes, but much of what we do today could be done by technology in the future,” Elmahfoudhi says.

However, maintaining the high levels of expertise among commodity trade finance teams will remain a key concern as participants reorient themselves in the wake of the recent commodity market exits or restructurings at many banks.

McWilliams warns that a strong commodity trade finance offering is based on lenders’ in-depth understanding of the markets in which they are operating. “Both parties need to be aware of the nuances that exist within the industry and how the bank’s products should be structured and monitored – and it’s incumbent upon both the bank and the trader to have transparency of communication.”

As such, while banks such as Citi will continue to develop their digital offerings to clients, its commodity talent needs will not change. “We will continue to look for the kind of talent that suits the client-facing work that we do, that includes individuals that bring industry expertise and an ability to deliver a high-quality service,” she says.

Indeed, as banks remain on high alert for suspicious activity, ABN AMRO’s Elmahfoudhi says the ability to detect early warning signals about fraudulent behaviour is based on “an understanding of the flows it is financing”. Emphasizing the importance of human analysis in this respect, he adds: “Procedures are something that come with banking, but this understanding is powered by people’s knowledge of the commodity markets.”

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